How Can I Fund a Roth IRA If My Income Is Too High?

High earners can make indirect contributions via a backdoor Roth

High earners who exceed annual income limits set by the Internal Revenue Service (IRS) can’t make direct contributions to a Roth individual retirement account (Roth IRA). The good news is that there’s a loophole to get around the limit and reap the tax benefits that Roth IRAs offer. This strategy, known as a backdoor Roth IRA, allows those with high incomes to make indirect contributions.

Key Takeaways

  • High earners may not be able to make direct contributions to a Roth individual retirement account (Roth IRA) due to income limits set by the Internal Revenue Service (IRS).
  • A loophole, known as the backdoor Roth IRA, provides a way to get around the limits.
  • In a backdoor Roth IRA, a person makes a nondeductible contribution to a traditional IRA, then converts that account to a Roth IRA.
  • Tax implications will come into play in determining whether this strategy is worthwhile for you.

How Can I Fund A Roth IRA If My Income Is Too High To Make Direct Contributions?

Roth IRA Income Limits

Roth IRAs provide unique tax advantages for retirement savers. The money contributed to the account is taxed in that year. But when the account owner withdraws the money in retirement, no further taxes are due on either the money contributed or the growth achieved.

But those with modified adjusted gross incomes (MAGIs) above certain levels are limited in the amounts that they can contribute, or banned from Roth ownership altogether. The income limits are updated annually.

For tax year 2022, single and head of household filers with MAGIs of $129,000 to $144,000 can contribute limited amounts. For married couples filing jointly, the income phaseout range is $204,000 to $214,000. For 2021, income limits were $125,000 to $140,000 for single and head of household for 2021, and $198,000 to $208,000 for married filing jointly.

Taxpayers with incomes above those top numbers cannot contribute at all to a Roth. However, all is not lost for those who exceed the limit.

The Backdoor Roth IRA Strategy

The removal of a $100,000 MAGI limit for Roth conversions in 2010 created a loophole in the tax code that allows high-income filers to legally make indirect contributions to Roth accounts using the backdoor Roth IRA strategy.

A backdoor Roth IRA is not a type of retirement account, but rather a strategy to convert funds in a traditional IRA or 401(k) to a Roth IRA.

To use the backdoor Roth IRA strategy, you’ll need to take the following steps:

  1. Open a traditional IRA with your IRA custodian of choice. It is usually easiest, but not necessary, to use the same custodian that holds your Roth conversion IRA or where you plan to open your Roth.
  2. Make a fully non-deductible contribution to your traditional IRA. The contribution limit for 2021 and 2022 is $6,000, plus an additional $1,000 catch-up contribution for those ages 50 and older. That means not reporting your traditional IRA contribution as a deduction for MAGI on your Form 1040, even if you otherwise might be eligible to deduct it.
  3. Next, convert the traditional IRA balance into a Roth IRA. Because the MAGI threshold for contributions does not apply to conversions, the income limitation does not apply.
  4. Repeat this process every year that your MAGI is too high to allow you to make a direct contribution to your Roth IRA.

Tax Scenarios and Other Considerations

The backdoor strategy works best if you don’t already have a traditional IRA, because it will leave you owing no taxes on your contribution. If you do have a traditional IRA that you have funded with deductible contributions, however, the tax benefit will be reduced, and computing your taxes becomes more complicated.

Understanding this takes time, but it’s worth paying attention to the following three situations or discussing them with your tax advisor:

Example 1: You Owe Zero Taxes

You are 40 years old and make $200,000 a year. You open a new IRA and make a nondeductible $6,000 contribution. You then convert this account with the $6,000 to a Roth IRA. You have no other traditional IRAs. Your tax bill for the conversion is zero because you did not deduct your contribution.

Example 2: You Owe Taxes on All Previous IRA Balances

Your actions and circumstances are identical to the first situation, except that you also have a traditional IRA rollover account that was funded entirely with deductible contributions. You got a tax deduction when you made these contributions.

If you try to convert the entire amount that you have in IRAs—both your $6,000 nondeductible contribution and the rest of your IRA balance—you will have a tax bill. How much you owe depends on how large that rollover IRA is, and your current income.

This is because under the pro rata rule, all of your IRAs are treated as one communal IRA. The amount of your Roth IRA conversion that is taxable is proportional over your total IRA balance.

Figuring the Tax Bill

If the IRA is worth $49,500, $5,352 of your $6,000 would be taxable:

  • Nondeductible contribution to traditional IRA = $6,000
  • IRA rollover balance = $49,500
  • Total of contribution plus IRA balance = $55,500 ($6,000 + $49,500)
  • $6,000 / $55,500 = 0.108 = 10.8%. This is the percentage of your conversion that will be nontaxable.
  • $6,000 × 10.8% = $648 nontaxable conversion balance
  • $6,000 – $648 = $5,352 taxable conversion balance
  • Only the $648 will be subtracted from the total contribution as nontaxable

If the IRA is worth $3,000, only $1,980 would be taxable:

  • Nondeductible contribution to traditional IRA = $6,000
  • IRA rollover balance = $3,000
  • Total of contribution plus IRA balance = $9,000 ($6,000 + $3,000)
  • $6,000 / $9,000 = 0.666 = 67%
  • $6,000 × 67% = $4,020 nontaxable conversion balance
  • $6,000 – $4,020 = $1,980 taxable conversion balance
  • $4,020 will be subtracted from the total contribution as nontaxable

If you have one or more IRAs that you funded with deductible contributions, even the backdoor strategy cannot keep you from owing taxes on a Roth conversion. You can’t open a second IRA and roll over only that second account and owe no taxes.

The Roth IRA will have just the $6,000 in it. Your other IRAs won’t be folded into it; they’ll just be included in the government’s tax calculations. The tax bill will be assessed regardless of whether a new or existing account is used.

Example 3: You Owe Taxes on Some IRA Balances

This is a more complex circumstance, but the math is fairly straightforward. Under the pro rata rule, IRA conversions are taxed in proportion to the amount of taxable contributions across all of your IRA balances.

Imagine you are the same age with the same income as in the previous examples. You could have several IRAs that were funded partly with deductible contributions and partly with nondeductible contributions. For the sake of simplicity, though, imagine you have just two traditional IRAs, one funded each way:

  • IRA 1 ($60,000): Funded only with deductible contributions
  • IRA 2 ($34,000): Funded only with nondeductible contributions

You open a third traditional IRA with a $6,000 nondeductible contribution and convert that balance to a Roth IRA. The taxable proportion of your contribution is equal to the percentage of taxable contributions across all of your IRAs. Since 60% of your IRA balances were funded with pretax (deductible) contributions and 40% with after-tax (nondeductible) contributions, 60% of your conversion will be taxable.

For a $6,000 conversion, this means that $3,600 will be classified as income for the year of conversion. Depending on your annual income, that may move you to a higher tax bracket.

House Democrats proposed legislation in 2021—known as the Build Back Better infrastructure bill—that would restrict Roth IRA conversions from higher-income individuals starting in 2022. However, the bill was rejected by the Senate and a the slimed down version of the bill was signed into law in August 2022—the Inflation Reduction Act of 2022—which did not include conversion restrictions.

The Backdoor Strategy and Qualified Retirement Plans

If you or your spouse participates in a traditional qualified retirement plan at work that accepts rollovers of pretax (deductible) IRA balances, then you have another avenue with which you can avoid tax when you use the backdoor strategy to fund a Roth. Here’s how:

Roll over all your deductible IRAs into a traditional 401(k) at work before starting the conversion process. Then, open a new IRA with a $6,000 nondeductible contribution and convert that amount into a Roth IRA. Your tax bill will be zero because the government doesn’t include qualified-plan balances in calculating the tax on a backdoor Roth conversion. However, not all 401(k) plans offer this benefit.

Contribute to a Roth 401(k) If You Can

The backdoor strategy is unnecessary if your employer offers a Roth 401(k), and you are not making the maximum possible contribution. Roth 401(k) plans let you contribute up to $19,500 in 2021 and $20,500 in 2022 in after-tax dollars that you can collect tax free when you retire.

If you have only contributed $5,000 to your Roth account in the plan, then it would be simplest to contribute the remaining $14,500 in 2020 before opening a backdoor IRA. If you are 50 or older, you can contribute an additional $6,000 to a Roth 401(k).

One possible exception to this rule could be if you are unhappy with the investment choices that are offered inside the plan and wish to explore alternative options elsewhere.

Are Backdoor Roth Individual Retirement Accounts Allowed in 2022?

Yes. The backdoor Roth individual retirement account (backdoor Roth IRA) strategy is still currently viable. H.R. 5376, the Build Back Better infrastructure bill proposed in 2021, included provisions that would have reduced some benefits of Roth IRA conversions for all taxpayers starting in 2022. The bill was ultimately rejected by the Senate—and no proposed legislation includes limits on Roth conversion as of August 2022.

Is a Backdoor Roth IRA Worth It?

It really depends on your individual circumstances. Most people won’t make more in retirement than while working, though, so their tax rate in retirement likely will be lower than while working. As a result, doing a Roth IRA conversion is probably not worth it for most people.

What Is a Backdoor Roth IRA?

In a backdoor Roth IRA, a person makes a nondeductible contribution to a traditional IRA, then converts that account to a Roth IRA. This allows high income earners to get around the income limits on contributing to Roth IRAs.

The Bottom Line

High earners can circumvent contribution limits to Roth IRAs by using the backdoor strategy. You save the most if you do not have preexisting traditional IRA balances that must be factored into your tax bill or if your employer’s qualified plan allows rollovers of deductible IRA balances.

Article Sources
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  1. Internal Revenue Service. “Amount of Roth IRA Contributions That You Can Make for 2021.”

  2. Internal Revenue Service. “IRS Announces 401(k) Limit Increases to $20,500.”

  3. Internal Revenue Service. “2010 IRS Nationwide Tax Forum: Roth Conversions/Retirement Planning for Life Events.”

  4. “H.R.5376 - Inflation Reduction Act of 2022."

  5. "All Information (Except Text) for H.R.5376 - Inflation Reduction Act of 2022."

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