This Roth IRA Secret Could Maximize Your Retirement Savings

If you thought your income precluded you from using a Roth IRA, think again.
Updated April 11, 2024
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Many financial experts tout the benefits of Roth IRAs — with these accounts, you pay taxes on your contributions now in exchange for tax-free withdrawals in retirement. Sounds like a good deal, right?

Roth IRAs come with income limits, however, so higher earners sometimes miss out on these advantages. There’s a workaround for this, though, and it’s completely legal. Here’s how to create a backdoor Roth IRA.

The difference between a Roth vs. traditional IRA

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Before we jump in, it’s important that we cover some basic differences between a Roth IRA versus traditional IRA.

With a Roth IRA, you contribute after-tax dollars, and your contributions grow tax-free. In other words, you pay taxes on your contributions now so that you don’t have to pay taxes on your withdrawals once you retire.

With a traditional IRA, on the other hand, you contribute with pre-tax dollars, and you do pay taxes on your withdrawals in retirement. Annual contributions to traditional IRA accounts might be tax deductible for certain income brackets, whereas contributions to Roth IRAs never have an upfront tax benefit.

Another key difference is who can make these contributions in the first place. Anyone, at any income level, can take advantage of traditional IRAs (though these contributions may not be tax deductible).

You have to earn below a certain amount to even contribute to a Roth IRA, however. Unless you use a backdoor Roth IRA, that is. Here’s how to do it.

Step 1: Calculate your MAGI

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The first step is to make sure your modified adjusted gross income (MAGI) is as high as you think it is. This is the number that determines if you’re eligible to contribute to a Roth IRA.

To calculate your MAGI, you’ll need your most recent tax returns. You’re going to find your adjusted gross income (AGI), then add back certain deductions to get your MAGI. To make this step easier, use this IRS worksheet.

Step 2: Check the Roth IRA income limits

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Next, see if your MAGI disqualifies you from contributing to a Roth IRA the regular way. These limits can change from year to year, so look for the most up-to-date information.

If you’re under the income cap, you don’t need to use the backdoor method. If your MAGI is above the current threshold, proceed to Step 3.

Step 3: Check the contribution limits

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At this point, you know that the backdoor method is the only way you can contribute to a Roth IRA. Before you go any further, though, you need to know this year’s IRA contribution limits. You can invest up to this amount — but not a penny more. You’ll need that information for Step 4.

Step 4: Figure out what you can contribute

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Now, it’s time to determine how much money you can contribute. If you can, try to max out your IRA contribution. Opening a backdoor Roth IRA is a multistep process, so to get the most value for your time (and your money), it’s in your best interest to invest as much as possible.

Step 5: Determine your brokerage of choice

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Prepared with a comfortable contribution amount, you now need to decide on a brokerage or investment platform to help you take care of the rest.

If you already know where you want to open your backdoor Roth IRA, proceed to Step 6. If you don’t yet have an investment company in mind, look through our list of the best brokerage accounts.

Step 6: Open and fund a traditional IRA

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This is where things get exciting. You’re only a few steps away from having your backdoor Roth IRA. In order to get there, you need to start by opening a traditional IRA. Contact your brokerage or visit their website to complete this step. You’ll likely need your ID to open your traditional IRA, so be sure to have it handy.

Step 7: Open your Roth IRA

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In the previous step, you opened and funded a traditional IRA. Now, you need to open a Roth IRA. (But don’t fund it yet! That’s coming up next.)

The process for creating a Roth IRA is very similar to that of a traditional IRA, but for a little extra help, use this guide to walk you through how to open a Roth IRA.

Step 8: Move your traditional IRA contributions to your Roth IRA

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As soon as you open your Roth IRA, you want to immediately roll over the contributions you made to your traditional IRA. You can shift your traditional IRA contributions to your Roth IRA online, over the phone, or with in-person help, depending on what you’re comfortable with and what your brokerage offers.

Once you’ve rolled over your contributions, pat yourself on the back. You are now the proud owner of a backdoor Roth IRA. As an added bonus and for maximum benefit, you can repeat these same steps every single year — as long as you haven’t already hit the annual Roth IRA contribution limits.

Mistakes to avoid when creating your backdoor Roth IRA

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First and foremost, you shouldn’t wait to convert your traditional IRA into a Roth IRA. If you leave your contributions in the traditional IRA account for too long, the investments may grow, which will result in a tax bill — and extra hassle — for you.

Additionally, you need to be aware of the pro rata rule. It’s a little tricky, but in simplest terms, this rule dictates how the IRS determines your tax liability when you have a combination of already-taxed and not-yet-taxed IRA contributions. If you don’t have any other IRA accounts besides your backdoor Roth IRA, you should be in good shape here. If you do, however, then the IRS may assess taxes on a portion of the amount rolled over into your backdoor Roth IRA. If you have both types of IRAs, you must take a percentage from each account when you take a distribution.

Another error you don’t want to make is neglecting to file Form 8606. This is the form the IRS uses to calculate your pro rata tax liability. Even if you don’t have other traditional IRA accounts, you have to file this form every year that you perform an IRA conversion, which includes the years you create a backdoor Roth IRA.

Bottom line

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Backdoor Roth IRAs are a useful strategy for people in higher income brackets. They can be complex, though, and they aren’t the kind of thing you want to figure out as you go. If you’re nervous about setting up your backdoor Roth IRA, work with a financial planner who knows how to save for retirement strategically. They can guide you through the process so you can maximize your savings.

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Author Details

Sarah Sheehan Sarah Sheehan is a writer, educator, and analyst who focuses on the impact of health, gender, and geography on financial equity. Her ultimate goal? To live beyond the confines of chasing the next dollar — and to teach everyone else how to do the same.

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