The ‘Backdoor Roth IRA Contribution’. Is it Right for You.

In my practice, a large group of folks that I work with are people who are in the middle or later years of their careers. Those who have worked hard for years and are starting to think about their retirement years and how to best get there successfully. Last week, I met with a very nice couple from Duxbury, I will call them Tom and Sarah. They are both age 55, been married for almost 30 years and have one son out of the house and one in his last year of college. Tom has worked as a software engineer for almost thirty years, while Sarah is an HR Director for a large realty company. They’re heading into those final 5-10 years before they retire and wanted to make sure they were taking advantage of every opportunity available to them as retirement looms on their horizon.

Tom and Sarah listen to Jen and my radio show religiously every Saturday.  Tom said he finally came to the conclusion from listening to it that it was time to build a retirement system as he begins transitioning from his accumulation to distributions years. As we discussed the building blocks of a sound retirement system, one of the areas of discussion was the need for them to take steps now to reduce their taxable income in retirement so they can keep more of what they save. 

They have done a great job over the years maxing out their company 401(k) plans, but this has resulted in the bulk of their retirement funds being held in pre-tax accounts. While this allows more of your money to go to work right away, the kicker here is that you will owe income taxes when you start taking the funds out in retirement. 

You see, the risk here is that you may have considerably less than you thought once taxes are deducted. Not only are you guessing what your actual tax rates will be years from now but the income from your retirement plan could also cause your Social Security benefits to be taxable as well. For these reasons, Tom and Sarah agreed to explore tax free options, and the Roth IRA in particular. The key benefit of a Roth IRA is that the money grows tax deferred and qualified distributions are tax free.

However, regular contributions to the Roth are limited by income. You can’t fund a Roth IRA if your modified adjusted gross income exceeds $140,000 in 2021 if your tax filing status is single, $208,000 for married couples who file jointly, and $10,000 for married filing separately. And Tom and Sarah, while they don’t consider themselves rich, don’t qualify because their income exceeds these limits. 

But this is where we can get creative. We can use what’s called the “Backdoor Roth IRA Contribution” in cases like this. This is a workaround that enables “high-income” savers to sidestep the income restriction. So how does it work? Let me share with you what I explained to them.

First, we want to put contribution in a traditional IRA. You might already have one, or you might need to open one and fund it. Next, convert the contribution IRA to a Roth IRA. Anyone can convert assets from a traditional IRA to a Roth IRA because there are no income limits for this. You will pay income taxes on any pre-tax amounts included in the conversion, as all contributions to Roth IRAs are post-tax dollars. If the traditional IRA contribution is the only amount in your traditional IRA (which includes all of your traditional SEP and SIMPLE IRAs in this case) and you do not claim a deduction for the traditional IRA contribution, the conversion would be tax-free. But, if you have pre-tax amounts and after-tax amounts in any traditional IRA, the conversion would be partially taxable. Taking this a step further, to make this strategy most effective, you should consider paying any taxes due from funds outside of the IRA; otherwise, you are starting off with a lower balance, and potentially a 10% federal penalty for using IRA funds to pay the taxes due at conversion. 

The process itself is fairly simple – so why don’t more people do this? Well, it’s not the right solution for everyone. For example, you can’t actually contribute more than $6,000 a year to a Roth IRA, or $7,000 annually if you’re 50 or older by the end of the year. That may be why some high earners aren’t interested.

However, some 401(k) plans allow after-tax contributions and immediate rollover of those after-tax amounts to a Roth IRA. These after-tax when added to other contributions to the 401(k) is capped at  $58,000 for 2021. This is known as a “mega backdoor Roth conversion.” This is the strategy that Tom and Sarah are considering for their own situation, as their retirement funds are primarily invested in their respective companies’ 401(k) plans.

As we talked through this option, I also advised them of a few key items. They should check with the plan administrator to make sure that this option is available and ensure the conversion is handled as a direct rollover to the Roth IRA. The direct rollover is designed to avoid the 60-day deadline which applies to indirect rollovers. 

Some experts suggest waiting at least 30 days to avoid penalties under the “step transaction doctrine.” Even if a series of steps are all permitted, the IRS can view the steps as one combined action based on the underlying intent and disallow that action. But some experts disagree and recommend that the conversion is done immediately so that any earnings occur in the Roth IRA where they would eventually become tax-free. These experts disagree and say there is no regulations or official guidance that says that the step transaction doctrine applies to IRAs.

You also want to make sure to leave the money in the Roth IRA for at least 5 years after your first Roth contribution or rollover/conversion, and until your age 59½ . If you don’t, you could owe income taxes and an additional 10% federal penalty on any withdrawals of earnings. 

The backdoor Roth is perfectly legitimate solution to funding your Roth IRA. It’s been a viable option for many since the income limits for Roth conversions were repealed in 2010. So for those of you who are “too rich” to fund a Roth IRA directly, this provides a viable option to add tax-free income to your retirement. Folks, it gets tricky out there so make sure to seek out a qualified retirement specialist and do yourself a favor and check it out.

And as always – be vigilant and stay alert, because you deserve more!

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. Insurance offered through its affiliate, CutterInsure, Inc. We do not offer tax or legal advice. Jeff can be reached at

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