How to Build Roth Dollars With a High Income

April 17, 2023

If you are above the income limit to contribute to a Roth IRA, you’ve probably at least heard of something called a backdoor Roth IRA contribution. Depending on how immersed you are in the world of finance, and how comfortable you are DIY-ing, you may be hesitant to do a backdoor Roth yourself – or you may already be using the strategy. “Backdoor” makes it sound unapproachable and shady, but in reality the process can be pretty simple if you make sure to measure twice (or thrice) and cut once.

Can I make a backdoor Roth IRA contribution?

How do you know if you can or even need to make a backdoor Roth contribution? The first step is knowing the Roth income phaseouts. For 2023, they are $138,000 to $153,000 for single tax filers and $218,000 to $228,000 for married couples filing jointly. If you know you are going to be below the income limits next year, that’s great! You can just contribute to a Roth IRA normally and don’t need to worry about backdoor Roth contributions.

If you aren’t sure whether or not income limits will affect your ability to max out your Roth IRA, you have a few different options. The first, and what many people in this situation do, is wait to contribute until they are sure they will be under the limit (you have until April 15th of the following year to max out your Roth IRA). But you don’t need to wait; if you are able to use the backdoor Roth strategy, you can max out earlier in the year, regardless of whether you end up below or above the income phaseout.

If you know you will be above the income limit to contribute, you will need to use the backdoor Roth conversion strategy to build Roth IRA dollars. If you have pre-tax IRAs, SEP IRAs, or SIMPLE IRAs, this strategy may not work for you. This is due to the pro-rata rule, which could cause a portion of your pre-tax IRA assets to become taxable when converting assets to a Roth IRA.

If you have pre-tax IRA assets but still want to build Roth IRA dollars, it could be worth considering rolling pre-tax IRA dollars into an employer-sponsored plan, such as a 401(k). 401(k) assets are not factored into pro-rata calculations, so this would allow you to proceed with the Roth conversion. However, make sure you know the pros and cons of both holding those pre-tax dollars in an IRA and moving them to your employer plan before you consider rolling any assets over. Employer-sponsored plans have some ERISA protections that IRAs do not, but investment options may be more limited and expensive.

How do I do it?

To recap, if you are considering making a backdoor Roth contribution, you:

  • Are above the income phaseout or might be above the income phaseout.
  • Have no pre-tax IRA assets that would cause you to fall victim to the pro-rata rule.

There are no income limits on non-deductible IRA contributions, which is what makes the backdoor Roth possible. If you know you can make a backdoor Roth contribution, all you need to do is 1) Make a non-deductible IRA contribution, then 2) Convert those dollars to a Roth IRA. That’s it! There are several pitfalls to watch out for, though. Be careful investing non-deductible contributions, since non-deductible IRA earnings are taxable. Any growth that occurs before you convert the assets to a Roth IRA will be taxed. You will also want to be careful of transaction and account fees. Custodians may charge an account closing fee if you are not careful with the funding and conversion from the traditional IRA.

The transaction may confuse both your tax preparer and the IRS as they process your tax return. A requirement of this planning strategy is completing Form 8606, “Nondeductible IRAs,” with your annual federal tax return. It is not uncommon for tax preparers to complete the form inaccurately, which can lead to an unnecessary overpayment of taxes (erroneously reporting the conversion as income) and potential tax notices from the IRS.

What if I can’t do it?

If you are over the income limit and have pre-tax IRA assets that aren’t going anywhere, the backdoor Roth conversion strategy may not work for you. Even if you can’t build Roth IRA dollars, you can still build tax-free retirement dollars. There’s no income limit for making Roth 401(k) contributions or HSA contributions. If your employer offers a Roth option in your employer-sponsored plan, you can build more Roth dollars (up to $22,500 in a 401(k) in 2023, not including the catch-up for those 50+, and even more if your employer plan allows for mega backdoor Roth conversions).

HSAs don’t have an income limit, although you do need to be enrolled in a high-deductible health plan (HDHP) in order to make contributions. You may be able to make contributions through an employer plan, if they have one, or you may need to open your own HSA. Contributing through an employer plan is preferable since you will receive an additional FICA tax break on contributions. For 2023, HSA contribution limits are $3,850 for individuals and $7,750 for families (and a $1,000 additional catch-up contribution for those 55 and older).

I need some help!

Not everyone is confident in their ability to execute more advanced financial strategies on their own, and that’s okay! Backdoor Roth conversions can have unintended tax consequences if something goes wrong, so enlisting the services of a professional may give you additional peace of mind. Helping with backdoor Roth contributions is just one of the many things a fee-only financial advisor can do for you. Feel free to learn more about our advisory services or submit a “Work With Us” form if you are interested in taking the relationship to the next level.

Get Daniel’s newsletter in your inbox a week early by signing up for FYI by FTE.



Most Recent Episodes

The Best and Worst Types of Life Insurance!

No matter how much you know about finance, you’ve definitely heard about life insurance: maybe from commercials pitching it as something to buy your baby, or a family member or friend that got into the industry. Is life insurance worth getting or something you should...

How to Recover From 4 HORRIBLE Financial Mistakes!

In our nearly four decades of combined experience managing money, we’ve seen some horrible financial mistakes - here are the four worst we’ve seen first-hand and what you can do to avoid making a similar mistake. In this episode, you’ll learn: The worst financial...

New Data: Active Investments Are Better Than Index Funds?

A new research paper is out that claims active funds from two large providers, Vanguard and Fidelity, beat their own index funds. Are active funds beating index funds? What’s going on here? Let’s find out! For more information, check out our free resources...

Why Americans Are Actually Broke! (2023 Edition)

Americans might be bad with money, but you don’t have to be. In this episode, we discuss the underlying reason why Americans are so bad with money and how you can do it better. In this episode, you’ll learn: Common financial pitfalls you should avoid Practical steps...

Build Wealth With the 3 Bucket Strategy! (By Age) 2023 Edition

We believe there are three distinct taxable buckets you have the option of investing in for retirement. We’ll talk about how to balance those buckets by age and show a case study by age that shows what your buckets may look like! In this episode, you’ll learn: The...

Debt Ceiling Crisis: World’s Financial System at Risk?

Should you be worried about the debt ceiling crisis? Although political leaders have so far been unable to come to an agreement, we'll tell you what history says will happen and what it means for your finances. For more information, check out our free resources...

Financial Advisors React to INSANE Money Advice on TikTok!

Is financial advice on TikTok all bad or is there some good advice out there? Check out our brand new TikTok react show where Brian and Bo give their honest reactions to trending financial advice. Enjoy the Show? Sign up for the Financial Order of Operation (FOO)...

How to Save Thousands of Dollars in Taxes in 2024

Tax season is over for most of us, but that doesn’t mean it’s time to stop thinking about your taxes! Planning out your tax strategy in advance can save you time and money on your taxes. In this Q&A, we’ll discuss the line items on your return to pay attention to...

Average 401(k) Balance by Age (2023 Edition)

Are you doing better than the average American at saving in your 401(k)? We'll talk about basics of a 401(k), including new limits, employer matches, and vesting schedules, how many millionaires are created by 401(k)s, and of course the average 401(k) balance by age....