The backdoor Roth IRA: Is this the greatest investment plan ever?

By Naveed Saleh, MD, MS | Fact-checked by Barbara Bekiesz
Published June 6, 2022

Key Takeaways

  • The backdoor Roth IRA has become increasingly popular among physicians and other high earners.

  • Traditional IRAs and Roth IRAs mainly differ on who can qualify based on income. Income restrictions are placed on the Roth. Converting a traditional IRA to a Roth IRA offers certain tax advantages to the investor.

  • Backdoor Roth IRAs can get tricky. In these cases, it’s probably best to enlist the help of a professional.

A higher income typically opens the door to more investment opportunities. There is, however, one notable exception: the Roth IRA.

The Roth individual retirement account (IRA) is typically unavailable to most higher-income earners (such as physicians) due to inflexible income caps for contributors.

One workaround has become popular among financial advisors and other investment gurus in recent years: the backdoor Roth.

To do this, the investor first opens a traditional IRA, makes a desired contribution, and later converts the traditional IRA to a Roth IRA.[] But before we delve into this game changer, let’s compare traditional and Roth IRAs.

Traditional vs Roth IRA

Both of these investments permit the investor to save for retirement, but they differ in key ways. For an exhaustive description, go to the IRS website.[] Here are the highlights.

Income. Individuals with taxable income can contribute. Although there are no income restrictions on traditional IRAs, for the Roth IRA, those who are married and filing jointly or qualifying widowers must earn less than $204,000. If single, this requirement drops to $129,000.

Contributions. The most you can contribute to these accounts in 2022 is $6,000 (traditional) and $7,000 (Roth) if aged 50 years or older.

Minimum distributions. You must start taking minimum distributions from a traditional IRA during the year after you turn 72, whereas you don’t have to take minimum distributions with a Roth IRA. Distributions from a Roth IRA aren’t taxable, but those from a traditional IRA are.

Transferring to Roth IRA

In 2010, Congress passed legislation that permitted converting from traditional to Roth IRAs, allowing for more flexibility.

First, open a non-deductible traditional IRA and make after-tax contributions of up to $6,000 ($7,000 if age 50 or older). Every year that this is done, you must file the IRS Form 8606.

Second, transfer the assets from the traditional to the Roth IRA. Although you can convert the IRA at any point, some financial advisors recommend waiting a few months.

Remember that when converting to a backdoor Roth, you must pay taxes on whatever money you transfer from a traditional to a Roth IRA in that tax year, as well as any earnings and appreciation.[]

For those who don’t have any other IRAs, calculating the tax that's due on the conversion is straightforward. Things get tricky, however, if you have other IRAs. In these cases, it’s probably a good idea to leave things to your accountant.

The IRS pro-rata rule necessitates all traditional IRA assets be used when calculating the conversion’s taxes. These include those funded with pre-tax (deductible) and after-tax (nondeductible) contributions. You then pay a proportional sum of taxes on the original account’s pretax contributions and earnings.

Alternate methods

There are two other ways to create a backdoor Roth IRA.

One is to convert an entire IRA to a Roth IRA. 

The other involves rolling over your 401(k) into a Roth IRA. This tactic works only if the 401(k) you participate in allows conversions. Pre-tax deferrals and earnings must be considered with this type of rollover.

Looking forward

The backdoor Roth IRA is legally permitted under current US law. The IRS, however, may change its tune on this investment.

The Build Back Better Infrastructure Bill has provisions that limit some Roth IRA conversions. This law is currently stalled in the US Senate.

Tax considerations

If you think your taxes will rise or your tax bracket will increase upon retirement, it’s probably a better idea to pay taxes up front on investments such as a Roth IRA.

One issue to keep in mind when converting a sizable IRA or 401(k) is tax implications; you’ll have to pay taxes on any money converted, and this could be substantial. In such cases, it’s probably a good idea to confer with tax and investment professionals.

What this means for you

A backdoor Roth IRA is an attractive option for many higher-income investors (such as physicians), as it has no required minimum distributions and its distributions are tax-free. But be mindful of the potential tax implications for switching from a traditional to a Roth IRA. It may be beneficial to speak with investment and tax professionals before taking the leap of converting your investments along these lines.

Related: 5 improvements doctors can make to their financial portfolios
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