Is a Roth conversion the same as a backdoor Roth?

Maybe. A backdoor Roth is a tax-free Roth conversion executed under certain circumstances. All backdoor Roth’s are considered Roth conversions but not all Roth conversions are considered backdoor Roths. A backdoor Roth conversion is typically executed to help reduce lifetime taxes by reducing taxes on investment growth. 

Tennis analogy

To make sense of this let’s use a tennis analogy. Tennis consists of hitting a tennis ball into the opposite court. But how the action of hitting a tennis ball is described depends on the circumstances surrounding it. If you are casually hitting with a friend, it’s called “practicing.” If you are playing a match, you call it a “competition.” And if you are a professional, hitting a tennis ball is called “work.” The same action of hitting a tennis ball takes on a different name depending on the circumstances around it. In the same manner, a Roth conversion is called by different names depending on the circumstance. A “backdoor Roth” is the name for a Roth conversion under specific circumstances.

What is a Roth conversion?

A Roth conversion is when you take money from a pre-tax retirement account and move it into a Roth (after-tax) retirement account. For example, moving money from a traditional IRA to a Roth IRA is a Roth conversion. Generally, the US tax code allows retirement plan owners to do this, but they will usually have to pay taxes on the amount of money moved into the Roth account. There are many rules and penalties to watch out for when considering Roth conversions, make sure you speak with your tax advisor before attempting this.

What is a backdoor Roth IRA conversion?

A “backdoor Roth,” also known as a backdoor Roth IRA contribution, is when an individual cannot directly contribute to a Roth IRA, so they execute a tax-free Roth conversion to get money into a Roth IRA. I know, I said earlier Roth conversions are taxable, but there are some circumstances when they are not taxable. Going through the steps will highlight why backdoor Roth’s are a tax-free Roth conversion.

The steps for a backdoor Roth IRA conversion:

  1. You have income from employment or self-employment during the year.
  2. Your income (defined as modified AGI by the IRS) is too high and you are not allowed to make a contribution to a Roth IRA.
    1. See this handy chart by the IRS to determine if your income limits your Roth IRA contributions for 2022.
    2. If you’re single and have over $144,000 of employment income, you may not be able to make Roth IRA contributions.
      If you’re married and your combined employment income is over $214,000, you may not be able to make Roth contributions.
  3. Since you can’t contribute to a Roth IRA, you make a non-deductible contribution to a traditional IRA.
    1. A non-deductible IRA contribution is money placed into a traditional IRA that receives some but not all of the tax benefits associated with putting money into a traditional IRA. Non-deductible IRA contributions do NOT lower your taxes in the year you make the contribution, but the growth of the money is not subject to taxes until the funds are withdrawn from the IRA. A non-deductible IRA contribution is sometimes called an after-tax IRA contribution.
    2. If you have income from employment and/or self-employment, contributions to a traditional IRA are usually allowed. However, some of the tax benefits of the contributions are tied to income limits.
    3. The rules are complicated for whether you are allowed to get a tax deduction for traditional IRA contributions.
  4. You wait for a certain time period, and then convert the non-deductible portion of the IRA to a Roth IRA. If done under certain circumstances, this will be a tax-free conversion! A tax-free Roth conversion is very similar to making a contribution to your Roth IRA, which is why it receives the name “backdoor Roth.” Ideally, there will be little to no tax owed for the Roth conversion. Since the non-deductible portion is after-tax money, no taxes are owed on this. Only the growth will be taxed. However, nothing related to taxes is ever easy, and there is another complication, the pro-rata rule.

The IRA pro-rata rule explained

One of the sneakier rules that trips up a lot of people when they try to do backdoor Roth conversions is the IRA pro-rata rule. This IRS rule requires owners to think of all their IRA accounts as one account. So even though you may have two separate IRA accounts, even at different custodians (one at Schwab, one at Fidelity, etc.), the IRS makes you look at them as if all your IRA money is in one account. Please note this doesn’t apply to spousal accounts in this situation. Anytime you take money out of an IRA, including for Roth conversions, the IRS requires you to do a special calculation to determine how much of the IRA withdrawal will be with pre-tax dollars and after-tax dollars. The after-tax dollars are the non-deductible IRA contributions. If you have pre-tax money in traditional IRAs, then the Roth conversion to get money into your Roth IRA will be likely be partially taxable. The Roth conversion will likely be partially taxable regardless of which IRA account you pull the money from into your Roth IRA. 

Are Roth conversions subject to the 10% penalty for early distributions from IRAs?

Generally, withdrawals from pre-tax IRA accounts are subject to a 10% penalty if withdrawals are made before the IRA owner is 59 1/2 years old. There are exemptions from this. Roth conversions are not subject to the 10% early distribution penalty from IRAs, because they are technically not classified as an IRA withdrawal. However, any money withdrawn from an IRA that is used to pay taxes on a Roth conversion would be subject to the 10% early withdrawal penalty if the account owner is under age 59 1/2, and doesn’t qualify for an exemption. In most cases, it makes sense to pay any taxes due on Roth conversions from money that is outside a retirement account, such as bank account.

Successfully executing backdoor Roth conversions can reduce lifetime taxes. However, Roth conversions are complicated tax planning techniques that should not be attempted before speaking with your tax advisor.


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