What is a backdoor Roth IRA?

Direct Roth IRA contributions phase out above income thresholds, but conversions from a traditional IRA have no income limit. The backdoor Roth exploits that asymmetry: contribute to a traditional IRA on a non-deductible basis, then convert those funds to a Roth. Because the contribution was made with after-tax dollars and there is minimal growth in between, the conversion generates little or no taxable income, and the money then grows tax-free in the Roth. The strategy has been widely used for years and Congress has been aware of it without closing it, though proposals to do so surface periodically.

The complication that catches people is the pro-rata rule. The IRS treats all your traditional, SEP, and SIMPLE IRAs as a single pool for conversion purposes, and each conversion is deemed to come proportionally from pre-tax and after-tax money across that entire pool. If you hold a large rollover IRA from a former 401(k), converting six thousand dollars does not convert your six thousand of after-tax money, it converts a proportional slice, and most of it becomes taxable. This surprises people who did the mechanics correctly and then received an unexpected tax bill.

The common workaround is rolling existing pre-tax IRA balances into a current employer's 401(k) if the plan accepts incoming rollovers, since 401(k) balances are excluded from the pro-rata calculation, leaving a clean slate for the conversion. Two further notes. Form 8606 must be filed to document the non-deductible contribution and the conversion, and failing to file it is the most common execution error, since it is what establishes your basis and prevents being taxed twice. And a separate strategy called the mega backdoor Roth uses after-tax contributions to a 401(k) with in-plan conversion, which permits far larger amounts but requires specific plan features many plans lack. Both are situations where a tax professional's review before executing costs less than the mistake.