Psst! Is this Backdoor Roth Legal?

Backdoor Roth IRAs in a Nutshell

When you hear something is done in the background, it can sound a little shady. A backroom deal is one that was brokered in secret and may be illegal or dishonest to reach an agreement. A back alley is an unsavory place where a fight or a drug deal happens. Is it any wonder when we hear the term “backdoor Roth” that it makes us think twice about the legality of such an arrangement? No one wants to run afoul of the long arm of the IRS when it comes to filing taxes correctly. So with that in mind, let’s explore what a backdoor Roth IRA is and see if it is on the up and up.

Basic Limits on Roth IRAs

If you are a high income earner, the IRS disallows some forms of retirement investment. I’ll skirt the discussion about why disincentivizing retirement saving is a bad idea and instead I’ll stick to the facts. In 2025, just as in 2024, you lose the ability to contribute directly to a Roth IRA if you file singly and make more than $150,000 for the year or you are married filing jointly and make over $236,000 per year. Beyond those income thresholds the ability to contribute is decreased and then eliminated completely. That’s an unfortunate part of the IRS tax code because Roth IRA contributions grow tax free which is more advantageous in retirement than having to pay taxes on Traditional IRA withdrawals.

But wait! There is a loophole in the tax code. It sounds too good to be true, and that phrase should set off alarm bells in your head. If it sounds too good to be true, it probably is. In this case – and feel free to fact check me – this loophole is a fairly easy way for high income earners to still get tax-free growth for life from their IRA contributions. The approach is called a “backdoor Roth IRA” and despite the shady sounding name, it is completely legal.

Who Should Consider a Backdoor Roth IRA?

If you are earning more than the Roth IRA income limits listed above but you still want your money to grow tax free, the backdoor Roth should be something you strongly consider. It is not a complicated process, but you do have to have your ducks in a row to get the maximum benefit from a backdoor Roth.

Standard IRA Contributions

For those unfamiliar with IRAs, let’s quickly walk through how IRA contributions work. An IRA account has a maximum amount you can contribute each year. In 2025 as in 2024, you can contribute $7,000/year into an IRA. If you are over 50 years old or turn 50 this year, your contribution limit rises to $8,000/year because you get to take advantage of a $1,000/year catchup contribution. That $7,000 or $8,000/year is a total per person, so if you are a married couple, you and your spouse can each contribute $7,000 (or $8,000 if you are over 50) into your own IRA account as long as you have a household income over that covers the contribution amount. If only one spouse works, but makes more than $14,000 in income, both IRAs can be fully funded.

Contributing an IRA account – Roth or traditional – is a simple process. You can have pre-tax money deposited directly into a traditional IRA or post-tax money deposited into a Roth IRA. Simply set up a transfer to the IRA account, decide how to invest the money within the account and you are done. The backdoor Roth takes a few extra steps, but it is well worth the effort.

How a Backdoor Roth IRA Works

For individuals whose income puts them over the Roth IRA contribution limits, the backdoor Roth is the way to go. Here are the steps to follow:

First, if you don’t already have a traditional IRA account and a Roth IRA account, open one of each. You can do this at the broker of your choice. Fidelity, Charles Schwab, and Vanguard are just three of many options available on the market. For ease of managing the accounts, I recommend using one broker for both the Traditional IRA and Roth IRA account. When you have your two IRA accounts open, make a contribution to your traditional IRA account. You can contribute the maximum for the year ($7,000 for most people as detailed above) in one transfer or you can make multiple contributions over the course of the year. The amount doesn’t matter, but as you will see later, timing does matter.

After your traditional IRA contribution is made, you can perform a Roth conversion on that money. Most brokerage services allow you to do this Roth conversion by completing a form online. You tell them how much money to convert, and those funds will be moved from your traditional IRA account to your Roth IRA account. Any time you perform a Roth conversion, you need to be aware of two things. First, because you are moving from a pre-tax account to a post-tax account, you have to pay the taxes on any gains at the time of the Roth conversion. You need to make sure you have money to cover taxes on those gains. Second, you cannot undo this conversion.

This is where timing is your ally. When you make your traditional IRA contribution, do not invest that money, just leave it in a cash position. Why? By leaving it in cash, the chance that you will have gains on your money is very low. You may make a tiny bit of interest, but that is why the timing is important. It is best to perform the Roth conversion a day or two after your funds hit your traditional IRA account. By performing the conversion immediately after the contribution is made, you should have no gains on the money – thus no taxes due. If you let that money sit and potentially grow in your traditional IRA in an investment rather than in cash, when you do the conversion, you’ll need to pay taxes on the money you have earned. It is wise to do that conversion immediately, invest the money once it is in your Roth account, and let that investment grow 100% tax free.

Limits and Considerations

As of this writing (January 2025), the IRA has not set any limitations on the number of Roth conversions you can perform. If you contribute $1,000 a month for seven months to fully fund your IRA, you could contribute monthly from January through July and perform a Roth conversion after each contribution. Seven contributions, and seven conversions of $1,000 each will max out your Roth contribution for the year. You could also make one contribution to max out your traditional IRA at $7,000, then do one Roth conversion and be done for the year. If you are able to do so, that allows that money to grow tax free for a longer period of time.

As with any retirement contributions, be sure to keep records of traditional IRA contributions and your Roth conversions. You’ll want to have these at tax time to have a clean paper trail of your Roth conversion to show that you did a backdoor Roth conversion, not a Roth contribution. As silly as it may seem, you cannot contribute directly to a Roth if you exceed the income limits, but anyone can use the backdoor Roth conversion to move money into a Roth IRA.

Keys to Roth Conversions

For you high earners to get the most out of your Roth IRA conversion, make sure you follow the best practices:

1. Contribute only into your traditional IRA account, never directly to your Roth IRA.
2. Make sure your traditional IRA contribution goes to cash, not into an investment. This will limit or eliminate taxes you need to pay on any gains.
3. Perform the Roth conversion as soon as you see the money in your traditional IRA account. Once again, this limits or eliminates any possible gains where you would owe taxes at the time of the conversion.

Window of Opportunity

One final note on the Roth IRA and IRA contributions in general. You have until April 15 (or the IRA tax filing deadline each year) to contribute to your IRA for the previous year. That means that even if you don’t have an IRA account today, you have time to open your traditional and Roth accounts and follow the backdoor Roth process described in this article. With IRA contributions limited each year, this is a golden opportunity to “double fund” your retirement within this window, making contributions for 2024 and 2025. I urge anyone who is able to take advantage of this opportunity to save for your retirement.

This article is designed to help you maximize your retirement investing. If you have resolved to make progress on your financial goals this year, start the process with a financial checkup. Schedule a free no-obligation consultation to see where you are on the financial roadmap and build a plan for a better future for you and your family.