What it means
Roth accounts are attractive because the money grows and comes out tax free, and there are no forced withdrawals during the original owner's lifetime. Direct contributions are blocked above an income threshold, which is precisely the group most interested in tax-free growth.
The workaround relies on a gap in the rules: contributions to a traditional IRA are open to anyone with earned income, and conversions from traditional to Roth have had no income limit since 2010. So the saver contributes non-deductible money, then converts it, and pays tax only on any growth between the two steps.
The trap is the pro-rata rule. For tax purposes all of a person's traditional, SEP and SIMPLE IRAs are treated as one pot at year end, so if most of that pot is pre-tax money, most of any conversion is taxable no matter which dollars you think you moved.
The usual escape route is to roll existing pre-tax IRA balances into a current employer's 401(k) plan before the year ends, because workplace plan balances are excluded from the pro-rata calculation. That single step often turns a heavily taxed conversion into an almost tax-free one.
Two practical points round it out. Conversions can no longer be undone, so a mistake is permanent, and each conversion starts its own five-year clock before the converted amount can be withdrawn penalty free before age 59 and a half.
In practice
Real-world examples.
Example
A 38-year-old surgeon with no existing IRA balances contributes $7,000 to a traditional IRA in January and converts it to a Roth a week later. Because the account held nothing else and earned only $4 of interest, the conversion is effectively tax free.
Example
A married couple both contribute $7,000 each to traditional IRAs and convert, giving $14,000 of new Roth money in one year. Each spouse's pro-rata calculation is done separately, so the husband's old $50,000 rollover IRA does not taint the wife's conversion.
Example
A start-up founder rolls a $180,000 rollover IRA into her new employer's 401(k) in October, leaving her IRA empty. She then makes a $7,000 non-deductible contribution in November and converts it in December with no taxable income arising.
Formula
Calculation
Taxable portion of a conversion = amount converted x (pre-tax IRA balance / total IRA balance at year end)
A consultant earns too much to contribute to a Roth directly, so she puts $7,000 of after-tax money into a traditional IRA. She already holds $63,000 of pre-tax money in a rollover IRA from an old job, so her total IRA balance is $63,000 + $7,000 = $70,000.
The pre-tax share is $63,000 / $70,000 = 90%. Converting the $7,000 therefore produces taxable income of $7,000 x 90% = $6,300, with only $700 treated as a tax-free return of her after-tax contribution. At a 24% marginal rate the tax due is $6,300 x 24% = $1,512.
Had she first rolled the $63,000 into her employer's 401(k), her year-end IRA balance would have been $7,000, all of it after-tax. The taxable portion would then be $7,000 x 0% = $0, and the conversion would have cost nothing in tax.Case study
Seen in the real world.
Priya Raman is an invented character in this illustrative scenario, a fictional marketing director at a mid-sized firm. She had heard about the backdoor Roth from a colleague, contributed $7,000 to a traditional IRA and converted it the next day, expecting no tax at all.
What she had forgotten was a $93,000 rollover IRA left over from a job three employers ago. At year end her total IRA balance was $100,000, of which $93,000 was pre-tax, so 93% of her $7,000 conversion, or $6,510, was taxable and cost her $1,562 at a 24% rate.
The following year she asked her plan administrator to accept the old rollover balance into her current 401(k), which took six weeks. With her IRA emptied of pre-tax money, her next $7,000 conversion was fully tax free. The illustrative lesson is that in a backdoor Roth the order of operations matters more than the contribution itself.
Watch out
Common mistakes.
- Ignoring old rollover IRAs when calculating the tax. The pro-rata rule aggregates every traditional, SEP and SIMPLE IRA you hold on 31 December, not just the one you contributed to.
- Claiming a deduction for the traditional IRA contribution. The whole point is that the contribution is non-deductible, and taking a deduction turns the conversion into a fully taxable event.
- Leaving the money in cash for months before converting. Any investment growth in the traditional IRA before conversion is taxable, so most people convert within days.
Questions
People also ask.
Does a spouse's IRA balance affect my calculation?
No, the pro-rata rule is applied per individual, so each spouse's own IRA balances are the only ones that count.
Is this the same as a mega backdoor Roth?
No, the mega version routes after-tax contributions through a workplace 401(k) plan and allows far larger amounts, but it requires the plan to permit after-tax contributions and in-plan conversions.
Do I need to file anything special?
Yes, the non-deductible contribution and the conversion are both reported on the relevant IRA tax form, and failing to file it means losing the record of your after-tax basis.
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