If you are a high-income earner, your direct retirement contributions are limited by the Internal Revenue Service (IRS) when using traditional or Roth individual retirement accounts (IRAs). Using a strategy called a backdoor IRA offers a retirement savings option, regardless of your income level.
IRA Contribution Limits
As of 2024, the IRS increased contribution limits to $7,000 for individuals under age 50 and $8,000 for those over age 50. Taxpayers can also deduct contributions they make to an IRA as long as they meet requirements and their income is under the phaseout limits.
Traditional IRA
For single taxpayers covered by a workplace retirement account, the traditional IRA phaseout range is between $77,000 and $87,000. For married couples filing jointly, the phaseout is between $123,000 and $143,000. The IRS contribution limits will increase to between $79,000 and $89,000 for single filers in 2025 and $126,000 and $146,000 for married filers in 2025.
For married taxpayers not covered by a workplace retirement account but married to someone who is, the traditional IRA phaseout is $230,000 and $240,000 for married filers in 2024. This will increase to between $236,000 and $246,000 in 2025.
The phaseouts do not apply if neither the taxpayer nor the spouse has coverage under a workplace retirement plan.
Roth IRA
For Roth IRAs, the contribution limits are based on your modified adjusted gross income.
For single taxpayers making contributions to a Roth IRA, the phaseout range is between $146,000 and $161,000, and for married couples filing jointly, the income phaseout range is between $230,000 and $240,000. The phaseout range for a married individual filing separately who makes contributions to a Roth IRA remains at $0 and $10,000.
This will increase to between $150,000 and $160,000 for single filers in 2025 and $236,000 and $246,000 for married filers in 2025.
What is a backdoor IRA?
Since 2010, the IRS has not set income level restrictions for individuals who want to convert a traditional IRA to a Roth IRA. High-income individuals use the backdoor IRA strategy by contributing to an existing traditional IRA and then rolling the funds over into a Roth IRA. Your IRA administrator can help you with this process.
There are no income limits for making a nondeductible contribution to a traditional IRA; however, there are contribution limits.
If you contribute pre-tax earnings to your traditional IRA and roll it over to a Roth IRA, you will need to pay taxes on the converted amount. You will also owe taxes on any investment earnings that have accumulated since you rolled the funds from the traditional IRA to the Roth IRA. Once you transfer the funds into your Roth IRA, you won’t pay taxes on any subsequent earnings, and your distributions will remain tax-free.
If you made after-tax contributions to your traditional IRA, converting the funds to a Roth IRA won’t result in additional taxes.
If you have a combination of pretax and aftertax contributions in your traditional IRA, you cannot roll over just the aftertax contributions and leave the pretax dollars in the traditional IRA.
You can roll over your after-tax contributions to a Roth IRA and leave the earnings on your after-tax contributions in your traditional IRA.
File IRS Form 8606 to report your conversion and the nondeductible amount of the conversion to ensure your contribution is not subject to double taxation.
What are the potential benefits of a backdoor IRA?
Backdoor IRAs have several potential benefits. In addition to providing a retirement savings option, backdoor Roth IRAs have the following potential benefits:
- Roth IRAs don’t have required minimum distributions.
- Unlike traditional IRAs, Roth IRA distributions are not taxable.
- Savers pay taxes upfront, which can be important when passing accounts to heirs.
- Allow retirement savers to diversify their accounts.
- Provide the ability to take advantage of this retirement savings strategy before any tax law changes might occur.
When planning your retirement account investments, consider working with a tax professional or financial advisor. Depending on your age, retirement plans, goals, and specific financial situation, using a backdoor Roth IRA strategy may or may not make sense for you.
The backdoor Roth IRA strategy is legal but under scrutiny. Future legislation may alter its status and restrict its use.
Talk with a fee-only financial advisor at Frame Wealth Management. Whether you need assistance with retirement planning, investment management, tax strategies, or comprehensive financial planning, I am here to help.
Give us a call today at 866-395-1786 or contact us online to schedule a meeting and discuss your unique financial needs. Let us be your trusted partner on the path to financial success.
