Backdoor Roth IRA: Why It’s Not as Simple as It Sounds
It’s that time of year again — April. Hopefully, your tax return is either filed or well on its way. Around this season, we often get questions about IRA and Roth IRA contributions and strategies.
These questions tend to come from high earners who don’t qualify to contribute directly to a Roth IRA and can’t deduct their Traditional IRA contributions. For these individuals, the Backdoor Roth IRA can be a powerful strategy — but it’s not the right fit for everyone.
If you're thinking ahead to your 2025 financial planning, here’s a breakdown of what the Backdoor Roth IRA is, how it works, and when it makes sense.
The IRS sets limits on who can contribute to a Roth IRA. A Backdoor Roth IRA is a perfectly legal workaround for high-income earners who exceed the income limits for Roth IRA contributions
For 2025, if your income is too high to contribute directly to a Roth, here’s how the backdoor strategy works:
- You make a nondeductible contribution to a Traditional IRA (up to $7,000 for 2025, or $8,000 if you’re 50 or older).
- You then convert that Traditional IRA contribution to a Roth IRA.
Simple, right? Well — not always. There are some tax traps to watch out for.
While the Backdoor Roth IRA is a clever workaround, it may not be as straightforward as it seems. The biggest complication arises from the IRS’s pro-rata rule. In simple terms, the IRS considers all your Traditional IRA balances when determining how much of your Roth conversion is taxable, not just the contribution you are converting.
For example, if you make a nondeductible $7,000 contribution to a Traditional IRA and want to convert it, that’s easily done if you have no other IRA money. However, let’s assume you had a 401(k), changed jobs, and rolled over your $100,000 balance to a Traditional IRA. The IRS doesn’t allow you to convert only the new nondeductible IRA contribution. Instead, they view your IRA as one large bucket: the $100,000 is pre-tax from your previous 401(k) (before-tax money), and the new $7,000 is nondeductible (after-tax money). As a result, only about 6.5% of your conversion would be considered tax-free, while the remaining portion would be treated as ordinary income.
Another common mistake is not filing Form 8606 to report your nondeductible IRA contributions. If you don’t file this form, the IRS won’t know how much of your IRA is nondeductible (after-tax money) and how much is pre-tax money. Consequently, they may treat the entire amount as fully taxable, even if that is not accurate.
That’s why it’s crucial to work with a financial advisor who takes a holistic approach to financial planning. Even routine tasks, such as rolling over an old 401(k) to an IRA, should be carefully considered. At Wolf Group Capital Advisors, we help our clients understand how today’s decisions impact tomorrow’s goals.
Sincerely,
Associate Financial Advisor
About Wolf Group Capital Advisors
At Wolf Group Capital Advisors, a comprehensive wealth management firm and Registered Investment Advisor (RIA) based in the Washington, D.C. metropolitan area, nothing is more important than the fiduciary responsibility we have in managing your wealth. Taking the utmost care, we focus on providing advice tailored to your specific circumstances. With more than two decades advising U.S. expatriates and non-US citizens employed by international organizations, we are qualified in investment strategies addressing global issues. Empathy and curiosity—combined with our experience in life planning and investment management—enable you to explore a wider set of possibilities that can lead to a fulfilling life you’ve worked hard to attain.
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