HomeBusinessIs double taxation a risk with backdoor Roth conversions?

Is double taxation a risk with backdoor Roth conversions?

Financial advisor and columnist Michele Cagan

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I would like to ask about the backdoor Roth IRA. Let’s say you exceed the income limit for Roth contributions, so you make a traditional contribution with no tax deduction and then make a backdoor Roth. Is that conversion taxable? Then you pay tax on that money twice, since you already paid tax on that income. I’m confused.

– Jeff

The rules for backdoor Roth IRAs can seem confusing, and some scenarios are more complicated than others. Ideally, a non-deductible traditional IRA (after taxes) that converts to a Roth IRA would not be subject to any taxes so that the funds are not taxed twice. To be clear, converted funds are not double taxed, but some circumstances may result in a taxable transaction. That’s where the rules get more complicated. (And that’s why it’s a good idea to consult a financial advisor when deciding whether a backdoor Roth makes sense for you.)

Let’s take a step back for a moment and look at the backdoor Roth. Because many people are not eligible to contribute to the Roth IRA due to their income level, the backdoor Roth strategy helps circumvent these rules. And because Roth IRAs offer the opportunity for tax-free growth and withdrawals without the burden of required minimum distributions (RMDs), this can be a very lucrative move.

For tax year 2023, you cannot contribute to a Roth IRA if your modified adjusted gross income (MAGI) is more than $153,000 for single filers or $228,000 for married couples filing jointly. Those limits will increase to $161,000 and $240,000 respectively for 2024.

Although you can no longer contribute to a Roth IRA if your income exceeds these limits, you can still contribute to a traditional IRA regardless of your income level. That’s the premise for your backdoor Roth.

The mechanisms for creating a backdoor Roth are simple (ignoring the tax issues for the moment). You contribute to a traditional IRA and then convert it to a Roth IRA. It’s that simple. (But if you need additional guidance regarding backdoor Roth conversions or other financial maneuvers, consider talking to a financial advisor.)

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A backdoor Roth IRA is a legal loophole for people whose income exceeds the limits for contributions to a Roth IRA.
A backdoor Roth IRA is a legal loophole for people whose income exceeds the limits for contributions to a Roth IRA.

For many people, the long-term tax benefits of Roth conversions far outweigh the drawbacks. These benefits include:

  • Tax-free growth

  • Tax-free withdrawals upon retirement

  • No RMD requirements, so you can grow your money for as long as you want

But in some cases the disadvantages outweigh the advantages. A backdoor Roth conversion may not make financial sense if:

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