By Dr. Tyler Scott, WCI Columnist

As the daylight fades ever earlier and the hushed softness of newly driven snow quiets the world around me, I, in only the second winter of my newly blossomed financial planning career, am already starting to form a Pavlovian association between this frosty season and the ding of my inbox indicating yet another question about Backdoor Roth IRAs. While the excitements and befuddlements surrounding this favorite tax loophole among high earners are decidedly evergreen, there seems to be a disproportionate amount of energy surrounding the Backdoor Roth during these crisp and festivous months.

Some combination of pragmatic end-of-year tax planning, the ubiquity of human procrastination manifesting at the end of the calendar, and the eagerness of the financial optimizers in action at the beginning of the calendar all conspire to make wintertime ripe for questions regarding the Backdoor Roth IRA and IRA contributions in general.

Or maybe it’s just because the need to utilize the Backdoor Roth IRA process is determined by one’s Modified Adjusted Gross Income, or MAGI, making the Backdoor Roth the modern and ironic Gift of The Magi for those financially fortunate and literate enough to receive it.

Regardless of the reason, given this elevated seasonal interest, I’d like to offer some considerations regarding direct (aka “Frontdoor”) and indirect (aka “Backdoor”) Roth IRA contributions, particularly in the context of when your life may be changing in the year ahead.

 

What Is a Backdoor Roth IRA?

If you don’t know about the Backdoor Roth IRA, stop reading this article and first read the foundational posts on the subject below.

In short, a Backdoor Roth IRA is a series of steps taken to use a loophole in the tax code that would otherwise prevent “high earners” from contributing to a Roth IRA. This loophole allows for anyone with earned income (or married to anyone with earned income) to make a non-tax deductible contribution to a traditional IRA and shortly thereafter convert those funds to the highly tax-advantaged Roth IRA.

 

Who Needs to Use the Backdoor Roth IRA Loophole?

For 2024, the MAGI limits for making the full $7,000 direct, Frontdoor Roth IRA contributions are determined by your tax filing status as follows:

  • Single: $146,000
  • Head of Household: $146,000
  • Married Filing Separately (and not living with spouse during the year): $146,000
  • Married Filing Jointly: $230,000
  • Qualifying Widow(er): $230,000
  • Married Filing Separately (and living with spouse during the year): $0

Anyone with a MAGI above these limits who wants to make the maximum contribution to their Roth IRA for the 2024 tax year must make use of the Backdoor loophole. Most readers of this blog are above those limits and, thus, are not necessarily the intended audience of this column.

Who is the intended audience for this column?

I am writing this article as a word of warning to those who think they will have a MAGI under the ever-changing annual limits in the coming tax year and, therefore, believe they do not need to venture into the mysterious and foreboding realm of the Backdoor Roth IRA. Depending on life circumstances, those people could end up being wrong, costing them time and money.

The following are demographics of people I have encountered who, mistakenly, thought they did not need to use the Backdoor process and ended up with a mild-to-moderate case of IRS-induced tax anxiety with its known comorbidity of paperwork-induced rage and exasperated time wasting.

 

Those Finishing Training

This is the most common group to find themselves stubbing their toe against the direct Roth IRA stumbling block. As faithful WCI readers, many residents and fellows have gotten into the excellent habit of making a direct Roth IRA contribution in January each year.

However, this habit can prove problematic when you make that contribution in January of your final year of training, a year in which you will finally and mercifully have a few months of attending-level income later in the year. Even with a handful of “real paychecks” combined with a partial year of resident income, it is easy for a new attending to exceed the MAGI limits for direct Roth IRA contributions.

For example, a single resident making $60,000 a year completes their $7,000 direct Roth contribution in January and finishes training in June. Their income from six months as a resident is $30,000. They take off July to move and get settled before starting their new attending job in August which pays $360,000 annually. Five months of that income is $150,000, giving them a gross annual income of $180,000, which is above the MAGI limit of $146,000.* That makes their direct Roth IRA contribution from January “ineligible.”

*Advanced readers may start doing some math here about how they could get their MAGI under $146,000, via above-the-line deductions like 401(k)/403(b)/457(b) contributions. While this technically may be possible in rare cases, keep in mind that the year they finish residency should be a year where they were already making Roth contributions to their residency 403(b) for part of the year. Also, this is a year that they should be doing Roth conversions of any pre-tax balances in 403(b)s/401(k)s and especially any traditional, SIMPLE, or SEP-IRAs to avoid pro-rata rule issues with their future Backdoor Roth IRA, all of which will raise their MAGI.

 

Those Getting Married to Another Earner

Marrying another earner during the year can also cause your direct (Frontdoor) Roth IRA contribution to be deemed ineligible by the IRS.

Let’s say our single resident still has three years left before becoming an attending. When Cupid’s arrow strikes in the hospital cafeteria and they find themselves married to an attending orthopedic surgeon later that year, they are no longer a single tax filer with $60,000 of gross income. Instead, they are a Married Filing Jointly tax filer with $760,000 of gross income, and they now have a small mess to clean up regarding their well-intended direct Roth IRA contribution from earlier in the year.

Note that tax filing status is determined by whatever is true for you on December 31 each year. If you were single all year and got married on December 30, you must file your taxes under one of the married designations.

 

Those Divorcing a Non-Earner

Cupid’s arrow cuts both ways, and we have all seen the statistics that tell us more than half of marriages result in divorce.

Consider a married earner with a MAGI under the Married Filing Jointly direct Roth IRA income limits but above the single income limits ($200,000 works as a good example for 2024). Our married earner has become accustomed to making a direct Roth IRA contribution for themselves and their “stay at home” spouse each January. By the end of the year, the couple is divorced, and both spouses are filing their taxes as Single or Head of Household.

The non-earner has no problem because they have a MAGI of $0, but our earner who thought they were making an eligible direct Roth IRA contribution suddenly finds themselves with a MAGI that exceeds the limit for a Single or Head of Household filer.

 

Those Filing Taxes as Married Filing Separately for PSLF Optimization

This can be, and has been, an entire blog post on its own so I am intentionally not going into the weeds on this one.

For our purposes, let’s agree that some people have read enough on their own about Public Service Loan Forgiveness (PSFL) and the myriad Income Driven Repayment (IDR) plans or paid a student loan expert to explain their options to them well enough to understand this complex and dynamic area of personal finance. During this educational endeavor, it was determined that it makes sense for them and their spouse to file their taxes separately even though they live together so they can make the lowest possible payments while one or both of them await forgiveness of their loans.

As outlined above, the MAGI limit for direct Roth IRA contributions for those in this situation is $0. Staying below a $0 cap is a mathematical challenge.

Consider a couple who was under the Married Filing Jointly income limits for direct Roth contributions and make their maximum allowed Roth contribution each January. In March of the following year, they meet with StudentLoanAdvice.com and learn they need to file their taxes separately for last year and for the foreseeable future. They unexpectedly and unknowingly find themselves with ineligible contributions to that Roth IRA both from two months ago and from 14 months ago (from January in year 1 and from January in year 2).

 

Those Who Make More Than They Expected

Backdoor Roth IRA problems

Happily, sometimes people just end up with more income during the year than they forecasted. This can be the result of unexpected raises, unwanted extra shifts, or unplanned bonuses for themselves or their spouse. Sometimes people end up moonlighting more than they anticipated, change to a higher-paying job/role, or have a side hustle that produces more or faster than anticipated.

Sometimes people leave their dental career to follow a physiologically mandated and philosophically motivated switch to flat fee financial planning that they think will not produce much income but goes way better than expected while also earning unplanned money writing for their favorite blog and helping that blog’s subsidiary company during busy times in the same year their spouse who works for that same company gets a promotion and a raise to produce the podcast—all of which makes their direct Roth IRA contributions from 11 months ago ineligible. Hypothetically speaking, of course.

In other words, lots of unknown stuff can happen during a year that really changes where someone’s MAGI ends up landing.

 

Those Losing Qualifying Widow(er) Status

Fortunately, this doesn’t come up often, but I think it’s worth mentioning. First, let’s define what a qualifying widow(er) is for tax purposes.

Recall from above that I said your tax filing status is determined by your marriage status on December 31 of each year. The one exception to that rule is when your spouse dies. In the year of your spouse’s death, you can still file your taxes Married Filing Jointly. For the next two years after that, you can file as a qualifying widow(er) assuming you don’t remarry, have at least one child you can claim as a dependent, and pay for more than half the cost of keeping up a home. After that, you file your taxes as a Single filer or Head of Household.

In that tax year when you lose qualifying widow(er) status, if your MAGI is below the qualifying widow(er) limit but above the Single/Head of Household limit, you can find yourself making an ineligible direct Roth IRA contribution.

 

Other Groups

I can’t think of any other groups that this column could apply to, but I bet you can. I look forward to learning from you in the comments!

More information here:

How I Failed and Then Mastered the Backdoor Roth IRA

 

How Do You Avoid This Problem?

Simply put, when in doubt, just use the Backdoor loophole. There is no penalty, problem, or punishment if you use the Backdoor Roth IRA loophole unnecessarily.

You’ll probably have to do it one day anyway, so just learn to do it now and you’ll quickly realize it’s not very hard. Especially with all the great online tutorials that show you exactly how to do it.

More information here:

Vanguard Backdoor Roth Tutorial

How to Do a Backdoor Roth IRA at Fidelity

 

What Should You Do If You Messed Up?

If you are reading this and are realizing one of these scenarios applies to you (and it's left you feeling sweaty and tachycardia): I’m sorry and you’re welcome.

Don’t stress too much; it’s not that big of a deal to fix the error. The solution is to recharacterize your Roth IRA contributions into traditional IRA contributions and then start the Backdoor Roth process from there.

There are a few pitfalls to be aware of with an IRA recharacterization:

  1. This is going to require calling the custodian of your IRA, being on hold, filling out paperwork, and navigating a bureaucratic process that will reduce your free time and raise your blood pressure.
  2. Any growth that occurs on your original (ineligible) direct Roth IRA contributions from the date of the contribution to the date of the conversion will be taxable to you at your marginal tax rate as ordinary income. This is likely to be a few hundred dollars of added tax.
  3. The deadline to complete a recharacterization is October 15 of the year following the ineligible contribution. For example, if you make an ineligible Roth IRA contribution in January 2024, you have until October 15, 2025, to do the recharacterization. Note that if you make an ineligible Roth IRA contribution in April 2024 for the 2023 tax year, the deadline to fix that via recharacterization is October 15, 2024. If you miss that deadline, you must remove the entire Roth IRA contribution along with any growth and pay a 6% penalty on the amount removed.

 

The Bottom Line

Here's the TLDR of this post.

  • Beware of making your direct Roth IRA contribution early in the year. Lots of things can happen that may make that contribution ineligible in the ~15-21 months before you file your tax return.
  • If there is any doubt about your income, marital status, PSLF strategy, etc., either 1) Wait until you have completed most of your tax return to make your direct Roth IRA contribution or 2) Just use the Backdoor Roth IRA process to make your contributions in the first place.

 

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Have you ever messed up your direct Roth IRA contribution? What happened? How did you fix it? What did it cost you? Comment below!