Backdoor Roth IRA

INTRODUCTION

This is the White Coat Investor Podcast: Financial Bootcamp, your fast track to financial success.

Dr. Tyler Scott:
Hello, everyone. My name is Tyler Scott with White Coat Planning, and I’m here today to talk about the backdoor Roth IRA. This episode will be a little bit longer than others in the Bootcamp series, as we’re going to cover not just the steps of a backdoor Roth IRA process, but also three of the most common questions and mistakes that come up when people do it.

The steps for a backdoor Roth IRA are really quite simple, but they generate a lot of questions, and I think that’s totally reasonable because the whole backdoor Roth IRA concept is not at all intuitive. It would be easier if we didn’t have to use the so-called backdoor. If we could just make direct front door contributions to our Roth IRA, that would be awesome, and we wouldn’t get all these questions. But we can’t, or at least most of us can’t.

The U.S. Congress has decided that if you make too much money, you can’t make direct contributions to your Roth IRA. Well, how much is too much? In 2026, if you’re single and your modified adjusted gross income, or MAGI, is $168,000 or more, you can’t make any direct contributions to a Roth IRA. If you’re married filing a joint return and have a MAGI of $252,000 or greater, you cannot make direct Roth IRA contributions.

These numbers go up a little each year with inflation, but either way, it’s sad news for most listeners of this podcast. The good news is that there’s a loophole, a workaround for this income restriction. In my opinion, the loophole makes absolutely no sense. It’s not intuitive or logical at all, but I love it because it means that my wife and I and all of my clients can maneuver our Byzantine tax code to get money into our Roth IRAs each year via what we lovingly call the backdoor Roth IRA.

That term is totally made up, by the way. If you search the IRS website for “backdoor Roth,” nothing is going to come up. It’s just a conceptual term to describe the following steps of the loophole.

Step number one: Make a non-tax-deductible contribution to a traditional IRA. Leave the money in cash. Do not invest it yet.

Step two: Convert those non-deductible dollars from the traditional IRA to the Roth IRA.

Step three: Invest the money in the Roth IRA according to your written investment plan.

And step four: Fill out Form 8606 completely and correctly and file it with your tax return each year.

That’s it. That’s the loophole. Those are the steps.

Before doing step number one, there’s one thing you need to check. It’s the thing that trips up more backdoor Roths than anything else. It’s called the pro rata rule.

Here’s the problem: When you do a Roth conversion, the IRS doesn’t let you pick which IRA dollars you are converting. It takes all of your traditional IRAs, rollover IRAs, SEP IRAs, and SIMPLE IRAs and treats them as one big pre-tax pot, and they use that collective balance as listed on December 31 each year to determine the size of this pot. Any conversion you do comes out of that pot proportionally, or pro rata, as a mix of after-tax dollars and pre-tax dollars.

My favorite way to explain this is the cream-in-the-coffee analogy. Your pre-tax IRA money is the coffee. Your after-tax non-deductible contribution is the cream. Once you pour cream into the coffee, you cannot take a sip of just cream any longer. Every sip you take is a mix of both. The same is true for your IRAs. Once after-tax money is mixed in with pre-tax money, every dollar you convert is part taxable and part tax-free.

Let’s put some numbers on this. Let’s say you have $92,500 in a rollover IRA from an old job, all pre-tax. You contribute $7,500 non-deductible dollars to a traditional IRA and convert it to your Roth IRA, thinking the conversion is tax-free. But the IRS looks at the whole pot. That’s $100,000 total in the pot, and only 7.5% of it is after-tax. So only 7.5% of your conversion, or $560, is tax-free. The other $6,940 is taxable.

Timing matters also because the IRS uses your December 31 balance. You can do a perfectly clean backdoor Roth in February, roll over an old 401(k) into an IRA in November, and still get caught by the pro rata rule for that year.

So what counts as coffee and what doesn’t? The following count: traditional IRAs, rollover IRAs, SEP IRAs, and SIMPLE IRAs. The following do not count: 401(k)s, 403(b)s, 457s, Roth IRAs, and any inherited IRAs, even if that inherited IRA was one of the kinds of coffee I just mentioned that were “bad,” the traditional, rollover, SEP, and SIMPLEs. Your spouse’s IRAs don’t count either because the pro rata rule applies to each person separately.

If you do have pre-tax money in an IRA, you have two main ways to fix this problem. The most common is to roll that money into your current employer’s 401(k) or 403(b), if the plan accepts roll-ins. Many plans do, but you just need to check first. If you’re self-employed, a solo 401(k) can do this same job.

The other option is just to convert all of the pre-tax dollars to Roth and pay whatever taxes are due, which can make sense to choose this option if you’re in a low-income year or if you just have a low balance in a pre-tax IRA.

No matter how you get there, the goal is the same. You need to have a zero-dollar pre-tax IRA balance on December 31 every year across all pre-tax IRAs except the inherited ones. So unlike real coffee, you actually can get the cream back out. You just have to move the coffee somewhere else first.

Okay, so that’s the pro rata rule, and now I have you reaching for some cold brew. Let’s look at some common backdoor Roth mistakes, which generate most of the questions I get at White Coat Planning and Jim gets at the White Coat Investor on the podcast.

Common mistake number one: converting more than the contribution limit.

Let’s say you make the maximum allowable contribution to the traditional IRA for 2026, which is $7,500, or $8,600 if you’re 50 or over, and you leave that in cash in the traditional IRA, just like I told you to do earlier. Then a day or two later, you convert the entire balance of the traditional IRA to the Roth IRA, and the balance is $7,500.33. So far, you’re doing great, but now you’re worried about this 33 cents taking you above the annual limit.

First, where did the 33 cents come from? It’s interest. Remember how we said to leave the money in the traditional IRA in cash? Well, at most brokerages like Vanguard, Fidelity, and Schwab, that cash earns interest, and even a day or two of interest on $7,500 can add up to some cents or a few dollars.

Well, now what? The 2026 limit is $7,500, and people worry they’ve broken some kind of rule by exceeding that limit. It just begs the question: What limit? This is where people get caught up. The limit is for the contribution, not for the conversion. There is no limit on how much you can convert from your traditional IRA to your Roth IRA in a given year.

And if you’ve listened to this podcast much, you already know this in the deep recesses of your brain somewhere because you’ve heard the questions we get all the time from people considering doing a Roth conversion. Often, these people are approaching retirement and have cut back at work. Maybe they’re already in retirement, or they’re in a lowish tax bracket for some other reason, like taking a sabbatical or going back to school or being in training, something like that.

These people want to take advantage of their low tax bracket by moving money from a pre-tax account, like a 401(k) or rollover IRA, into their Roth IRA. Well, this is a taxable event because the money is being moved from a pre-tax universe to a post-tax universe. Given that taxes will be owed on the conversion, people ask us how much should I convert, or when should I consider a Roth conversion.

All of this is to say that there is no limit on how much you can convert to your Roth IRA at any time. If you want to move $5 million there, no one’s going to stop you. You just need to understand how much in taxes you’re going to owe on that conversion.

This all brings us back to our 33 cents. Given that step one of this process was to contribute $7,500 of non-deductible after-tax money, do we owe any taxes for moving that post-tax money to a post-tax account like a Roth IRA? No, we do not. Did we break any rules by converting more than the $7,500 limit? No, we did not. But if we have any earnings on our $7,500 between the time of the contribution and the time of the conversion, do we owe taxes on those earnings? Yes, yes we do.

Is there a limit on how much we can convert to our Roth IRA? No, that’s what we just talked about. So can we convert $7,500.33 to our Roth IRA without breaking any rules? Yes, absolutely. The only question is how much will we owe in taxes for doing so.

The $7,500 was a tax-free conversion because it was already after-tax dollars, but we do theoretically owe ordinary income taxes on the 33 cents of growth. I say theoretically because in reality we don’t report cents on our tax returns. So when you fill out Form 8606, 33 cents rounds down to zero, and hence no tax due.

But what if it was 87 cents, or $5, or $20 of interest that had accumulated? You just owe taxes on that growth amount. If your marginal tax rate is 40% and you convert $7,505, you owe $5 times 40%, which equals $2 of taxes. No big deal, right? You didn’t break any rules. The backdoor Roth police are not coming to your door. You just have to pay taxes on the extra amount you converted due to growth.

Alternatively, you could leave the 87 cents or the five bucks in the traditional IRA, but that will complicate your or your CPA’s task of filling out Form 8606. Remember the cream and the coffee. Those leftover dollars are pre-tax coffee sitting in your traditional IRA on December 31, and they’ll make next year’s conversion partly taxable.

Jim has a whole post about all this called “Pennies and the Backdoor Roth IRA” that will walk you through all of it if you want to read more. For now, suffice it to say that it is much easier and cleaner to just get all your pre-tax IRAs down to $0 before December 31 each year.

And that leads me to my final point here about problem number one. Sometimes you can see the extra interest before you do the conversion, which is actually kind of nice. At least you know it’s there. The more annoying version of this problem I see all the time with clients is they put $7,500 in the traditional IRA early in January. They convert the entire balance later that month, and that balance shows $7,500 at that time, so they think they’re good to go. They think they’re all clean and done.

But then, when they send me their account balances in June for our annual meeting, I see the traditional IRA has $1.68 in it, and I tell them, “Hey, you should clean this up. Your Form 8606 will be a little wacky, and the pro rata rules can apply down the road.”

And they say, “Wait, what the heck? I converted the entire balance when I was done. There was no money left in the traditional IRA. Where did this dollar and 68 cents magically come from?”

The answer is that it was an interest payment made in arrears. Often, these brokerages don’t make daily interest payments. They do it weekly or monthly. So, you know, if you put the money in on January 2 and converted it on January 4, well, on January 9 they look back and say, “Hey, how much did Joe have in his account on January 2? Oh, it looks like he had $7,500 in there. We owe him $1.68,” and then they put the interest payment in long after you think you’ve emptied the account.

So look out for that. I personally always log into my traditional IRA around December 1 or Thanksgiving each year just to make sure it’s at zero.

In short, don’t worry if you convert a little over the contribution limit in a given year. You’ll owe a little tax on that. Just make sure you get your traditional IRA to zero by the end of the calendar year so your paperwork is easy. This is the easiest of the backdoor Roth IRA mistakes to fix.

Common mistake number two: making a direct Roth contribution when you weren’t eligible.

This one is a little more complicated to clean up. It’s making a direct Roth IRA contribution and realizing later that your income for the year was too high. This is usually a mistake made out of benevolent exuberance. People who have been in a good habit of funding their Roth IRA early in the calendar year back when their income was below the limits keep doing it without thinking about the totality of their income for that year.

Then they realize after the fact that their income for the year exceeds the limits for direct Roth IRA contributions, and they need to fix what is now an ineligible or excess contribution. This happens so often that I wrote a blog post about it called “Backdoor Roth When Your Life Is In Flux.” Jim has one too called “IRA Recharacterizations: I Should Have Backdoor Roth.” So go read those for more information on this topic.

In my post, I point out a few common scenarios where you’ll find yourself wishing you would use the backdoor loophole. The most common situation is for someone in their final year of training, like a resident or fellow. They are so accustomed to being low income that they don’t pause to realize that even with a partial year of full attending income, by the end of the year their income will exceed the limits, even though they were a poor resident at the time of the contribution back in January or February. When you take the entire year into account, they made too much money for that direct contribution.

Another situation is getting married to another earner during the year. Let’s say you’re a first-year resident making $60,000, and you make your direct Roth IRA contribution in January, and then you marry an attending in July. Guess what? Your tax filing for that year is going to be married filing jointly, and your combined income is going to be way above the income limits.

Now your Roth IRA contribution you made back in January needed to happen via the backdoor loophole, even though you made the direct contribution as a well-meaning, low-income single person at the start of the year.

Similarly, those who divorce a non-earner can be in the same boat. Consider a married earner with a MAGI under the married filing jointly income limits for direct Roth IRA contributions, but above the single limits. So $200,000 of income works as a good example.

Our married earner has become accustomed to making direct Roth IRA contributions for themselves and their stay-at-home spouse each January, but by the end of the year, the couple is divorced, and both spouses are filing taxes as either single or head of household. The non-earner has no problem here because they have a MAGI of zero, but our earner, who thought they were making an eligible direct contribution, suddenly finds themselves with a MAGI that exceeds the limit for a single or head of household filer.

Another situation where this comes up a lot is with clients pursuing Public Service Loan Forgiveness. For complex reasons that go well beyond today’s episode, just know that it can make sense for some couples to file their taxes separately, even though they’re married and living together, and this is so they can make the lowest possible student loan payments while one or both of them pursue loan forgiveness.

The MAGI limit for direct Roth IRA contributions begins to phase out at $0 of income for married people filing separately, and let’s agree that staying below $0 of income is mathematically challenging for a household.

So consider a couple who are under the married filing jointly income limit, and they make their maximum Roth IRA contributions each January. Then let’s say March of the following year, about 15 months later, they meet with one of our student loan experts at White Coat Planning for a consultation on their student loans and learn that, in fact, they need to be filing their taxes separately, both for the previous tax year that they haven’t filed yet and for the years to come.

They have unexpectedly found themselves with ineligible contributions from both the Roth IRA contribution they made a couple months ago in January of this year and for the Roth IRA contributions they made 15 months ago. Now they’ve got two years of ineligible contributions in their Roth IRA if they decide to file separately.

This accidental direct Roth IRA contribution can also happen to people who just end up making more money in a year than they expected. And this actually happened to me when I switched from dentistry to financial planning. I had every reason to believe that my first year in the new job would be a low-income year as I got my feet underneath me, so I made a direct Roth IRA contribution for both me and Megan, my wife, in January of 2022.

To my great surprise and delight, it didn’t take me nearly as long as I thought to hit my stride in this new world, and I ended up surpassing the MAGI limit for direct Roth IRA contributions by the end of 2022. That was a happy oops, but still an oops.

The point is, there are a lot of ways that this mistake happens. It’s not just for those finishing training, though that’s probably the most common group who makes this mistake.

Well, how do you fix it? First, don’t stress too much. It’s not that big of a deal to fix. The solution is to recharacterize your Roth IRA contributions into traditional IRA contributions and then start the backdoor process from there.

To recharacterize is to say, “Oops, my bad. That’s not what I meant to do. Let’s turn these Roth dollars back into traditional IRA dollars.”

There’s just a couple things to be aware of if you do this. First, it’s going to require calling the custodian of your Roth IRA, being on hold, filling out paperwork, and navigating a bureaucratic process that’ll eat up some of your time and probably raise your blood pressure a little bit.

If you don’t already have a traditional IRA, you’re going to need to open one first. And before you do the backdoor step, remember the pro rata rule. If you rolled your residency 403(b) into a rollover IRA, or you have a SEP IRA from moonlighting, you’ve got to deal with that first.

Next, keep in mind that any growth on the original ineligible Roth IRA contribution from the date of the contribution until the date of the recharacterization, those earnings move over to the traditional IRA as well. When you convert it all back to the Roth IRA, that growth will be taxable to you as ordinary income at your marginal tax rate. This can result in a few hundred dollars of tax.

And finally, just know that the deadline to complete a recharacterization is October 15 of the year following the tax year the contribution was originally for. If you made an ineligible contribution for the 2026 tax year, you have until October 15, 2027, to get it recharacterized.

But remember, you have until April 15 to make your Roth contribution from the previous year. So if you made an ineligible contribution early in 2026 for the 2025 tax year, your deadline to fix it via recharacterization is October 15, 2026, because 2026 is the year after 2025, and you messed up your 2025 contribution, even though you made that contribution early in 2026.

If you miss the deadline, recharacterization is off the table. You’ll need to withdraw the excess contribution, and you’ll owe a 6% penalty on that excess amount for every year it stayed in the Roth IRA. So don’t let it get to that point. Get your recharacterization done on time. Get those dollars into a traditional IRA and start the backdoor process from there.

That takes us to common mistake number three: not filling out Form 8606 or filling it out wrong.

This may not be the most common question we get, but it is the most common mistake I see when reviewing clients’ tax returns. Here’s why the form matters so much. After you do your conversion, your brokerage sends you a Form 1099-R the following January. It shows your $7,500 leaving the traditional IRA, and it often lists the amount as fully taxable with a little box checked that says “Taxable amount not determined.”

The brokerage has no idea whether your contribution was deductible. You never told them, and there’s no way to tell them. Form 8606 is the only place you can tell the IRS, “Hey, I already paid tax on this money.”

If that form isn’t filed or it’s filled out wrong, the IRS sees a $7,500 distribution from your IRA and treats it as taxable income. You already paid tax on that money when you earned it, and now you pay tax on it again. You can get taxed twice on the same dollars, which is terrible. That’s the exact opposite of the whole point of this exercise.

And I see this happen in two main ways. First, people do their backdoor Roth and never tell their CPA, so their CPA gets Form 1099-R and has no idea there was a non-deductible contribution made and reports the conversion as taxable.

Second, the CPA knows about the backdoor Roth maneuver but fills out the form wrong anyway. This happens a lot when you make last year’s contribution between January and April and then convert it this year, and you end up splitting the paperwork across two tax years.

So two things. First, tell your CPA about your backdoor Roth every single year in writing. Don’t assume they’ll figure it out. Second, actually look at Form 8606 yourself before it’s filed. You don’t need to understand every line. Just look at line 18, the taxable amount for your conversion. For a clean backdoor Roth, it should say $0 or a few dollars because of the interest, like we talked about earlier. If it says $7,500, something is definitely wrong.

And I’ll tell you a little personal story here. I do my own taxes every year with TurboTax, and getting TurboTax to fill out Form 8606 correctly is actually the hardest step in my whole backdoor Roth process every year. The contribution and conversion take me 10 minutes, maybe. TurboTax is the hard part.

What makes it so confusing is that the conversion goes in the income section where you enter Form 1099-R, and the contribution goes in the deductions and credits section where you tell it the contribution was non-deductible. Since you’re usually doing the income section first, you end up entering the second step before the first step. It’s kind of a mess.

Jim has a post with screenshots that walks you through it. It’s called “How to Report a Backdoor Roth on TurboTax.” I pull it up every year when I do my tax return. Again, when you’re done, look at Form 8606 that TurboTax generates and do the same check on line 18.

If you’re listening to this and realizing you got it wrong in a past year, don’t panic. It’s usually fixable. You can file an amended return with a correct Form 8606. You generally have three years to claim that refund. If you never filed a Form 8606 for a year and you made non-deductible contributions, you can usually file it late to establish your basis.

The real disaster is when nobody catches it and that after-tax basis gets lost forever. Jim has a post on this as well called “How to Fix Backdoor Roth IRA Screwups” that goes through all these fixes.

The moral of the story is: When in doubt, just use the backdoor loophole. There’s no penalty for using it if you don’t have to. Make sure to check for cream in your coffee before you start. Get your traditional IRA to zero by December 31, and make sure Form 8606 gets filled out correctly every year.

Thanks for listening, and happy backdoor Rothing.

DISCLAIMER

The White Coat Investor Podcast is for your entertainment and information only and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.