Divorce the IRS

The Backdoor Roth IRA Strategy Explained

• James Miller

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One of the biggest misconceptions in retirement planning is the idea that high earners are locked out of Roth IRAs forever.

They’re not.

In this episode of The Divorce the IRS Podcast, we break down one of the most widely used advanced Roth strategies available today: the backdoor Roth IRA.

The backdoor Roth strategy gives higher income earners a legal pathway to move money into Roth accounts, even when their income exceeds the standard Roth IRA contribution limits. While the process itself is relatively simple, there are several important tax rules and planning nuances that investors need to understand before implementing it.

We walk step-by-step through how the strategy works, beginning with a nondeductible IRA contribution and ending with a Roth conversion. You’ll learn why this strategy exists within the tax code, how it functions mechanically, and why Roth accounts continue to play such a powerful role in long-term tax planning.

This episode also explores several important areas that often create confusion, including IRS Form 8606, the step transaction doctrine, how small amounts of growth are treated before conversion, and why the pro rata rule can create unexpected tax consequences for investors who already own other IRA accounts.

We also discuss why existing rollover IRAs can complicate the process and some of the strategies investors use to simplify future Roth conversions.

If your goal is to create more tax-free retirement income and gain greater control over future taxes, understanding how the backdoor Roth works is an important piece of the puzzle.

And this conversation doesn’t stop here.

In the next episode, we’ll dive into another advanced Roth strategy that may allow some investors to move substantially larger amounts into Roth accounts: the Mega Backdoor Roth.

In This Episode

• How the backdoor Roth IRA strategy works
 • Why high earners can still legally utilize Roth accounts
 • The role of nondeductible IRA contributions
 • Why Roth conversions have no income limits
 • How IRS Form 8606 factors into the strategy
 • The IRS step transaction doctrine explained
 • How taxes apply to growth before conversion
 • What the pro rata rule is and why it matters
 • Why rollover IRAs can complicate Roth planning
 • Strategies that may help simplify future conversions

What’s Coming Next

• How the Mega Backdoor Roth strategy works
 • Advanced Roth funding opportunities for higher earners
 • Ways some investors move significantly larger amounts into Roth accounts
 • Additional tax-free retirement income strategies


SPEAKER_00

Welcome to the Divorce the IRS Podcast, the retirement income planning podcast designed specifically for those who want to pay the least amount of taxes possible and build a retirement income that lasts. Inspired by the best-selling book, Divorce the IRS, you get to go behind the scenes with financial planner, author, and speaker Jimmy Miller. Learn how to set yourself up to pay the least amount of taxes in retirement when you'll need your money the most. And now, here's your host, Jimmy Miller.

SPEAKER_01

Welcome. Welcome to episode 20 of the Divorce the IRS podcast. Today, we're going to bust the misconception that some people make too much money to put money into a Roth IRA by exploring just one of the strategies that anyone can use to fund a personal Roth IRA, the Backdoor Roth Strategy. Let's dive right in. The Backdoor Roth IRA strategy has been around for many years. It's a completely legal way for high earners to fund a Roth IRA. And the strategy is straightforward, although there are some nuances that we'll discuss today as well. Let's start by looking at the mechanics of how this strategy works. The Backdoor Roth strategy is composed of two distinct steps. In the first step, you start by contributing the allowable IRA amount for the year, which is $7,500 for people under $50 and $8,600 for people 50 and older in 2026 to a regular traditional IRA. The catch here is that although there are income limits on a regular deductible traditional IRA, much like the Roth IRA, there are no income limits if you make the contribution and don't take the tax deduction, or IRS loan as I like to call it. Thus, the traditional IRA becomes a non-deductible IRA. And since you're not getting the tax deduction for this contribution, you are contributing after tax money, just like you would to a Roth IRA. But it isn't a Roth IRA quite yet. It's just a non-deductible IRA at this point. The second step to the backdoor Roth strategy is then to complete a Roth conversion and convert that money, the money in the non-deductible IRA, to a Roth IRA. This works because there are no income limits when converting an IRA to a Roth IRA. There is also no tax on the conversion since the money was originally contributed after tax, and you took no deduction on the contribution. So, no income limit to contribute to a non-deductible IRA and no income limit to convert that money in the non-deductible IRA to your Roth IRA. Welcome to the Backdoor Roth IRA strategy. Now there are a couple of other nuances that need to be discussed here and that you should know about before you run out and attempt this strategy on your own. Let's discuss the four most important ones. First, to let the IRS know that the money you put into the regular traditional IRA in step one was actually non-deductible, and thus you had no income limit when making that contribution. You will need to make sure you fill out IRS Form 8606 and submit it with your taxes in the year you make the contribution. This is pretty easy and straightforward and a simple form to fill out and include with your tax return. If you work with a tax professional, they will know exactly what to do when you ask them to fill out Form 8606 to make your contribution non-deductible. Second, you should wait at least a few business days after you contribute to your non-deductible IRA before converting that money over to your Roth IRA. This is to avoid the IRS step transaction doctrine. The IRS step transaction doctrine states that if you do transactions one right after the other in a series of immediate steps, the IRS can consider all the steps together as just one transaction. This would make the backdoor Roth strategy appear from an IRS perspective as one transaction, a contribution to a Roth IRA, instead of the two distinct transactions that it is. So waiting a few business days before converting your non-deductible IRA over to your Roth IRA negates the step transaction doctrine. Now, in the real world, I have never actually seen the IRS impose the step transaction doctrine or be worried about the backdoor Roth strategy. And I have seen people complete both steps of the backdoor Roth in one business day without any problems. The backdoor Roth strategy has been around for a long time now, and there's a lot of information out there about it. If you want to learn more, you can simply Google it, and even all the big reputable investment companies like Fidelity and Schwab have information about it and will allow you to use this strategy. I just think it's better to be 100% safe and wait a couple of days before converting. So you're sure the transactions won't fall under the step transaction doctrine. Now the third thing to keep in mind is that any growth you might have in the non-deductible IRA that happens before you convert that money to your Roth IRA will be tax deferred, not tax-free. So if you're waiting a week between step one and step two to make sure you're safe from the step transaction doctrine and your account gains $5 of interest or growth of any sort in that time, the $5 of growth will be taxable to you when you convert the money to your Roth IRA. Now, this is a small price to pay for using the backdoor strategy, and it really isn't a big deal. I just want to make sure you know how everything works. Once the money has been converted to your Roth, all the future growth should be tax-free for you. The fourth thing to keep in mind with the backdoor Roth is that the strategy gets a little trickier if you have other IRAs or rollovers out there. This is because of something called the ProRADA rule, which you should be aware of. The ProRadder rule states that if you have other personal pre-tax accounts like another traditional IRA or a rollover IRA from an old 401k or SEP IRA, you have to consider this money in step two of the backdoor raw strategy. You don't have to worry about pre-tax money that might be in a 401k or a 403B plan, though. And you also don't have to worry about pre-tax money in a 457 plan, a deferred comp plan, or a cafeteria plan either for the ProRATA rule. Let's take a look at a simple example with round numbers to understand how this rule affects the backdoor strategy. Let's assume you have $93,000 in a rollover IRA at Schwab from an old 401k that you rolled over a couple of years ago from an old job that you had. Now you want to contribute $7,000 to a non-deductible IRA as part of the backdoor RAW strategy. You can do this, and after you do, you will have exactly $100,000 in traditional IRA accounts, $93,000 in that pre-tax or old rollover IRA, and $7,000 that's after tax or non-deductible. Now, the problem with this scenario is that you want to convert just the $7,000 in your non-deductible IRA over to your Roth, which is step two of the backdoor Roth strategy, and complete the strategy. If you could do this, there would be no tax on the $7,000 you converted because it was contributed to the non-deductible IRA with after tax money. But unfortunately, the IRS won't allow you or a person in this situation to just convert the $7,000 that is after tax contributions. The IRS will impose the pro rata rule on the conversion and only allow the percentage of the total to be converted without tax. So in this example, 93% of the money is pre-tax and 7% of the money is after tax or non-deductible. So if you convert the $7,000 in the non-deductible IRA to your Roth IRA, which you can, the IRS is only going to allow 7% of the $7,000 to be considered the portion of after tax money that you converted, thus taxing you on 93% of the conversion. Now technically, this is fine and legal, and it does accomplish getting more money into your Roth, which was the original goal. But it also makes things messy. As going forward, you have to keep track of how much of the remaining IRA money, both pre-tax and non-deductible, you have in your accounts, and then use the pro router rule again every time you want to do a Roth conversion. This becomes a bit of a tax nightmare. Your tax professional can and will track this for you, but is likely to charge you a bit more for your return with this embedded complication. One strategy you can use to get around the ProRad rule, if you have other pretax money in your name in other IRA accounts, is to move those other IRA accounts into your current workplace retirement plan, like your current 401k. The money in your 401, both pre-tax and or Roth, doesn't count in the ProRadder rule, thus making your backdoor strategy more attractive and much easier to enact. Well, that's it for this rather technical episode of the Divorce AIS podcast. I hope that I was able to explain it all in a way that made sense to you. Of course, this is all laid out in my book, Divorce AIRS. And if you want to learn more about this or any of the strategies we discuss in this podcast, you can grab a copy of the book and digest all of this at a deeper level. A quick Google search will also bring up lots of details on this strategy for you as well. In the next episode, we're going to take a look at another strategy designed for hire earners to get even more money into Roth accounts. That strategy is called the Mega Backdoor Roth. And you will want to know all about it as well, so stay tuned for that episode.

SPEAKER_00

Want even more ideas, tools, and resources on how to navigate your financial life? Check out all the resources on the Divorce the IRS website at divorce-the-IRS.com or the Bayabub Wealth website at BayabubWealth.com and subscribe to the blog to stay up to date on issues affecting retirement income planning. Don't forget to subscribe to the podcast so you never miss an episode. Bayabub Wealth and Bayabut Wealth Abroad are DBAs of Bayabwealth LLC, a Florida registered investment advisor. This podcast is designed for general education purposes only and shouldn't be taken as legal investment or tax advice. You should seek out a qualified tax professional or licensed financial advisor to determine what is best for your personal situation.