Alexis Akira Toda

Alexis Akira Toda

Mathematical economist

Backdoor Roth

2 minute read

Published:

I have been investing in a Roth IRA. Currently, the contribution limit is $7,000/year.

I haven’t been paying attention much, but there are income limits for traditional and Roth IRAs. For traditional, married couples filing jointly cannot deduct contributions if their modified adjusted gross income (MAGI) is above $136,000. For Roth, married couples filing jointly cannot contribute if their MAGI is above $240,000.

Because I recently got a raise by changing employers, I can no longer contribute to a Roth. However, there is a legal loophole known as the backdoor Roth. All you need to do is contribute to a traditional IRA (which is not tax-deductible due to the income limit, but that is irrelevant), then do a Roth conversion. This way, anybody can contribute to a Roth regardless of their income. So from next year on, I can simply contribute $7,000 of cash to my traditional IRA account, do a Roth conversion, and invest the funds in whatever way I like.

However, this year there is a problem because I have already contributed to a Roth IRA before I knew I would exceed the income limit. I did a bit of research and found this article. Reading it, I did the following.

  1. First, I recharacterized this year’s Roth contributions to traditional.
  2. Then, I contributed cash to a traditional IRA to hit the annual contribution limit.
  3. Finally, I converted all funds from traditional to Roth.

The idea is that, by recharacterizing my existing Roth contributions to traditional, it’s as if I contributed to traditional in the first place. To save my mental resources, I added enough cash to hit the $7,000 annual contribution limit right away, so I can forget about it for this year. Because the existing contributions to Roth had capital gains, by recharacterizing to traditional, I will have to pay capital gains taxes. This TurboTax article explains how to handle taxes.

It’s fun to learn new money tips, but I spent a few hours doing so. Since the income limit for Roth is not binding due to the backdoor Roth loophole, it would make more sense for the government to simply eliminate the income limit for Roth altogether. And if there is no income limit for Roth, there should be no limit for traditional either. Our lives will be much simpler that way.

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