Backdoor Roth Taxes

The plain answer

A backdoor Roth IRA usually involves making a nondeductible contribution to a traditional IRA and then converting that money to a Roth IRA. The contribution does not create a second tax deduction, and the conversion is not automatically tax-free.

If you have no other pre-tax IRA money and the contribution has not earned anything before the conversion, little or none of the conversion may be taxable. If you have pre-tax IRA money, the pro-rata rule can make part of the conversion taxable.

How it actually works

The pro-rata rule treats all of your traditional, SEP, and SIMPLE IRAs as one combined balance for this calculation. You cannot select only the after-tax dollars in one IRA and convert those dollars tax-free while leaving all pre-tax IRA dollars untouched.

The calculation compares your after-tax basis with the total value involved in the year’s IRA distributions and conversions, plus the value remaining in those IRAs at year end. The after-tax percentage is the tax-free share of the conversion. The rest is generally taxable as ordinary income.

For example, if only 10% of the relevant combined IRA amount is after-tax basis, generally only 10% of the conversion is tax-free. Moving the nondeductible contribution into a separate traditional IRA does not avoid aggregation.

IRS Form 8606 reports nondeductible traditional IRA contributions, tracks after-tax basis, and calculates the taxable portion of a conversion. Basis that is not used this year carries forward, so keeping prior Forms 8606 is important.

A backdoor contribution and a Roth conversion are related but separate tax events. Growth between the contribution and conversion is generally pre-tax money, so converting that growth can create a small amount of taxable income.

What this means for you

Before converting, total every traditional, SEP, and SIMPLE IRA you own. Employer plans such as a 401(k) are not included in this IRA pro-rata calculation, although a plan’s rules may affect whether moving IRA money into the plan is available.

Estimate the taxable portion before acting. A transaction that creates a larger tax bill than expected may still fit a long-term plan, but do not spend a dollar to save thirty cents in taxes.

Keep records showing the nondeductible contribution, conversion, year-end balances, and every filed Form 8606. Each spouse applies the rule to their own IRAs and files their own Form 8606 when required.

For the investing steps and account mechanics, see Backdoor Roth IRA explained.

Common mistakes

• Assuming a nondeductible contribution makes the full conversion tax-free
• Ignoring a traditional, SEP, or SIMPLE IRA held at another institution
• Trying to isolate after-tax dollars in a separate IRA to escape the pro-rata rule
• Forgetting to file Form 8606 or losing the basis carried forward from an earlier year
• Treating taxes withheld from the conversion as money that reached the Roth IRA
• Converting without setting aside cash for the resulting tax bill

Related pages

• Roth conversions
• Traditional vs. Roth: the tax question
• How an IRA works
• Retirement withdrawal strategies