Since 1998, the Roth IRA has been an alternative retirement savings vehicle to the traditional IRA. After investors contribute directly to a Roth IRA using after-tax contributions, earnings are tax-free, no matter how much they have grown. 

When the IRS lifted income restrictions on Roth IRA conversions in 2010, high income earners started using a loophole known as the backdoor Roth to convert after-tax dollars to Roth IRAs that they otherwise would not have been eligible for. In November 2021, the U.S. House of Representatives approved a measure that would have closed the backdoor Roth loophole, but the legislation has stalled in the Senate. For now, the backdoor remains open, but it may not always stay that way.

Is the backdoor Roth IRA going away?

Investors using backdoor Roth strategies take after-tax contributions made to a traditional IRA or qualified 401(k) plan, then convert them to a Roth IRA. This bypasses income limits on contributions to Roth IRAs imposed by the IRS. The Roth conversion deadline is Dec. 31, and the conversion applies to the current tax year. 

The perception among some politicians in Washington is that the backdoor Roth gives high income individuals an unfair means to exploit the tax system. A provision in President Biden’s $1.7 trillion omnibus legislation—The Build Back Better Act—closes the backdoor Roth loophole. The bill passed the House and moved to the Senate. But West Virginia Senator Joe Manchin’s reluctance to support Build Back Better stymied the bill, and its status is in limbo. 

The backdoor Roth remains a legal option for now, but a retooled Build Back Better Act could come back and close the loophole. It might even be retroactive, impacting backdoor Roth conversions that have already occurred, which has some investors questioning whether it remains a viable strategy. 

Specific propositions in Build Back Better that could affect backdoor Roth IRAs

The reforms to retirement savings plan rules in the bill passed by the House could yield trillions of dollars in revenues that would help to pay for new spending in the Build Back Better Act. TheHouse bill would phase in between 2022 and 2032. Key provisions include:

Restrictions on contributions to all IRAs.

High income single filers earning over $400,000 and married couples over $450,000 would not be allowed to make additional contributions to any of their IRAs, if the grand total of all their retirement investments—traditional IRAs, Roth IRAs, annuity contracts, 457(b) deferred compensation plans, and defined contribution accounts—topped $10 million.

No more backdoor Roth conversions of after-tax contributions

. After-tax rollovers from a traditional IRA or 401(k) plan  to a Roth IRA would end. 

• This change would apply to everybody, regardless of income
• Pre-tax IRA conversions would still be allowed until 2032, but taxes would be applied upon conversion. 

• Mega backdoor Roth conversions—which permit individuals to convert as much as $38,500 from qualified 401(k) plans to a Roth IRA—would cease as of January 2022. If Build Back Better becomes law, this provision might be retroactive.

High income earners will be excluded from any Roth conversions

. By 2032, individual high earners over $400,000 and couples over $450,000 wouldn’t be able to make any kind of Roth conversions, including traditional IRAs and Roth 401(k) plan conversions. 

Required minimum distributions

. High income individuals and married couples with any type of defined contribution retirement savings account (IRAs and 401(k) plans) totaling $10 million or more, would be required to withdraw 50% of the amount above $10 million—starting December 31, 2028. Any individual or couple at these income thresholds with more than $20 million in retirement accounts AND who with some portion of those funds held in a Roth IRA would have to make withdrawals according to the lesser of two options: (a) take out the entirety of the Roth balance or (b) withdraw enough from all accounts to reduce the total balance to $20 million. Early withdrawal penalties would not apply.

Potential impacts of Build Back Better

If the bill were to make passage through the Senate, the tax advantages of a backdoor Roth IRA conversion would start phasing out in 2022. High income earners in particular would feel the impact. 

• Mega backdoor Roth conversions would end, backdated to January 2022.
• Aggregated retirement account balances would be capped.
• Minimum distributions would be required after 2029 for some.
• The backdoor would permanently close in 2032.

What makes Roth IRAs so unique?

IRAs of all types offer many benefits to investors. Roth IRAs do not provide for tax-deductible contributions like a traditional IRA, but they have distinguishing features that make them worth considering. 

• Individuals below the income threshold (currently a modified adjusted gross income of $144,000 for a single filer, $214,00 for married filing jointly or widowed) can make after-tax contributions with the assurance that future earnings and qualified distributions would be tax-free. 
• Unlike a traditional IRA, individuals can continue making contributions after age 70 ½. 
• There are no required minimum distributions. 
• Investors can bequeath qualified distributions to a beneficiary—all of it tax-free. 

Roth conversion rules have changed over time

. Before 2010, you could only roll over from another type of IRA (or qualified retirement plans) into a Roth IRA if your modified adjusted gross income was less than $100,000 and your filing status was anything except married filing separately. These income and filing status restrictions were lifted in 2010, which is what opened backdoor access to the Roth IRA. 

• Backdoor Roth conversions became a popular option for high income earners. So long as you made after-tax contributions, you could do conversions regardless of income level, despite the income restrictions on direct contributions to Roth IRAs. 
• Currently, the maximum annual contribution to a Roth is $6,000 per year ($7,000 if you’re over age 50). Conversions don’t have such contribution limits. You can convert some or all of the funds in a traditional IRA to a Roth IRA.
• There’s an even bigger backdoor available for high income earners—the mega backdoor Roth—which permits conversions up to $38,500 from qualified 401(k) retirement plans into a Roth IRA. Note that the 401(k) plan must allow for such mega backdoor Roth conversion—not all of them do. 

The backdoor Roth IRA is a legal maneuver, but in the eyes of some observers, it seems contrary to the original intention of the Roth IRA, which was designed to help middle class earners save for retirement. In the name of fairness, the Build Back Better Act wants to shut the backdoor Roth loophole for good and restore the original intent of the Roth IRA—to encourage middle income earners to save for retirement. 

FYI: Try Titan’s free Roth IRA Calculator to project how much your Roth IRA will give you in retirement.

What does the future hold?

Whether backdoor Roth strategies will remain legal is an open question. There is a range of possible outcomes. 

• If the bill as currently written becomes law in 2022, it could retroactively apply to January 1, 2022. Analysts don’t agree whether this outcome will happen. 

• The ban on conversions could begin as soon as 2023. The uncertainty makes some investors hesitant to do any backdoor Roth conversions for this tax year. 
• The bill might not pass at all, and the backdoor Roth would be preserved, as is.

The situation demands close scrutiny, and investors might consider talking with a financial advisor about tax implications and other options, in the event that the backdoor shuts for good.