By Joel Chouinard, CFP®
February 17th, 2025
A good rule of thumb for investors is to maximize tax-advantaged accounts before investing in a taxable account. The theory is that because there is no “tax drag” in a tax-advantaged account, if all else is equal, the money should grow faster than in a taxable account, especially when growth starts compounding. For example, if you invest $7,000 per year and earn an 8% average rate of return, you can expect to accumulate close to $800,000 in 30 years (ignoring taxes and fees). In contrast, if your money is in a taxable account and you withdraw it after 30 years, you’ll end up with around $680,000, assuming a 15% long-term capital gains rate. If your funds were in a Roth IRA, you’d get to keep every penny of the $800,000. That’s a $120,000 difference simply by choosing the right account!
The issue is because of the tax advantages, the IRS places restrictions on how much and who can contribute to these accounts. And you guessed it, high-income earners like Big Law attorneys are often the targets of those restrictions. But did you know you can still contribute to a Roth IRA even if you make above the income limits? You can do so by using the backdoor Roth IRA strategy.
What Are Roth IRAs?
Individual Retirement Accounts (IRAs) are among the few tax-advantaged accounts available. IRAs come in two forms: Traditional and Roth. The primary difference is how withdrawals get taxed. On one hand, withdrawals from a Traditional IRA are typically taxable*. On the other hand, funds in a Roth IRA can generally be withdrawn tax-free in retirement, provided you meet certain requirements**. For the 2025 tax year, the contribution limit is $7,000 per person and $8,000 for individuals over 50 years old.
So, why wouldn’t everyone choose a Roth IRA since withdrawals are tax-free compared to the taxable withdrawals from a Traditional IRA? Well, the IRS sets income limits on who can contribute directly to a Roth IRA. In 2025, if your Modified Adjusted Gross Income (MAGI) is above $165,000 for single filers or $246,000 for married filers, you cannot contribute directly to a Roth IRA.
These limits become relevant very early in a Big Law attorney’s career, with a first-year salary starting at $225,000 per year (plus a potential $20,000 bonus). If you exceed the income limit, thankfully, there is still a way to benefit from tax-free growth using the backdoor Roth IRA strategy.
How the Backdoor Roth IRA Funding Strategy Works
The Backdoor Roth IRA is a simple, four-step process:
Step 1 – Open a Traditional IRA account and make a non-deductible contribution. Traditional IRAs don’t have income limits, so anyone can contribute. Leave the money in cash or a money market account (i.e., don’t invest the money yet).
Step 2 – Open a Roth IRA account (but don’t fund it). This is the account that will ultimately receive the funds.
Step 3 – Convert your Traditional IRA non-deductible contribution to your Roth IRA account. To do so, your financial institution will ask you to complete a Roth Conversion form.
Step 4 – Invest your dollars. Now that the money is in the Roth IRA, you can invest it and enjoy tax-free growth!
Keep in mind that since you made your non-deductible Traditional IRA contribution using after-tax dollars (money on which you have already paid taxes), and there was no growth in that account (because you left it in cash), you should not owe taxes on the conversion. However, if you have other pre-tax IRA accounts, beware of the pro-rata rule (see more on this below).
Reporting Your Backdoor Roth IRA Contribution on Form 8606
The process of executing the Backdoor Roth IRA strategy is relatively straightforward. Where most people get in trouble is during the reporting on their tax returns. To report your Backdoor Roth contribution, you must file Form 8606. This form reports non-deductible contributions to Traditional IRAs as well as Roth conversions. Its primary purpose is to determine whether your Roth conversion was taxable due to the pro-rata rule (see more on this below).
The key is to communicate your strategy with your accountant so they can report it accurately on your tax return. If you simply hand over your tax documents and assume everything will work out, think again. During my review of clients’ tax returns, I’ve often uncovered situations where backdoor Roth contributions were reported incorrectly, leading clients to potentially pay taxes twice on the same money. I’m all about tipping, but please don’t tip the IRS!
Beware of the Pro-Rata Rule
If you have money in a Traditional IRA that was established by rolling over a pre-tax 401(k) or other pre-tax workplace retirement accounts from previous jobs, beware of the pro-rata rule. If this applies to you, the Roth conversion, which is typically tax-free, will need to be counted as income.
For example, assume you have $21,000 in a Traditional IRA, which was funded with a rollover from an old pre-tax 401(k). That year, you want to utilize the backdoor funding strategy, so you first make a $7,000 non-deductible contribution to your Traditional IRA (step 1). You now have a total of $28,000 in that account, consisting of $21,000 of pre-tax (75% of account value) and $7,000 of after-tax dollars (25% of account value). Due to the pro-rata rule, when you complete your Roth conversion (step 3), only 25 percent of your $7,000 contribution ($1,750) will be tax-free. The rest ($5,250) must be reported as ordinary income on your tax return for that year. This calculation is done on Form 8606.
To get around the pro-rata rule, you can roll your Traditional IRA back into your current 401(k), assuming your plan allows it. This will “zero out” your pre-tax IRAs and allow you to use the backdoor Roth IRA strategy without any tax implications. Another strategy is to convert your entire pre-tax Traditional IRA to your Roth IRA, but be aware that you will owe taxes on the full conversion.
Other Things to Consider with Your Roth IRA
- Between January 1st and April 15th is a great time for Big Law attorneys to fund Roth IRAs because you can still contribute for the previous tax year if you haven’t reached the maximum amount allowed yet. Most Big Law firms hand out their year-end bonus around this time, so you can use it to fund both this year and last year's contributions. If you need other ideas on how to allocate your year-end bonus, read this article. Note that contributions for the previous tax year must be made before you file your taxes or before the tax-filing deadline, whichever comes first.
- If you are over the Roth IRA income limits and have a non-working spouse, they can also use the backdoor funding strategy even if they are not earning income.
Final Note
The backdoor Roth IRA strategy allows high-income earners to bypass Roth IRA contribution limits and benefit from tax-free growth. Big Law attorneys can optimize their retirement savings by following the steps outlined and carefully navigating the various rules. I encourage you to speak with a financial planner to ensure this strategy aligns with your overall financial plan and start building your tax-free retirement nest egg today!
*If the entire balance of the Traditional IRA was pre-tax (i.e., taxes have never been paid on this money), then the entire withdrawal is taxable as ordinary income. If there was a portion of the Traditional IRA that was post-tax, then the withdrawals are subject to the pro-rata rule.
**Contributions to a Roth IRA may generally be withdrawn at any time without tax consequences. Earnings may generally be withdrawn tax-free if the account is held at least 5 years and withdrawals are made after the account owner reaches age 59 ½. If earnings withdrawals are made before the 5-year period or age 59 ½, income taxes are due, and a 10% federal tax penalty may apply.
SharpEdge Financial LLC is a registered investment adviser registered with the State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments or types of investments are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment. The author of this publication may hold positions in investments or types of investments mentioned. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.