Retirement Unlock: Understanding the Backdoor Roth IRA
A story about a high-income earning household and how they opened a door to tax free retirement savings.
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Many high-earning families save responsibly and invest well, yet still miss opportunities—especially when it comes to Roth IRAs. In this episode of Well Balanced, Senior Wealth Advisor Mike Nesheim describes how one couple used a retirement savings strategy hiding in plain sight: the backdoor Roth IRA.
The Challenge: Income Limits Prevent Direct Roth IRA Contribution
A physician and his spouse were contributing to their retirement accounts, but their income exceeded the limits for direct Roth IRA contributions. They assumed the door to tax-free retirement savings was closed. It wasn’t.
How the Backdoor Roth IRA Works
When income is too high for a direct Roth contribution:
• You can still make a nondeductible (after-tax) contribution to a traditional IRA.
• Those dollars grow tax-deferred inside the IRA.
• You can then convert that after-tax contribution to a Roth IRA, unlocking tax-free growth and withdrawals in retirement.
In this case, the spouse, who wasn’t working full-time, could still contribute because they filed taxes jointly. By converting those contributions annually, the couple was able to create a long-term savings strategy where future value could be withdrawn tax-free at retirement.
Why It Matters: Tax-Free Growth and Flexibility
Roth IRAs offer:
• Tax-free growth
• Tax-free qualified withdrawals
• No required minimum distributions
• Greater flexibility when tax brackets change over time
Over many years, consistent contributions and conversions can create meaningful value and long-term flexibility.
Know the Rules: The Pro Rata Rule
The strategy isn’t complicated, but it does require care. The IRS applies the pro rata rule when you hold both pre-tax and after-tax IRA balances. All IRA accounts are viewed together when calculating how much of a conversion is taxable. If you have only after-tax money and no pre-tax IRA balances, the conversion is generally tax-free. But if you have mixed balances, the taxable amount is prorated.
This is exactly why coordination with your advisor and tax professional is essential. When implemented thoughtfully, a backdoor Roth IRA can become a valuable lever in a flexible, long-term plan.
Turning Insight Into Action
For the physician and spouse, this strategy transformed a seemingly closed door into a powerful planning opportunity. It’s a reminder that small adjustments can create meaningful long-term benefit.
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If you’re wondering whether a backdoor Roth IRA or Roth conversion fits into your household plan, connect with your Vector advisor. We’re always here to help you explore options in a way that aligns with your goals.
Chapters
0:09 – High-Earner’s Retirement Challenge
0:34 – Understanding Backdoor Roth IRA
1:28 – After-Tax Contributions
2:17 – Tax-Free Growth
2:43 – The Pro Rata Rule
3:46 – About Vector Wealth
4:36 – Three Simple Steps to Get Started
5:58 – Taking Action & Financial Future
6:11 - Regulatory
Transcript
(Adapted for readability)
Introduction: A High-Earning Couple's Retirement Challenge
I want to share a story about a couple that I helped take a closer look at optimizing their saving and investment strategy, a physician and a spouse. I'm Mike Nesheim and I am a senior wealth advisor at Vector Wealth Management. Like many high earning families, they were saving diligently, they investing well and doing just about everything right, but they were hitting a frustrating wall when it came to retirement contributions.
Understanding the Backdoor Roth IRA Strategy
Their household income was too high to make direct Roth IRA contributions, and they assumed that meant the door to tax free and retirement savings was closed. It wasn't. Once we sat down and walked through the options, they realized there was a way to unlock that door through what's called a backdoor Roth IRA.
It's not a new idea, but it's one that can have a real impact when applied thoughtfully. Here's how it works. When your income is above the limit to contribute directly to a Roth IRA, you can still make a traditional IRA contribution. Anyone with earned income can at higher income levels, those contributions simply become a non-deductible, meaning you do not get a tax break upfront like you would with a typical 401k, for example, where contributions come straight from your paycheck before taxes.
How After-Tax Contributions Work
These are after-tax dollars, but they can still grow tax deferred. Inside your IRA, you can buy, sell, and rebalance investments without triggering taxes along the way. Now here's the next step and where the real opportunity lies through a backdoor Roth conversion. You can move those after-tax dollars into the Roth IRA where they can grow and eventually be withdrawn tax free in retirements.
That's the best of both worlds. Tax deferred growth while you invest and tax free income when you need it most. In their case, the physician's spouse wasn't working full time, but because they filed taxes jointly, the household's income could be used to fund an IRA contribution for both of them. From there, the spouse's contribution could be converted into a Roth IRA, creating a source of future tax-free income for the household.
The Power of Tax-Free Growth
Here's why that conversion can be powerful. A Roth IRA grows tax free and qualified withdrawals are tax free in retirement. That means no required distributions and no surprises later when tax brackets shift for this couple. That meant more control and potentially tens of thousands of dollars in reduced taxes over the next 20 years if they continued contributing and converting over the years.
Important Rules: The Pro Rata Rule
Those annual contributions have an opportunity to grow and compound tax free through retirement. Now, this isn't a strategy to just jump into blindly. There are a few rules to understand. One of them is called the pro rata rule. It applies when you have or will have a mix of pre-tax and after-tax money in your IRAs, whether it's traditional SEP or simple IRAs.
If you have balances in pre-tax IRAs, your conversion will be prorated across your total pre-tax and after-tax balances. In other words, the IRS looks at all of your IRA accounts combined when determining how much of your conversion is taxable. If on the other hand, you only have after tax IRA money with your, with your one contribution and no pre-tax balances at anywhere, then your conversion is generally tax free, is because of these nuances that we recommend working closely with your advisor and tax professional to map out the most efficient approach before you convert.
Three Simple Steps to Get Started
Three simple steps to help you along the way. If this idea sounds like it might fit your situation. Here's a simple way to start. Number one, consider whether your household income or long-term tax picture might make a backdoor Roth IRA worthwhile. Number two, talk with your advisor and tax professional to evaluate timing existing IRA balances and the potential tax impact.
Number three, complete the conversion with your advisor. At Vector, we can help handle nearly all the details for our clients and make the process easy. Done correctly, a Roth conversion can create decades of tax-free growth through a one time or recurring annual strategy. Strategies like this one are simple levers, ways to align to resources with your goals, whether it's how you invest, when to claim your social security, or how you draw from taxable versus accounts.
It all adds up to an aligned and flexible plan. For the physician and his spouse, that small insight, the ability to make backdoor Roth IRA contributions transformed a missed opportunity into a confident, tax efficient strategy for their future. If you're wondering whether a backdoor Roth IRA, or Roth Conversion could strengthen your household plan, connect with your Vector advisor, we'd be happy to walk through the details and explore how this might fit.
Conclusion: Taking Action on Your Financial Future
And if this story resonates or reminds you of someone in your life, share it. Sometimes the right idea at the right time makes all the difference. Thanks for listening. See you next time and stay well balanced.
Contact Us or Schedule an Intro Call
These discussions aim to spark dialogue about enhancing retirement readiness and making more informed financial decisions. At Vector, we delve into the nuances of scenario planning, offer insights and guidance tailored to each client's unique circumstances. If you or someone you know is pondering their financial future or seeking clarity on their retirement plan, we're here to help.
Disclosures
Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for any individual. This material is not intended as, nor should it be relied upon for, tax, legal, or accounting advice. Always consult your own tax, legal, and accounting advisors before making decisions or implementing strategies. Listeners are encouraged to seek advice from a qualified tax, legal, or investment adviser to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance. Investments involve risk and unless otherwise stated, are not guaranteed.
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