Gen Xers Get Final Shot At $1.01 Million Backdoor IRA Loophole

Between now and Dec. 31 looks highly likely to be your very last chance to take advantage of one of the best retirement planning tax breaks. That legal loophole is the Roth conversion of after-tax money in retirement accounts. It’s also known as the backdoor Roth IRA.


Why does Congress look determined to bolt shut backdoor Roth IRA conversions of after-tax money after Dec. 31? One big reason is that the money maneuver gives the typical 50-year-old a shot at a $1.01 million windfall. Tax-free. It’s that last detail that Congress wants to end.

The demise of backdoor Roth IRAs would apply to all taxpayers, regardless of income level.

Eliminating those conversions would help fund the proposed $3.5 trillion budget reconciliation package proposed by the House Ways and Means Committee. How? It would reduce the amount of money that flows into Roth IRAs, from which account owners can eventually withdraw it tax-free.

Roth IRA: Aftertax Vs. Pretax

Those conversions of after-tax money are different from “regular” Roth conversions. Those involve the more common transfer of pretax money from a traditional IRA or 401(k), where it gets a deduction. Then, it gets converted into a Roth account.

Congress is eying elimination of those for single taxpayers whose income is a new category, which Congress calls “adjusted taxable income,” over $400,000 and over $450,000 for married joint filers.

In 2021, you can’t contribute to a Roth IRA if your modified adjusted gross income (MAGI) is $140,000 or more. If you’re married and filing jointly, your MAGI must be under $208,000.

Differences between “taxable income,” “adjusted gross income” and “modified adjusted gross income” are explained here.

Millions Of Investors Affected

The threat to Roth conversions of after-tax money is broad. It would impact taxpayers regardless of their income level. “This proposal could affect millions of people with after-tax retirement accounts,” said Ed Slott, founder of

Fidelity Investments alone says 214,000 of its customers did such conversions year-to-date through June 30. That was a 29% increase over the same period last year.

Why Make Aftertax Contributions To An IRA?

One of the key benefits of a pretax contribution to a traditional IRA is that you can deduct your contribution from that year’s taxable income. So why does anyone make an after-tax contribution, which is not deductible?

There are two reasons. First, you may not be allowed to deduct your traditional IRA contribution if you are covered by a 401(k) or similar plan and your income is too high.

Second, you can’t contribute to a Roth IRA if your income is too high.

Aiming For A Roth IRA From The Outset

Either way, your goal is to get the contribution money into a backdoor Roth IRA. “Especially if you expect your tax rate to rise once you’re in retirement, your tax savings is greater if you can withdraw money tax-free because it’s coming out of a Roth IRA,” Slott said.

Broadly speaking, two groups of retirement savers can do backdoor Roth IRAs. One group, probably the larger one, consists of workers who contribute up to $6,000 this year to a traditional IRA. Their contribution cap is $7,000 if they are age 50 or older.

They could have anywhere from one year’s worth of after-tax contributions to several decades’ worth in an IRA.

‘Mega Backdoor Roth IRA’

The second group consists of workers contributing to an after-tax 401(k) account, after maxing out their annual limit for tax-deferred contributions. Only workers whose plan permits such contributions can do that. Their own contributions plus their employer’s can total up to $58,000 each year ($64,500 if age 50 or older). If their plan also allows them to make in-service distributions — that is, withdrawals while they’re still working — they can convert that money to a backdoor Roth IRA.

Chances are, Slott says, they’ve been doing that year by year. They can even convert the money to a backdoor Roth 401(k), if their plan offers that option, Slott says.

That $58,000 contribution limit means a lot of money could be sitting inside such an account. “That’s why it’s called a mega backdoor Roth IRA conversion,” Slott said.

And since you’ve already paid tax on the income that funds the after-tax contributions in the first place, there’s generally no tax on the conversion. In contrast, any money converted from a regular, pretax IRA to a Roth IRA is taxed as ordinary income. “You get to move this money from one pocket to another at absolutely no cost,” Slott said. “And then you can withdraw it years later without it being taxed.”

Are You Rich Enough?

Of course, only a relatively small percentage of workers can afford to do a mega backdoor Roth IRA conversion. “Not everyone has enough disposable income to be able to set aside $58,000 of their income,” Slott said. “But if you can afford it, it’s a great tax deal.”

For people whose contribution cap now is just $6,000 or $7,000, the regular backdoor Roth IRA is a great deal. “Congress hasn’t passed it yet,” Slott said. “But the writing is on the wall. People should complete the conversion by Dec. 31 to be sure it will be allowed under current law.”

Backdoor Roth IRA Bonanza

So, drum roll: how much can a backdoor Roth IRA save you in taxes? Let’s say you are 50 years old. You’re a member of Generation X. Your age group’s IRA balance averaged $123,800 as of June 30, says Fidelity Investments.

Look what happens if you convert that nondeductible IRA balance to a backdoor Roth IRA. The conversion is tax-free. That’s the loophole that Congress aims to close.

Suppose you plan to retire at age 70. For the past 15 years, through ups and downs, the broad stock market in the form of the S&P 500 has gained an average of 10.5% a year.

At that same rate of growth, by age 70 that backdoor Roth IRA balance will be $1.01 million, according to Even if your rate of growth is just half that pace, 5.25%, your ending balance will be $353,750.

And the withdrawals would be 100% tax-free. Nice deal, no?

Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about personal finance and active mutual fund managers who outperform the market by picking top-performing growth stocks.


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