How to profit from the IRA backdoor strategy: An opportunity for high earners

For many Americans, preparing for retirement is a delicate balance between investment performance, tax benefits and anticipating future needs.

Retirement accounts such as Individual Retirement Accounts (IRAs) play a central role in this equation.

But for high-income taxpayers, direct access to certain tax advantages, such as those offered by Roth IRAs, is restricted. This is where a little-known but powerful strategy comes into play: the Backdoor IRA.

What is a Backdoor Roth IRA?

The Backdoor Roth IRA is not a special account, but a tax strategy. It allows people whose income exceeds the IRS thresholds to indirectly access a Roth IRA.

It involves contributing after-tax money to a Traditional IRA (a non-deductible contribution), then converting these funds into a Roth IRA.

This allows you to benefit from the advantages of the Roth, in particular growth and tax-free withdrawals at retirement, while bypassing income limits.

Why is this retirement strategy useful?

In 2025, single taxpayers can no longer contribute directly to a Roth IRA if their Modified Adjusted Gross Income (MAGI) exceeds $165,000. For married couples filing jointly, the limit is $246,000, according to the IRS requirements. These thresholds effectively exclude many executives, entrepreneurs and professionals.

Through the "back door", these taxpayers can still invest up to $7,000 a year ($8,000 if age 50 or over) in a Roth IRA. And there are no income restrictions. A rare opportunity to optimize your retirement planning strategy over the long term.

How to set up a Backdoor Roth IRA?

There are four key steps to implementing this strategy:

1. Open a Traditional IRA with a broker or bank.
2. Make a non-deductible (after-tax) contribution.
3. Convert these funds to a Roth IRA, ideally quickly, to avoid taxable gains.
4. Complete IRS Form 8606 to report the non-taxable nature of this conversion.

It is essential not to invest the funds prior to conversion, and to comply with all tax formalities, otherwise the tax authorities may wrongly consider the entire conversion to be taxable.

Beware the pro-rata rule

One of the main pitfalls of the Backdoor IRA is the famous "pro-rata rule". This rule requires that all of a taxpayer's Traditional IRAs (including SEP and SIMPLE IRAs) be taken into account when determining the taxable portion of the conversion.

For example, if you already have $90,000 in pre-taxed Traditional IRAs, and you add $10,000 in non-deductible contributions, any conversion will be considered to contain 90% taxable funds. This can result in an unexpected tax bill.

Fortunately, there are ways around this rule, including transferring old IRAs to a company 401(k), which doesn't enter into the pro-rata calculation.

What are the advantages of a Roth IRA via Backdoor?

The Roth IRA offers unique retirement benefits:

• Tax-free growth.
• Tax-free withdrawals after 59 and a half (and 5 years of ownership).
• No Required Minimum Distribution (RMD) at age 73, unlike Traditional IRAs,
• And an indirect advantage on the taxation of Social Security benefits, since withdrawals from a Roth IRA do not increase the taxable income used to calculate taxes on these benefits.

In other words, this strategy allows you to optimize your tax situation at retirement, protect your future income and even organize your succession with a Roth IRA.

For whom is the Backdoor IRA suitable?

This strategy is particularly relevant if:

• Your income exceeds direct Roth IRA contribution limits
• You've already maximized your 401(k) or don't have access to a Roth 401(k)
• You have no pre-existing traditional IRAs (or have moved them into a 401(k)) 
• You're in a high tax bracket today, but anticipate even higher rates in retirement

But beware, this is not a one-size-fits-all solution. If you need the funds in the short term, or if you don't want to deal with the tax complexities associated with the pro-rata rule, it's best to consult a tax advisor before taking the plunge.

A strategy to consider when preparing for retirement

Against a backdrop of increasing tax pressure and uncertainty about the future of Social Security, every opportunity to optimize your retirement tax situation counts.

The Backdoor IRA is one such powerful strategy that, although technical, can offer lasting benefits to high-income households concerned about their future financial independence.

However, it's important to master the rules, and not to overlook the importance of professional guidance, as one misstep can be costly. But if properly executed, this strategy can make the difference between a tax-free retirement... and a taxed retirement.