Determine Roth IRA Eligibility
Investors with earned income may be able to contribute to a Roth IRA. For 2025, the maximum Roth IRA contribution is $7,000. If you are aged 50 or older, you can make an additional $1,000 catchup contribution. For 2026, the maximum Roth IRA contribution is $7,500. And in 2026 for those aged 50 or older, the catchup contribution increases to $1,100, making the total contribution $8,600. If you are eligible for a Roth IRA, here a 3 Easy Reasons to Open a Roth IRA.
Earned income is from your wages as an employee. Additionally, any self-employed earned income would count also. You need to have earned income of at least the amount you are going to contribute to a Roth IRA to be eligible.
Remember, there is no age limitation in funding a Roth IRA. You only need the earned income mentioned above, and, absent the income limitations discussed below, you are good to go.
Income Limitations
However, there are income limitations that will disallow you to qualify for a Roth IRA. In 2025, a single individual they can contribute to the Roth IRA and get the full contribution if their modified adjusted gross income (MAGI) is under $150,000. If their MAGI is over $165,000, they are not eligible to contribute to a Roth IRA. Income between these two amounts allows for a partial Roth contribution.
A married couple filing jointly can contribute to a Roth IRA if their MAGI is under $236,000. If their MAGI is above or $246,000, they can not contribute to a Roth IRA. Income between these two amounts allows for a partial Roth contribution.
Practical Matters
As a practical matter, if your income is near the income limitations, hold off on funding your Roth IRA. You have until April 15th, the due date of your income tax return, to fund your Roth IRA for the prior year. In other words, for your 2025 income tax return, you have until April 15, 2026. However, wait until you get the green light from your CPA that you are eligible for the Roth IRA contribution.
Backdoor Roth IRA Conversion
For many years more aggressive investors who were not eligible to fund a Roth IRA due to their income level were funding a Roth IRA by using a Backdoor Roth IRA Conversion. This approach appeared to be a violation of the “Step transaction doctrine.” However, back in 2018 the Internal Revenue Service (IRS) indicated they would not challenge taxpayers using the Backdoor Roth IRA Conversion.
For example, Joe and Mary earn $300,000 a year. They contribute the maximum to their 401(k) plans every year. They would like to save more for retirement. However, due to their income, they are ineligible to fund a Roth IRA.
However, they may be able to take advantage of the Backdoor Roth IRA Conversion. First, in 2025, as they are both over the age of 50, they could each contribute the $8,000 to a non-deductible traditional IRA. Second, they would do a conversion using the Backdoor Roth IRA. The conversion means they are distributing the nondeductible traditional IRA out and converting this into the Roth IRA. As this was a nondeductible IRA, it should not result in any taxable income in the year of the conversion. However, any earnings while the funds were in the non-deductible IRA would be taxable income.
Funds inside Roth IRAs grow income tax free. To have the funds in a Roth IRA become tax free with a qualified distribution, you need to meet two criteria:
- The Roth IRA account needs to be opened for five years.
- The Roth IRA account owner needs to be at least age 59 ½ when taking a distribution.
To expand on this, for Roth IRA contributions, the five-year rule mentioned above:
Starting with the first year you make a Roth IRA contribution.
However, for the Backdoor Roth IRA Conversion, the five-year rule applies to each conversion you make.
Having said that, that is it. Meet these two straightforward conditions and all your Roth IRA distributions are income tax free.
If Joe and Mary’s income consistently remained above the income phase out limitations, they should consider doing an annual Backdoor Roth IRA Conversion. If they both did annual Backdoor Roth IRA Conversions for two decades of contributing $16,000 a year that would be $320,000 of Roth IRA Conversions. Plus, whatever the earnings are on this account.
That is a lot of money that will be income tax free.
You can see how much more tax efficient a Roth IRA is over investing in a taxable account. In a taxable account, any interest income earned would be taxable at ordinary income tax rates. The highest Federal Income Tax Rate is 37%. The highest State of Connecticut Income Tax Rate is 6.99%.
Long term capital gains (assets held for a year and a day) are taxed at 0% for lower incomes, 15% for middle incomes and 20% for higher incomes. Qualifying dividends are taxed at 15%. Non-qualifying dividends would be taxed as ordinary income.
You could be in retirement for a long time. To enjoy your retirement and keep it going, check out, Everyone Knows You Need to Diet and Exercise.
Complete the Correct IRS Form
Your CPA will need to prepare the appropriate IRS form. The form that documents your Backdoor Roth IRA Conversion is IRS Form 8606, Nondeductible IRAs.
This IRS Form documents that you contributed to a nondeductible IRA. It also documents that you did a Backdoor Roth IRA Conversion. This IRS Form is filed with your individual income tax return.
Caution Flag
However, caution needs to be exercised if you are considering a Backdoor Roth IRA Conversion. For investors that already have assets in an IRA, SEP IRA, or SIMPLE IRA this approach may not work for you. If you do not have any assets in these vehicles, you can do a Backdoor Roth IRA Conversion. However, if you have assets in any of these accounts, the pro rata rule comes into effect. Essentially, having assets in these accounts will diminish the tax advantage of the conversion. Not all of the conversion from the IRA to the Roth IRA will not be income tax free.
One feasible way around this is to determine if your employer’s 401(k) allows an IRA -to- 401(k) rollover. Follow up with your employers’ Human Resources Plan Administrator to see if it offers this.
If it does, and if you like how your employer’s 401(k) is structured, consider rolling your IRA to your employer’s 401(k). The main structural considerations are the plan investment menu options and the fees associated with the plan.
Do Not Have the Check Issued to You
Remember, if you are going to transfer funds from your IRA to your employers 401(k) plan, do not ask your IRA custodian to issue you a check. I know, you have 60 days to rollover the check into your 401(k) plan and not be taxed on it. It sounds straightforward, and it should be. It is just that sometimes:
Things can go sideways.
Do not have the IRA distribution check issued to you. First, your IRA custodian will need to withhold income taxes. This means the full amount of the distribution will not be converted due to the income tax withholding. If you want the full amount converted, you will need to have other sources of cash to fund the rollover portion of the income taxes that were withheld.
Second, if you miss the 60-day rollover window, this is all taxable income to you. Additionally, if you miss the 60-day rollover window and are under the age of 59 ½, with extremely limited exceptions, are subject to an additional early withdrawal penalty of 10%.
Ouch.
Instead, request a trustee-to-trustee transfer. Just complete the required paperwork with your IRA custodian. They will then have the assets in your IRA transferred into your 401(k) plan.
This will prevent this from going sideways.
Required Minimum Distribution Rules (RMD)
Unlike a traditional IRA, the Roth IRA is not subject to the required minimum distribution rules (RMD) during the account holder or surviving spouses lifetime. These rules require taxpayers with IRAs and 401(k)’s to begin taking distributions from these accounts when they turn 73. The IRS uses a life expectancy table to determine the annual RMD. However, the RMD rules do not apply to Roth IRAs for the account holder. Additionally, they do not apply if the surviving spouse if they elects to treat the Roth IRA as their own. This may allow a Roth IRA to grow income tax free for decades.
A non-spousal beneficiary of a Roth IRA does not have an annual RMD requirement. These beneficiaries could be children, grandchildren, other family members that you want to inherit your Roth IRA. However, the account must be distributed by the end of the tenth year after the account owner’s death.
Conclusion
For investors that are eligible to contribute to a Roth IRA, we strongly recommend it. If you are not eligible due to the income limitations, consider a Backdoor Roth IRA Conversion.
If you need help with Practical Steps to Fund a Backdoor Roth IRA Conversion, call Thomas F. Scanlon, CFP®, CPA at (860) 645-1515.
This is original content written by Manchester, Connecticut Financial Advisor Thomas F. Scanlon, CFP®, CPA.
The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Thomas F. Scanlon, CPA, CFP® and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and subject to change.
Changes in tax laws or regulations may occur at any time and could substantially impact your situation. While familiar with the tax provisions of the issues presented herein, Raymond James Financial Advisors are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Investing involves risk and investors may incur a profit or a loss.