Personal Finance
How high earners can use a backdoor Roth IRA
IRA access, tax breaks can phase out for high earners
IRAs have a $7,000 annual contribution limit for 2024. Investors age 50 or older can save an extra $1,000, or $8,000 total this year.
Investors who save in a pretax IRA typically get a tax deduction on their contributions. However, they generally pay income tax later on earnings and withdrawals. Roth contributions don’t get the same upfront tax break: Investors fund Roth IRAs with after-tax money, but generally don’t pay income taxes on earnings or withdrawals in retirement.
Many high earners can’t make the most of these tax-advantaged accounts, though.
For example, married couples who file a joint tax return can’t contribute to a Roth IRA in 2024 if their modified adjusted gross income is $240,000 or more. The income threshold for single filers is $161,000. (Eligibility starts to phase out even before these dollar thresholds, reducing how much investors can contribute.)
Likewise, there are income limits on deductibility for pretax (also known as “traditional”) IRAs, for those who also have access to a workplace retirement plan like a 401(k).
For example, single filers with income of $87,000 or more in 2024 don’t get a tax deduction for contributions to a traditional IRA, if they are covered by a retirement plan at work.
The same holds true for married couples filing jointly. For example, if your spouse participates in a 401(k) plan at work, you don’t get a deduction on IRA contributions if your joint income is $240,000 or more. If you are the one who participates in workplace 401(k), the limit is $143,000. (Again, you may only get a partial deduction below these dollar thresholds due to income phaseouts.)
The ‘only reason’ to save in a nondeductible IRA
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High earners can contribute to a so-called nondeductible IRA, however.
This is a traditional IRA, but investors don’t get a tax deduction for their contributions; they fund the accounts with after-tax money. Investors owe income taxes on growth later, upon withdrawal.
The ability to use the backdoor Roth IRA is a major benefit of these accounts, tax experts said.
It only applies to investors who make too much money to contribute directly to a Roth IRA or make a tax-deductible contribution to a traditional IRA, Slott said.
Here’s the basic strategy: A high-income investor would make a nondeductible contribution to their traditional IRA and then quickly convert the funds to their Roth IRA.
“The only reason you’d do [a nondeductible IRA] is if the intention was to do a backdoor Roth,” Slott said.
After making the nondeductible contribution, Slott recommends waiting about a month before converting the funds to a Roth IRA. This ensures your IRA statement reflects the nondeductible contribution, in case the IRS should ever require proof, he said.
Some investors may also be able to take advantage of a similar strategy in their 401(k) plan, the so-called mega backdoor Roth conversion. This entails shifting after-tax 401(k) contributions to a Roth account. However, the strategy isn’t available to everyone.
“All high wage earners should consider looking at both a backdoor Roth IRA and a mega backdoor Roth IRA if they can’t set up a Roth IRA,” said Ted Jenkin, a certified financial planner and founder of oXYGen Financial, based in Atlanta. He’s also a member of the CNBC Financial Advisor Council.
When a nondeductible IRA doesn’t make sense
A nondeductible IRA likely doesn’t make sense for investors who don’t intend to utilize the backdoor Roth strategy, according to financial advisors. In such cases, the investor would just let contributions stay in the nondeductible IRA.
For one, nondeductible IRA contributions carry potentially burdensome administrative and recordkeeping requirements, Slott said.
“It’s a life sentence,” he said.
Taxpayers have to file a Form 8606 to the IRS every year to keep track of their after-tax contributions to a nondeductible IRA, according to Arnold & Mote Wealth Management, based in Hiawatha, Iowa. Withdrawals “add more complexity” to that administrative lift, it added.
Why taxable brokerage accounts ‘are probably better’
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Without a backdoor Roth in play, most investors would be better suited by saving in a taxable brokerage account rather than a nondeductible IRA, advisors said. That’s because investors using the former will likely end up paying less in tax on their profits over the long term.
Taxable brokerage accounts “are probably better in most aspects,” Slott said.
Investors who hold assets like stocks in a taxable brokerage account for more than a year generally pay a favorable rate on their profits relative to other income taxes.
These “long term” capital gains tax rates — which only apply in the year investors sell their asset — are as high as 20% at the federal level. (High earners may also owe a 3.8% “Medicare surtax” on profits.)
By comparison, the top marginal income tax rate is 37%. Investors in nondeductible IRAs are subject to these generally higher rates on earnings upon withdrawal.
While taxable brokerage account investors pay taxes each year on dividend income, such taxes are generally not enough to negate the relative tax benefits of such accounts, advisors said.
“The tax deferral of non-deductible IRAs can be an advantage for some,” according to Arnold & Mote Wealth Management. “However, we find that this is quite rare.”
Additionally, investors in taxable brokerage accounts can generally access their funds anytime without penalty, whereas IRAs generally carry tax penalties when earnings are tapped before age 59½. (There are some IRA exceptions, however.)
Taxable accounts have no required minimum distributions while the account holder is alive, unlike traditional and nondeductible IRAs.
“A taxable account provides the flexibility to add money and take money out with few limits, penalties, or restrictions,” Judith Ward, a certified financial planner at T. Rowe Price, an asset manager, wrote recently.
Americans are growing increasingly uneasy about the state of the U.S. economy and their own personal financial situation in the face of stubborn inflation and tariff wars.
To that point, 73% of respondents said they are “financially stressed,” with 66% of that group pointing to the tariff wars as a main source, according to a new CNBC/Survey Monkey online poll.
The survey of 4,200 U.S. adults was conducted April 3 to 7.
Americans feeling financially stressed
CNBC/Survey Monkey polls from 2023, 2024, and this year have found that, on average, more than 70% of Americans said that they are stressed about their personal finances. This year’s survey found that 38% of respondents overall said they are “very stressed,” and 29% of high-earners with incomes of $100,000 or more also shared that sentiment.
Consumers are, of course, increasingly stressed by rising prices for essentials like food, energy, and shelter. This is due to a number of factors, including rising inflation, supply chain disruptions and geopolitical events.
In the new CNBC survey, 86% of Americans cite inflation as the top reason for their financial stress, while 75% pointed to interest rates and 66% cited tariffs.
While inflation peaked at 8% in 2022, a 40-year high, it has since cooled significantly, reaching 2.4% in March. Despite this decline, the increased prices during 2022 have led to a loss of purchasing power for Americans, meaning they can buy less with the same amount of money than before.
It would take nearly $114 today to buy what would have cost $100 in January of 2022, according to the Bureau of Labor Statistics.
And while Inflation has eased, experts do say the fallout from President Trump’s trade war threatens to put upward pressure on prices in the months to come.
Tariffs are generally considered to be inflationary, economists say. This is because tariffs increase the cost of imported goods, which can then be passed on to consumers in the form of higher prices. This can lead to a temporary increase in the overall inflation rate.
“We know that tariffs are inflationary,” said David McWilliams, an economist, podcaster and author. “We know that’s hitting on people’s expectations of how much money they’re going to have in their pocket in a couple of months time.”
So, when it comes to financial stress caused by tariffs, 59% of those surveyed by CNBC oppose President Trump’s tariff policy, with 72% concerned about the impact on their personal financial situation.
As a result, 32% said they have delayed or avoided making retail purchases, and 15% said they have “stocked up.”
What’s more, 34% of those surveyed said they have made changes to their investments due to recent stock market volatility from tariffs.
Handling financial stress
Many investors are concerned about their retirement savings, but financial experts say it’s important for those with a long-term perspective to understand that short-term market volatility is a distraction that’s better off ignored.
“The biggest thing is that it’s unknown, and when we don’t know things, and we can’t control things, that’s when our anxiety and our worry can spike, and it’s contagious,” said licensed therapist and executive coach George James, CNBC Global Financial Wellness Advisory Board member, a licensed therapist and executive coach.
While the market could be in for a bumpy ride over the next few months, experts say it’s best to stay the course and avoid making major portfolio changes based on the latest news.
To manage investments during the latest tariff volatility, for example, financial advisors urge investors to maintain a long-term perspective, review and potentially adjust their asset allocation, and consider diversification to mitigate risk. It’s also smart to bolster emergency funds, review your risk tolerance, and explore opportunities for tax-loss harvesting.
Financial experts also urge investors to focus on their risk appetite — and their goals.
“This is the time to evaluate short-, mid-, and long-term financial needs, concerns, and goals. Evaluation before action or inaction is essential,” said Michael Liersch, head of advice and planning at Wells Fargo, said in an e-mail to CNBC. “Getting specific on exact dollar targets, timelines around these targets, and their level of importance [priority] can create clarity around what should be done, if anything.”
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As investors digest the latest bond market sell-off, advisors have tips about portfolio allocation amid continued market volatility.
Typically, investors flock to fixed income like U.S. Treasurys when there’s economic turmoil. The opposite happened this week with a sharp sell-off of U.S. government bonds, which dropped bond prices as yields soared. Bond prices and yields move in opposite directions.
Treasury yields then retreated Wednesday afternoon when President Donald Trump temporarily dropped tariffs to 10% for most countries but increased levies on Chinese goods. That duty now stands at 145%.
As of Thursday afternoon, Treasury yields were down slightly.
Still, “there’s a massive amount of uncertainty,” Kent Smetters, a professor of business economics and public policy at the University of Pennsylvania’s Wharton School, told CNBC.
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Experts closely watch the 10-year Treasury yield because it’s tied to borrowing rates for products like mortgages, credit cards and auto loans. The yield climbed above 4.5% overnight on Tuesday as investors offloaded the asset. As of Thursday afternoon, the 10-year Treasury yield was around 4.4%.
Kevin Hassett, director of the U.S. National Economic Council, told CNBC on Thursday that bond market volatility likely added “a little more urgency” to Trump’s tariff decision.
As some investors question their bond allocations, here’s what advisors are telling their clients.
Take the ‘proactive approach’
Despite the latest bond market sell-off, there hasn’t been a recent shift in client portfolios for certified financial planner Lee Baker, owner of Apex Financial Services in Atlanta.
“I’ve been taking a proactive approach” by shifting allocations early based on the threat of future tariffs, said Baker, who is also a member of CNBC’s Financial Advisor Council.
With concerns about future inflation triggered by tariffs, Baker has increased client allocations of Treasury inflation-protected securities, or TIPS, which can provide a hedge against rising prices.
Consider ‘guardrails’
Ivory Johnson, a CFP and founder of Delancey Wealth Management in Washington, D.C., has also been defensive with client portfolios.
“I’ve used instruments to give me guardrails,” such as buffer exchange-traded funds to limit losses while capping upside potential, said Johnson, who is also a member of CNBC’s FA Council.
Buffer ETFs use options contracts to provide a pre-defined range of outcomes over a set period. The funds are tied to an underlying index, such as the S&P 500. These assets typically have higher fees than traditional ETFs.
Take a ‘temperature check’
With future stock market volatility expected, investors should revisit risk tolerance and portfolio allocations, Baker said.
“This is a good time for a temperature check,” he said.
Market turmoil has happened before and will happen again. If you can’t stomach the latest drawdowns — in stocks or bonds — this is a chance to shift to more conservative holdings, Baker said.
“We’re not selling because I’m concerned about the market,” he added. “I’m concerned about comfort level.”
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