Since Roth IRAs first came into being, taxpayers have been able to establish these accounts directly through contributions or by converting their traditional IRAs. Initially, these options were unavailable to higher-income individuals, as eligibility for direct contributions and conversions was limited by a taxpayer's modified adjusted gross income (MAGI). For example, in 2024, a married couple filing jointly cannot make a direct Roth contribution if that income exceeds $240,000.

But then the Tax Increase Prevention and Reconciliation Act of 2005 repealed the limitations on conversions for the wealthy, a change effective for the tax years beginning after 2009. As a result, Roth conversions became accessible to all taxpayers, regardless of income level, increasing their popularity and establishing them as a staple of financial planning.

Initially, taxpayers could undo the Roth IRA and change it back into a traditional IRA within a certain period. This option was reassuring, especially when the value of a converted Roth IRA had decreased. However, the Tax Cuts and Jobs Act of 2017 took away this ability to recharacterize, a change that reflected shifting governmental attitudes toward IRAs. Now, once an IRA is converted to a Roth, it cannot be undone.

There were shifts in political attitudes yet again in 2019. That year, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed. The law now requires most non-spousal inherited IRAs to distribute the entire account within 10 years, replacing the previous rule allowing distributions over the beneficiary's lifetime. This change significantly affected the previous assumptions driving IRA and Roth IRA conversions.

This new limitation on payouts has made Roths more attractive, because even as distributions from an inherited traditional IRA lead to taxable ordinary income over the 10-year period, a Roth IRA investment can grow tax-free until the end of the 10 years, at which point a fully tax-free distribution is made. This makes the Roth IRA a powerful estate planning tool for retirees with sufficient other assets to live on, allowing them to defer their distributions for the full 10 years.

Another advantage of these vehicles is that Roth IRAs or 401(k)s have no required minimum distribution requirement. Traditional IRAs do, and in 2024 those distributions must start when the account holder is 73. The Roth balance, meanwhile, can continue growing tax-free throughout a person’s retirement.

It should be noted that there is a distribution limitation specific to Roth IRAs: the five-year rule. It says you must wait at least five years after your first contribution to a Roth IRA before you can withdraw earnings tax-free. This rule applies to all Roth IRAs, including inherited accounts and those converted from traditional IRAs.

The Backdoor Roth IRA
Those whose income exceeds the Roth limits might turn to a strategy called the “backdoor Roth IRA,” which means contributing first to a non-deductible IRA and then subsequently converting it to a Roth. In 2024, single filers with a modified adjusted gross income above $161,000 and married couples whose incomes are above $240,000 are ineligible to contribute to a Roth IRA directly. But the backdoor Roth strategy allows them to navigate around these limits, since the nondeductible contribution to the traditional RIA has no income limits.

Since taxes have already been paid on the nondeductible contribution, the subsequent conversion to a Roth typically incurs little or no additional tax liability, though it depends on whether there are earnings on the contributed amount between the time of contribution and conversion. To minimize any earnings, and thus minimize taxes, the account holder will usually want to complete the conversion promptly after the contribution to the traditional Roth.

There’s a significant limitation on backdoor Roth conversions, however: the “pro rata rule.” This applies if you have other traditional IRA assets besides the after-tax IRA contributions you wish to convert. It requires that a proportional amount of both pretax and after-tax funds be converted to a Roth IRA, taking into account the total balance of all the account holder’s IRAs.

This requirement can force a contributor into a taxable conversion on the traditional portion of their portfolios, reducing the tax-free benefit of the conversion. Therefore, the backdoor Roth strategy is most suitable for investors who have only Roth accounts and no traditional IRAs.

To avoid the pro rata rule, investors must ensure they aren’t holding deductible, pretax funds in traditional IRA accounts at the time of conversion. If they are, they should consider converting those traditional IRA accounts into Roths before starting the backdoor Roth strategy. Alternatively, if the investor has access to an employer-sponsored retirement plan like a 401(k) that allows rollovers from traditional IRAs, they should consider rolling over any pretax traditional IRA funds into those employer plans.

The contribution limits for a backdoor Roth IRA are the same as those for traditional and Roth IRAs. In 2024, individuals under 50 can contribute up to $7,000 annually, and those 50 and older can contribute up to $8,000. The deadline for making a nondeductible IRA contribution typically aligns with the federal income tax return filing deadline for that tax year, usually April 15 of the following year. There is no deadline for converting nondeductible IRA contributions to the Roth IRA.

The Mega Backdoor Strategy
The mega backdoor Roth IRA strategy allows individuals to make additional after-tax contributions to their employer-sponsored retirement plans, exceeding the 2024 employee contribution limit of $23,000, with an additional $7,500 catch-up contribution for those over age 50. The 2024 mega Roth contribution amount is $46,000 of post-tax dollars, which means individuals can make a total after-tax contribution of up to $69,000, or $76,500 if they are over age 50. However, not all employers allow these contributions, so it is crucial for clients to check their employer's plan before considering this strategy.

The SECURE 2.0 Act Of 2022
This law added even newer wrinkles for those wishing to take advantage of Roth IRAs.

529 plans. One change is that starting in 2024, taxpayers may roll over up to $35,000 from overfunded 529 plan accounts into Roth IRAs—if the 529 accounts have been held for at least 15 years and the rollover is for the same beneficiary. The annual rollover amounts would be subject to Roth IRA contribution limits, and contributions made within the last five years are ineligible for the rollover.

Catch-up contributions are required to be Roths. When originally passed, the SECURE 2.0 Act said that employees earning $145,000 or more had to make their catch-up contributions to qualified retirement plans as post-tax Roth contributions beginning in 2024. However, this requirement was delayed for two years by the Internal Revenue Service (in Notice 2023-62), which pushed back the implementation until January 1, 2026. Additionally, starting in 2024, the catch-up amount will be indexed for inflation annually. Beginning in 2025, those aged 60 to 63 will be able to contribute an additional catch-up contribution of $10,000 to 401(k)s and similar plans each year.

No mandatory RMDs from Roths. The SECURE 2.0 Act also eliminated the requirement that savers take minimum distributions from their workplace 401(k), 403(b) or 457(b) plan Roth accounts. Plan participants who are already subject to Roth required minimum distributions may discontinue distributions in 2024.

The allowance of Roth contributions for matching or non-elective contributions. Effective immediately upon the passage of SECURE 2.0, participants in employer-sponsored 401(k), 403(b) and 457(b) plans can now designate some or all matching contributions and non-elective contributions as Roth contributions. Previously, employer matches had to be allocated to an employee’s pretax account.

Political Backlash
One of the most famous Roth accounts belongs to PayPal co-founder Peter Thiel, whose use of the vehicle was publicized in a 2021 article by the news site ProPublica. (The story was called “Lord of the Roths: How Tech Mogul Peter Thiel Turned a Retirement Account for the Middle Class Into a $5 Billion Tax-Free Piggy Bank.”) In 1999, Thiel had an income of $73,263, a figure beneath that year’s Roth income threshold of $110,000, the article said. He contributed $2,000 to a Roth IRA, which was used to purchase PayPal shares. By 2003, when PayPal was sold to eBay, Thiel’s Roth PayPal shares were worth $28.5 million. By 2019, his Roth IRA had grown to approximately $5 billion, ProPublica said.

In reaction to the revelations, the Ways and Means Committee of the U.S. House of Representatives drafted proposed legislation in 2022 aiming to prohibit wealthy individuals with retirement accounts exceeding $10 million from contributing extra savings. (The bill would also have introduced new annual minimum distribution requirements.) Roth strategies such as the backdoor Roth and the mega Roth conversions were to be limited or eliminated. Although this legislation was never enacted as law, it serves as a warning that these strategies could be modified or eliminated in the future.

Currently, the Roth conversion, the backdoor Roth and the mega Roth strategies remain effective techniques for people whose income exceeds the limits for direct Roth contributions—and who want to diversify their retirement savings. The strategies are ideal for investors expecting higher taxes in retirement or those wanting to leave tax-free inheritances. However, as the Peter Thiel story and the resulting political backlash have shown, there is always a concern that future tax law changes could crimp the benefits of Roth IRAs. But proactive retirement planning now can help both retirees and their heirs reap significant benefits in the future.

Daniel F. Rahill, CPA/PFS, JD, LL.M., CGMA is a wealth strategist at Wintrust Wealth Management. He is also a former chair of the Illinois CPA Society Board of Directors and is a current officer and board member of the American Academy of Attorney-CPAs.