Backdoor Roths and 401(k) Rollovers: Smart Strategy or Costly Mistake?
- Joseph Browning
- Sep 24
- 2 min read
For high-income earners, backdoor Roth IRA contributions are a powerful way to build tax-free retirement savings. On a separate note, rolling over an old 401(k) into an IRA can also be a smart move for better investment options and lower fees. However, when these two strategies intersect, the outcome can either work in your favor—or create an unexpected tax bill—understanding why is critical before making a move.
The Backdoor Roth in Brief
The backdoor Roth IRA allows taxpayers above income limits to fund a Roth account by:
Making a non-deductible contribution to a traditional IRA.
Converting that contribution to a Roth IRA.
Because the contribution is after-tax and converted quickly, the process is usually tax-free. This strategy is popular because Roth accounts offer tax-free growth and no required minimum distributions (RMDs), making them a cornerstone of long-term planning for high earners.
Where Things Go Wrong
Rolling a 401(k) into a traditional IRA introduces pre-tax dollars into the mix. When you later convert funds to a Roth, the IRS applies the pro-rata rule (aka the aggregation rule) across all your IRAs—not just the one you contributed to. Formula: after-tax contributions ÷ total IRA balance = tax-free percentage.
Example:
You contributed $7K this year in after-tax contributions to your Traditional IRA to then “backdoor” to your Roth IRA
You also made a $100K pre-tax rollover from an old employer into your Traditional IRA, or even a separate Rollover IRA
Only about 6.5% of your conversion is tax-free, and 93.5% of your conversion is taxable! This could turn what should have been a tax-efficient move into a costly surprise.
Why Growth Makes It Worse
A 401(k) rollover doesn’t just bring contributions—it brings years of market growth. That growth, while positive for your portfolio, increases the taxable portion of any Roth conversion. The larger your IRA balance, the smaller the tax-free percentage of your conversion. This is why timing and account structure are crucial when combining these strategies.
When a Rollover Still Makes Sense
Despite the risks, there are situations where rolling over a 401(k) into an IRA is still beneficial:
Better investment options or lower fees: Many 401(k) plans have limited menus or high costs.
Account consolidation: Combining multiple old retirement plans into a single IRA can simplify management and bring peace of mind, which for some investors may be a higher priority than optimizing for tax efficiency.
Strategic Roth conversion: Converting the entire IRA in a low-income year can make sense for long-term tax-free growth.
No future backdoor Roth plans: If you don’t intend to use the backdoor Roth strategy in the future, the pro-rata issue becomes irrelevant!
The Bottom Line
Both strategies can be valuable—but not always together. Before rolling over a 401(k) or executing a backdoor Roth, consult a qualified financial professional. Proper planning can help you avoid unnecessary taxes and make the most of these powerful tools.
