29—Lever #2: Taxes (Part Seven—IRA Phase-Out Rules and the "Backdoor Roth")
The IRS giveth and the IRS taketh away
This article may not pertain to most of you at this point in your stewardship journey, but you may have to deal with the IRS’ IRA “phase out” rules later on if your income increases.
This may surprise you, but the IRS has set income limits based on your modified adjusted gross income (MAGI) that phase out the deduction for pre-tax contributions to a Traditional IRA for individuals covered by an employer retirement plan (such as a 401k or 403b). Roth IRA contributions, however, are not limited by workplace plan participation and depend solely on income thresholds.
Deduction eligibility becomes more nuanced for married couples when only one spouse is covered by a workplace plan. The non-covered spouse can still claim a full deduction for contributing to a Traditional IRA or make a full Roth contribution if the couple’s MAGI is below a specified limit. Joint planning is essential in such cases.
The phase-out ranges are based on your MAGI. We didn't discuss MAGI in our previous tax articles. MAGI has nothing to do with the Nativity at Christmas; it is your adjusted gross income (AGI), which is gross income less certain deductions, with those deductions added back. It may also include some interest and dividend income. (It is “modified.”)
Your MAGI is a more holistic view of your total income. The IRS uses your MAGI for special purposes, such as determining your eligibility for certain tax credits and deductions for IRA contributions and the amount of certain other deductions or income exclusions you can get.
The Roth IRA was introduced in 1998 and had initial phase-out provisions. This meant that higher-income earners couldn't take advantage of it. The phase-out for married filing jointly was $150,000 to $160,000 back then. It mainly stayed the same until 2007, when it increased from $166,000 to $176,000 in 2009 and has increased gradually ever since.
The table below shows the MAGI phase-out limits for different types of IRAs for tax year 2025:
For 2025, single filers must have a modified adjusted gross income (MAGI) of less than $79,000 to make a fully deductible contribution to a Traditional IRA and less than $170,000 to make a full $7,000 contribution to a Roth IRA, while joint filers must have a MAGI of less than $236,000 to a Roth IRA. This opens the door to many families but also closes it to some.
If you are in the “range,” you can still contribute, but with limitations. For example, if you're married and your joint household income is $135K (the middle of the range), you can contribute to a Traditional IRA and get a partial tax deduction. If you want to contribute to a Roth IRA instead, you are eligible if your combined MAGI is below $246K, but your eligible contribution is reduced if it’s in the phase-out range.
If you exceed the MAGI maximum, you are out of luck EXCEPT you are still eligible to make non-deductible Traditional IRA contributions (that option also exists for 401k-type accounts). You do so with after-tax money (like contributing to a Roth, but you don't get a tax deduction), and the funds can grow tax-deferred (also like a Roth).
There is a wrinkle—you will have to pay taxes on it when you withdraw, just like you would a deductible Traditional IRA. That way, a non-deductible Traditional IRA is more like a taxable brokerage account than a deductible Traditional IRA or a Roth IRA.
The primary advantage of the non-deductible Traditional IRA is that you can do a "Backdoor Roth IRA." The strategy is called the "Backdoor Roth Conversion." Because the contribution limits apply to high-income earners, many of you may not have any reason to do a "backdoor Roth," at least not yet. But it might still be a good idea to be aware of it; perhaps it will come in handy one day. So, here is how to do it:
Step one: Make a non-deductible Traditional IRA contribution. For 2025, you can contribute $7,000. Your brokerage won't know that it's non-deductible; that is determined when you file your taxes the following April. That is simply a Traditional IRA contribution that you will not get a tax break on. You are essentially putting after-tax (rather than pre-tax) money into a Traditional IRA.
Step two: Choose a safe investment like a money market fund when making your (non-deductible) Traditional IRA contribution. Once the transfer is completed and you hold the money market fund in your (non-deductible) Traditional IRA, convert the balance to a Roth IRA. If you convert immediately after the initial account funding, you will owe very little in taxes. Some people like to wait a few days before converting.
Step three: Request your brokerage to make the Roth conversion. (You'll need a Roth account available to accept the funds.) Once you do the conversion, you have completed the " backdoor Roth IRA contribution" and can invest in whatever you want. However, if you have outstanding Traditional IRAs, this will complicate the tax reporting. Therefore, doing this in a Traditional IRA with a zero balance is best.
Step four: You must complete a special form (IRA Form 8606) when tax time rolls around. It's relatively simple, and if you use tax software, it will do it for you automatically. When entering a backdoor Roth in tax software, report the (non-deductible) Traditional IRA contributions, then report the conversion. That is a little out of sequence regarding how most tax programs work, but doing so will help prevent reporting problems.
For reflection: This article is unique because it mainly applies to high-income earners. As I said early on, this may not apply to you—not yet, anyway—but it might someday. How would you describe your heart attitude toward earning more money? Needing (or wanting) more income isn’t a sin, but wanting more and more because more is never enough could be. When someone asked billionaire John Rockefeller how much “enough” is, he replied, “just one dollar more.” Contentment is a key character trait when it comes to money; consider that when you think of what is “enough” for you. (We’ll talk more about contentment when discussing consumption and spending.)
Verse: “But godliness with contentment is great gain” (1 Timothy 6:6, ESV).