The Backdoor Roth IRA and how it relates to American expats

1. What is a Backdoor Roth IRA?

First, let's define the standard Backdoor Roth IRA. It is not an official account type, but rather a strategy used by high-income earners to fund a Roth IRA.

• The Problem: The IRS has income limits (Modified Adjusted Gross Income, or MAGI) that restrict who can contribute directly to a Roth IRA. If your income is above this limit, you are phased out.

• The Solution (The Strategy): There are no income limits on contributing to a Traditional IRA, and there are no income limits on converting a Traditional IRA to a Roth IRA.

The Backdoor Roth IRA is a two-step process:

1. Step 1: Contribute: You make a nondeductible (after-tax) contribution to a Traditional IRA. You can do this regardless of your income.

2. Step 2: Convert: Shortly after the contribution settles, you convert the entire balance of that Traditional IRA into your Roth IRA.

3. Since the initial contribution (Step 1) was made with after-tax dollars, the conversion (Step 2) is generally a tax-free event. You must report this two-step process to the IRS using Form 8606.

2. The Core Challenge for American Expats: The FEIE

For an American expat, the challenge isn't the income limit (most expats who need this strategy are over it). The problem lies in Step 1: The Contribution.

To be eligible to contribute any money to any IRA (Traditional or Roth), you must have taxable earned income (compensation from work) that is at least equal to the amount you contribute.

This is where the Foreign Earned Income Exclusion (FEIE) creates a major obstacle.

• The FEIE allows you to exclude a large portion of your foreign-earned income from your U.S. taxes (e.g., $130,000 for 2025).

• If you are an expat earning $120,000 and you use the FEIE to exclude all of it, your taxable earned income is $0.

• With $0 of taxable earned income, you are ineligible to contribute to an IRA, and you therefore cannot execute Step 1 of the Backdoor Roth IRA strategy.

3. The Solution: Two Paths to Eligibility

An expat has two main pathways to gain the "taxable earned income" needed to perform the Backdoor Roth IRA strategy.

Path 1: Use the Foreign Tax Credit (FTC) instead of the FEIE

This is the most common and effective solution for expats, especially those in high-tax countries (like most of Europe, Canada, or Australia).

• How it Works: Instead of excluding your income with the FEIE, you include it on your U.S. tax return. This means your foreign salary now counts as taxable earned income, making you eligible to contribute to an IRA.

• Wiping out the Tax: You then use the Foreign Tax Credit (FTC), which gives you a dollar-for-dollar credit for the income taxes you've already paid to your country of residence.

• The Result: For most expats in high-tax countries, the FTC will wipe out their entire U.S. tax liability. You successfully create the taxable earned income to make your Backdoor Roth IRA contribution, but you still end up owing $0 in U.S. tax.

Scenario: Expat in Germany

Income: $150,000

Taxes Paid to Germany: $45,000

Strategy: Forgo the FEIE and use the FTC.

Report Income: You report $150,000 of taxable earned income to the IRS. You are now eligible to make an IRA contribution.

Execute Backdoor Roth: You contribute $7,000 to a Traditional IRA and immediately convert it to a Roth IRA.

File Taxes: You calculate your U.S. tax bill (e.g., $30,000) and then apply the FTC for the $45,000 you paid in Germany. Your final U.S. tax bill is $0.

Path 2: Earn Income Above the FEIE Limit

If you live in a low-tax or no-tax country (like the UAE or Singapore) where the FTC provides no benefit, you can only use this strategy if your income is higher than the FEIE limit.

• How it Works: You can only contribute an amount equal to your earned income that is not excluded.

• Example: You earn $140,000 in Dubai. The FEIE limit for 2025 is $130,000.

• Taxable Income: Your taxable earned income is $10,000 ($140,000 - $130,000).

• Contribution Limit: You are eligible to contribute up to the annual IRA limit ($7,000 for 2025) because your taxable income ($10,000) is greater than that amount. You can now perform the Backdoor Roth IRA.

4. Important Considerations for Expats

Spousal IRA Contributions

The same logic applies. A non-working spouse can only receive a "Spousal IRA" contribution if the working spouse has enough taxable earned income to cover both contributions.

• If using FEIE (and income is fully excluded): Your taxable earned income is $0. You cannot make a Spousal IRA contribution.

• If using FTC: You have taxable earned income. You can make a Spousal IRA contribution for your non-working spouse.

The Pro-Rata Rule (A Major Pitfall)

This rule applies to all Backdoor Roth IRAs, but it's critical to understand. The IRS views all of your Traditional, SEP, and SIMPLE IRAs as one single account when you do a conversion.

If you have any pre-tax (deductible) money in any of those accounts, your conversion will be partially taxable. You cannot just convert the new nondeductible contribution. The Backdoor Roth IRA strategy works best for those who have a $0 balance in all pre-tax IRA accounts.

Practical Hurdle: Finding a Brokerage

This is a significant non-tax challenge. Due to complex regulations (like FATCA), many U.S. brokerages (like Vanguard and Fidelity) will no longer service clients with foreign residential addresses. They may freeze your account or force you to liquidate it.

You must find an expat-friendly brokerage. Interactive Brokers and Charles Schwab (through their international accounts) are two of the most common options for expats.

A Different (but Related) Strategy: The "Tax-Free Roth Conversion"

Finally, do not confuse the Backdoor Roth IRA with a different strategy available to some expats.

• Who is this for? Expats who use the FEIE and have existing pre-tax funds in a Traditional IRA or old 401(k).

• How it Works:

  1. You use the FEIE to exclude your foreign income, bringing your Adjusted Gross Income (AGI) to $0.

  2. You still get to take the full Standard Deduction (e.g., $31,500 for a married couple in 2025).

  3. You then convert an amount from your Traditional IRA to a Roth IRA equal to your standard deduction.

  4. The conversion counts as taxable income, but it is completely offset by your standard deduction, resulting in a $0 tax bill on the conversion.

This is not a contribution of new money, but a powerful way to move old, pre-tax retirement money into a Roth IRA tax-free, year after year.

Here is the step-by-step mechanical breakdown:

1. The Prerequisite: You must have funds in a pre-tax retirement account (e.g., a Traditional IRA).

2. Use the FEIE: You file your U.S. taxes and use the Foreign Earned Income Exclusion (FEIE) to exclude your salary.

3. Create $0 AGI: If your foreign salary is below the FEIE limit (e.g., $130,000 for 2025), your earned income is reduced to $0. Assuming you have little to no other income (like interest or dividends), your Adjusted Gross Income (AGI) will be $0.

4. Claim the Standard Deduction: Critically, using the FEIE does not prevent you from also taking the full Standard Deduction.

5. Execute the Conversion: You then convert an amount from your Traditional IRA to your Roth IRA. This conversion amount is considered taxable income.

6. The Tax Offset: This new "income" from the conversion "fills up" the 0% tax bracket created by your standard deduction. As long as the conversion amount is less than or equal to your standard deduction, your final taxable income is $0.

Example (Using 2025 Tax Figures)

Filing Status: Married Filing Jointly

• Foreign Salary: $180,000 (all earned by one spouse)

• Standard Deduction (MFJ): $31,500

• FEIE Limit (per person): $130,000

Tax Calculation:

1. Foreign Earned Income: $180,000

2. Apply FEIE: -$130,000

3. Adjusted Gross Income (AGI): $50,000 (This person could not use this strategy)

Let's try again. Assume their salary is $120,000.

1. Foreign Earned Income: $120,000

2. Apply FEIE: -$120,000

3. Adjusted Gross Income (AGI): $0

4. Action: They convert $31,500 from a Traditional IRA to a Roth IRA.

Final Tax Return:

• AGI from Salary: $0

• Add: Roth Conversion Income: +$31,500

• = Final AGI: $31,500

• Subtract: Standard Deduction (MFJ): -$31,500

• = Total Taxable Income: $0

Result: You successfully moved $31,500 from a pre-tax account to a post-tax Roth IRA completely U.S. tax-free.

Major Risks and Considerations

This strategy is powerful, but you must be aware of the pitfalls.

1. Host Country Taxation (The Biggest Risk): The U.S. may treat this conversion as tax-free, but your country of residence may not. Many countries do not recognize the tax-advantaged status of a Roth IRA and may view your conversion as either taxable income or a taxable distribution in the year you make it. This could result in a large, unexpected foreign tax bill that completely negates the benefit.

2. The Pro-Rata Rule Still Applies: This strategy works best if 100% of the money in all of your Traditional/SEP/SIMPLE IRAs is pre-tax (deductible). If you have any non-deductible (post-tax) basis in those accounts, the conversion will be a mix of taxable and non-taxable funds, which complicates the math.

3. "Overshooting" the Deduction: If you convert more than your standard deduction (plus any other deductions), the excess amount will be subject to U.S. income tax, starting at the 10% bracket. This isn't always bad, but it means the conversion is no longer "tax-free."

4. Other Income: If you have other U.S. income (e.g., from investments, dividends, or rental properties), that income will "use up" part of your standard deduction first, reducing the amount you can convert tax-free.

5. Timing: The Roth conversion must be completed by December 31st of the tax year.

Conclusion: The strategy is sound from a U.S. tax perspective. It's a well-known method for expats who use the FEIE to "fill up" their standard deduction with pre-tax retirement funds. However, the risk of it being taxed by your host country is significant and must be investigated first.

Last updated on Nov. 6, 2025