The Dividend Engine Issue No. 003 June 24, 2026
Weekly Letter on Passive Income
Fixed Income · Dividends · Roth Strategy · Options Income
Backdoor Roth $16,000/yr Pro-rata rule — avoid this trap Form 8606 — file every year Traditional IRA → Roth conversion SCHD tax-free in Roth JEPI ordinary income — Roth it No RMDs on Roth IRA ever TSP pre-tax balance growing Roth conversion window age 67–73 Tax-free inheritance for heirs Backdoor Roth $16,000/yr Pro-rata rule — avoid this trap Form 8606 — file every year Traditional IRA → Roth conversion SCHD tax-free in Roth JEPI ordinary income — Roth it No RMDs on Roth IRA ever TSP pre-tax balance growing Roth conversion window age 67–73 Tax-free inheritance for heirs
Editor's Note · Issue 003 Issue 001 introduced our GS-14 profile — $690,000 in pre-tax retirement accounts and no Roth IRA established. Issue 002 showed our GS-9 the right order of operations, including opening a Roth IRA early. This week both profiles converge on the same question: how do you get money into a Roth IRA when your income is too high for the direct route? The answer is the backdoor Roth — and it is simpler than most people think, with one trap that catches almost everyone.
📋 This Week's Profile · Two Households, Same Problem
The High-Income Roth Lockout
Anyone earning above the IRS Roth IRA income limit · Married or Single
2026 Direct Roth Limit (Single) $150,000 MAGI
2026 Direct Roth Limit (MFJ) $236,000 MAGI
GS-14 Household Income ~$200,000+ MFJ
GS-13 Solo Income (future) ~$105,000+
Annual Backdoor Roth Limit (50+) $8,000 per person
Combined Couple Contribution $16,000/yr
Roth IRA Established Not yet — changing today
Pro-Rata Risk Must check before starting

The Roth IRA is arguably the most powerful retirement account the IRS has ever created. Money goes in after tax, grows completely tax-free, and comes out tax-free in retirement — with no Required Minimum Distributions ever. You can hold it until you die and pass it to your children, who inherit a decade of tax-free dividend income.

There is one catch: if your income is above a certain threshold, the IRS says you cannot contribute directly. For 2026 that threshold is $236,000 modified adjusted gross income for married couples filing jointly. A GS-14 household earning $200,000 combined is approaching or over that limit depending on deductions. A GS-13 earning $105,000 individually is over the single filer limit of $150,000.

What most people don't know is that the income limit only applies to direct contributions — not to conversions. The backdoor Roth is simply the legal, IRS-sanctioned workaround that has existed since 2010 and shows no sign of going away.

"The income limit blocks the front door. The backdoor has been unlocked since 2010 — and the IRS put it there on purpose."

Roth Corner · Issue 003 · Feature

The Backdoor Roth: A Complete Step-by-Step Walkthrough

Two steps, one form, one trap to avoid. Here is exactly how to execute a backdoor Roth contribution from start to finish — and how to make sure you never pay unnecessary taxes doing it.

The mechanics of a backdoor Roth are straightforward. You make a non-deductible contribution to a traditional IRA — the income limit that blocks Roth contributions does not apply to traditional IRA contributions — and then you convert that traditional IRA balance to a Roth IRA. Since you already paid tax on the money going in, the conversion is tax-free.

That's it. Two steps. The complexity people encounter almost always comes from one source: the pro-rata rule. We will cover that in detail. But first, the step-by-step.

📋 The Complete Backdoor Roth — Step by Step
1

Open a Traditional IRA if You Don't Have One

Open a traditional IRA at your brokerage — E*Trade, Fidelity, Schwab, or Vanguard all work. This takes about 15 minutes online. You need one traditional IRA per person — the backdoor Roth is done individually, not jointly. A couple doing this will each have their own traditional IRA and their own Roth IRA.

✓ For our GS-14 couple: open two traditional IRAs and two Roth IRAs — one of each per spouse.
2

Make a Non-Deductible Traditional IRA Contribution

Contribute $8,000 to the traditional IRA (the 2026 limit for age 50+; $7,000 if under 50). Do NOT deduct this contribution on your taxes — it is a non-deductible contribution. This is critical. You are contributing after-tax dollars intentionally, which is what makes the subsequent conversion tax-free.

✓ You can contribute for the prior tax year up until the tax filing deadline (usually April 15). Example: contribute in January 2027 and designate it as a 2026 contribution.
3

Do NOT Invest the Money Yet — Convert Immediately

This is the most important timing instruction: convert the traditional IRA to Roth as soon as the contribution clears — ideally within a day or two, before it earns any interest or growth. If the money sits and earns $12 in interest before you convert, that $12 becomes taxable at conversion. Keep it in cash and convert it fast.

✓ At your brokerage this is usually a single button — "Convert to Roth IRA." It takes about 5 minutes.
4

Invest the Roth IRA Immediately After Conversion

Once the money lands in your Roth IRA, invest it immediately. For dividend-focused investors this is where SCHD, JEPI, JEPQ, VYM, and O belong. Every dollar of dividends these holdings generate inside the Roth is completely tax-free — forever. JEPI and JEPQ are especially valuable here because their ordinary income distributions, which are taxable in a brokerage account, are irrelevant inside a Roth.

✓ Priority order for Roth holdings: JEPI → JEPQ → O → SCHD → VYM. Highest ordinary income payers go inside the tax-free wrapper first.
5

File Form 8606 With Your Tax Return — Every Single Year

Form 8606 is how you tell the IRS that your traditional IRA contribution was non-deductible (after-tax). Without this form, the IRS assumes all traditional IRA contributions were pre-tax — and will tax your conversion as ordinary income, costing you thousands. File Form 8606 every year you make a backdoor Roth contribution, even if you owe no additional tax. Keep copies permanently.

✓ Your CPA or tax software (TurboTax, H&R Block) handles Form 8606 automatically if you tell it you made a non-deductible IRA contribution.

The Pro-Rata Rule — The One Trap That Catches Everyone

Here is where most people get burned. If you have any existing pre-tax money in a traditional IRA anywhere — including SEP IRAs and SIMPLE IRAs — the IRS applies what is called the pro-rata rule to your conversion. Instead of treating your $8,000 non-deductible contribution as a clean tax-free conversion, the IRS looks at ALL your traditional IRA money combined and taxes your conversion proportionally.

⚠️ Pro-Rata Rule — Real Example

How a $50,000 Old Traditional IRA Ruins Your Backdoor Roth

Suppose you have $50,000 in a rollover traditional IRA from an old job, plus you contribute $8,000 as a new non-deductible contribution. Total traditional IRA balance: $58,000. Your non-deductible (after-tax) portion is $8,000 ÷ $58,000 = 13.8%. When you convert $8,000 to Roth, only 13.8% — about $1,103 — is tax-free. The other $6,897 is taxable as ordinary income. At 24% that's a $1,655 unexpected tax bill. The backdoor Roth just became a partially taxable event.

The solution is straightforward but requires action before you start: roll any existing pre-tax traditional IRA balances into your TSP or 401k before executing the backdoor Roth. Most employer plans — including the TSP — accept incoming rollovers from traditional IRAs. Once the pre-tax IRA money is inside the TSP, it is no longer counted in the pro-rata calculation. Your traditional IRA balance is now zero, your $8,000 non-deductible contribution converts cleanly, and the entire amount is tax-free.

✅ The TSP Advantage · Federal Employees Specifically

Federal Employees Have a Built-In Pro-Rata Solution

Most federal employees hold their pre-tax retirement money in the TSP — not in traditional IRAs. If neither spouse has any existing traditional IRA balance from old rollovers or prior contributions, the pro-rata rule is simply not an issue. The backdoor Roth executes cleanly from day one. This is one of several quiet advantages FERS employees have over private-sector workers trying to execute the same strategy.

What 15 Years of Backdoor Roth Contributions Actually Builds

The backdoor Roth feels like a small annual exercise — $16,000 per year for a couple. But compounded over 15 years inside a tax-free wrapper invested in dividend growth holdings, it becomes genuinely significant.

📈 GS-14 Couple · Backdoor Roth Projection · 15 Years
Annual contribution (both spouses)$16,000
Years of contributions15
Total dollars contributed$240,000
Assumed annual growth rate6.5%
Estimated Roth IRA balance at retirement~$390,000
Annual dividend income at 6.5% yield~$25,000/yr
Tax owed on that $25,000$0 — forever
RMDs requiredNone — ever
Legacy value passed to heirs $390,000+ tax-free

That $390,000 passed to children comes with a 10-year distribution window — meaning heirs can withdraw the full balance over 10 years with zero federal income tax. If the Roth holds SCHD, JEPI, and JEPQ during that decade, it continues generating dividend income throughout the distribution period. The engine keeps running even after it's been inherited.

Roth IRA vs Traditional IRA vs TSP — Where Each Dollar Belongs

Not every dollar belongs in a Roth. The backdoor Roth is powerful but it works best as part of a coordinated three-bucket strategy — each account type serving a specific role.

Account Tax Treatment RMDs Best Holdings Priority
Roth IRA Tax free in and out None — ever JEPI · JEPQ · O · SCHD · VYM Highest ordinary income payers first
TSP (Traditional) Pre-tax now · taxable later Required at 73 C Fund · S Fund · I Fund Max for match · convert strategically
Brokerage After-tax · dividends taxed annually No RMDs SCHD · VYM · T-Bills Qualified dividend payers · T-Bill ladder

The guiding principle: put the holdings that generate the most ordinary income — JEPI, JEPQ, O — inside the Roth where that income is tax-free. Put holdings that generate qualified dividends — SCHD, VYM — in the taxable brokerage where the lower qualified dividend rate applies. Let the TSP hold index funds that grow aggressively and get converted systematically between ages 67 and 73.

The Conversion Window · Coming in Issue 005

The Backdoor Roth Is Just the Beginning

Annual backdoor Roth contributions build the engine during the accumulation phase. But the real power comes after retirement — the six-year window between ages 67 and 73 when a strategic TSP-to-Roth conversion can move hundreds of thousands of pre-tax dollars into the tax-free Roth, funded by the dividend income the Roth is already generating. The Roth pays its own conversion tax bill. Issue 005 covers this flywheel in full detail.

Backdoor Roth Quick Reference — 2026

📊 Key Numbers & Deadlines
Contribution Limit (Under 50)$7,000 per person
Contribution Limit (Age 50+)$8,000 per person
Married Couple Combined (50+)$16,000 per year
Direct Roth Income Limit (MFJ)$236,000 MAGI
Direct Roth Income Limit (Single)$150,000 MAGI
Backdoor Roth Income LimitNone — any income
Contribution Deadline (2026 tax year)April 15, 2027
Form RequiredForm 8606 — every year
Pro-Rata Rule RiskOnly if existing trad. IRA balance
TSP Roth Conversion Separate?Yes — does not affect pro-rata
Next Week · Issue 004

SCHD vs VYM — Which Dividend ETF Belongs in Your Portfolio First?

Both are excellent. Both belong in a serious dividend portfolio. But they play different roles — dividend growth vs current yield, quality vs breadth. We break down the key differences with real numbers and tell you which one to buy first depending on your timeline and goals.

Issue 005 · Coming Soon

The TSP Conversion Window: Six Years to Drain the Tax Time Bomb

The gap between retirement at 67 and RMDs at 73 is the most powerful tax arbitrage window most federal employees never use. We show exactly how to convert TSP money to Roth at controlled tax rates — using Roth dividend income to fund the tax bill — and what it means for the retirement income stack.

Disclaimer: The Dividend Engine is a financial education newsletter. All profiles and scenarios are composites for illustrative purposes only. Nothing here constitutes financial, tax, or legal advice. IRA contribution limits and income thresholds are based on 2026 IRS guidelines and are subject to change. The pro-rata rule involves specific IRS calculations — consult a qualified CPA before executing a backdoor Roth if you have existing traditional IRA balances. All investments involve risk.
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© 2026 The Dividend Engine · Educational purposes only · Not financial advice
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