See also my forum entry:
https://jazz.net/forum/questions/72529/for-what-is-the-quotbacklog-iterationquot-definition

If there is no Backlog Iteration or the path to the backlog Iteration has changed, without changing this in the process template, it may give you problems opening a plan. See my defect:

https://jazz.net/jazz/web/projects/Rational%20Team%20Concert#action=com.ibm.team.workitem.viewWorkItem&id=175748

I also saw issues with the Plan Row menu, where some menu items have not listed e.g. Iterations or Categories to move Workitems into. For this I do not have a defect yet.

In an Agile development model the bucket of workitems not yet assigned to a development iteration are considered still On the Backlog.

so for a Release(iteration), you should have one container where the incoming and not yet planned work is stored.
the Release Backlog
you could also have a Product Backlog, which is work no assigned to a Release.

the iteration setup in RTC is

Timeline (build product for next 10 years)
release iteration (how often do you intend to release product, yearly?)  so 10 of these
development iterations (aka sprints) how you break down the development work of the release (4 week srpint= 12 of these in a year?)
the product iteration and the release iterations should have backlogs to hold work not yet assigned to release and sprint (respectively)
 

Here's some additional information in the documentation:
http://pic.dhe.ibm.com/infocenter/clmhelp/v4r0m1/topic/com.ibm.team.concert.tutorial.doc/topics/tut_agile_plan_create_product_backlog.html

WRT the warning, you are probably thinking of the warning in the Backlog Iteration section of the Project Configuration page.  This warning does not actually reflect any problem, so you can ignore it.   To get rid of the warning, select as your backlog iteration an iteration that is an immediate child of the timeline, and that has no child iterations.

I suggest you just ignore the "Backlog Iteration" declaration.  As far as I can tell, all it is used for is to initialize the plan type when you create a new plan (i.e. it creates a "product backlog" plan if you select the iteration that is declared to be the backlog iteration).   But you can easily just manually select "product backlog" as the type of your plan, so this doesn't save you any significant effort.

But you do have to be careful about bug The backlog iteration '/development/backlog' for the timeline 'development' could not be resolved. (126347) .i.e. when you move your declared backlog iteration somewhere else in the timeline tree, it will refuse to let you open *any* plan until you have explicitly updated your "product backlog" to point to the new location.

Note: If anyone knows of any other semantics associated with the iteration you select as the "Backlog Iteration", please post it here as a comment.