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The Back -Door Roth IRA

The Back -Door Roth IRA

| April 26, 2017

Do you make too much income to contribute to a ROTH IRA?  Maybe your accountant broke you the bad news this year during tax time.  Maybe you have been in this position for a while.  The strategy I am about to discuss may give you a “back door” to making ROTH IRA contributions.  The 2017 income phase out levels for making ROTH contributions are:

Married, Joint: $186,000-$196,000
Single, HOH: $118,000-$133,000

There is a lot of hype around ROTH IRA’s due to their tax benefits, and the hype is well deserved.   For young people that have many years for their retirement assets to grow and compound, missing out on ROTH IRA contributions can be a big hit to a Retirement Strategy.

Recently I have seen some young couples that both work in good jobs and exceed these limits.  They were disappointed when their accountant told them that they did not qualify for ROTH IRA contributions last year.  You, like them, may have another option if you fit these specifications:

  • Little to no other assets in Traditional IRAs, SEP IRAs, and SIMPLE IRAs. .  I’ll explain why a little later.  This won’t apply to retirement accounts outside of these specifics types.
  • Income over the phase out limits.
  • A desire to make ROTH IRA contributions.

A Back Door ROTH IRA strategy allows individuals who are phased out and cannot make new ROTH contributions to get new money into such an account on a regular basis.  Here is how it works:

  1. First, you need to make a non-deductible traditional IRA contribution.
    1. This contribution will not be tax-deductible because you are over the phase out limits for deducting Traditional IRA contributions. Normally, this would not be such a great idea since the earnings would be taxable as income.
    2. Make sure you make earned income above or equal to the amount you are contributing. Annual contribution limit is $5,500 or $6,500 if you are over age 50.
    3. Must not be older than 70 ½ by the end of the year for which they are making the contribution.
  2. Second, convert the contribution to a ROTH IRA. Since the original traditional contribution was after-tax, there is no taxability of the principle being converted.  If there were any gains, only that portion will be realized as income. Hopefully this number will be small to none.
    1. This step becomes far more complicated if you currently have Traditional IRA, SEP IRA or SIMPLE IRA pre-tax assets. This is because you do not get to choose which dollars you are converting.  The proportion of your after-tax dollars to your existing pre-tax dollars is what will be converted.  This is known as the Pro-Rata Rule.  As an example, let’s say I have these traditional IRA assets:

$5,500 after-tax dollars and $30,000 pre-tax dollars=$35,500 total value
When I convert the $5,500 to a ROTH IRA it will be ($5,500/$35,500= 15.49%) only 15.49% non-taxable.  The remaining 84.51% of that conversion will be taxable as income.  Even worse than this, you would need to keep track of your pre-tax and post-tax dollars going forward.  This why this strategy works best if you have little to no Traditional IRA assets.  Again, this does not apply to your retirement accounts outside of Traditional IRAs, SEP IRAs and SIMPLE IRAs.

  1. Enjoy your ROTH IRA conversion without the pre-tax to post-tax income realization.

I want to make sure to bring up a few points before you act on this kind of strategy.  First of all, I did not have enough space in this blog to go over much of the rules, history, political environment, and specifics of this strategy.  I only brushed over the basics.  There are many politicians in Washington that are seeking to put an end to this type of strategy.  This strategy could see its end anytime in the near future.  I would greatly recommend consulting with both your Financial Advisor as well as your Accountant before going through with this type of strategy to make sure that it is done properly and that it is still available.



This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a lawyer or financial professional.

The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.