Back-door Roth IRA
Cindy Yu, CPA https://cindiellc.com/blog/
Income too high to qualify for Roth IRA? You can put some efforts to make it happen:
2-step Approach
- Put money in a traditional IRA account. You might already have an account, or you might need to open one and fund it.
- Convert your contribution to a Roth IRA. Your IRA administrator will give you the instructions and paperwork. If you don’t already have a Roth IRA, you’ll open a new account during the conversion process.
Tax Consequence
- Pay taxes for non-deductible IRA contribution. Only post-tax dollars go into Roth IRAs. So if you deducted your traditional IRA contributions and then decide to convert your traditional IRA to a backdoor Roth, you’ll need to give that tax deduction back. When it comes time to file your tax return, be prepared to pay income tax on the money you converted to a Roth. And see below for details on the pro-rata rule, which plays a big part in determining your tax bill.
- Pay taxes on the gains in your traditional IRA before the conversion. If the money in that traditional IRA has been sitting there awhile and there are investment gains, you’ll also owe tax on those gains at tax time.
- Pay no taxes after. The money in Roth grows tax-free
Tax Due at Conversion
- Zero tax dollar. No tax due if taxes are paid for all the converting amount
- Pro-rated tax dollar. When determining your tax bill on a conversion from a traditional IRA to a Roth IRA, the IRS is going to look at all of your traditional IRA accounts combined. And a word about timing: the IRS applies the pro-rata rule to your total IRA balance at year-end, not at the time of conversion.