retirement

Backdoor Roth IRA

There's a wrinkle in this tax-free strategy.

In Tax-Free Income for All we described a strategy you can use if you earn too much to contribute to a Roth IRA. To wit: Start contributing to a nondeductible IRA this year and switch the account to a Roth in 2010, when income restrictions on such conversions will disappear.

You can't contribute to a Roth IRA if you are single with income over $110,000, or if you're married with a joint income of $160,000 or more. And if your income is more than $100,000, you currently can't convert your traditional IRA to a Roth. The income limits on contributions will remain in effect even after the ceiling on conversions disappears.

By contributing to a nondeductible IRA now and converting to a Roth later, you would owe tax only on the earnings at the time of the conversion (because you didn't get a tax break on your contributions). This strategy works perfectly as long as you're dealing with a single IRA.

But there's a wrinkle if you have other IRAs -- such as a deductible account or a rollover from a company plan. In that case, the portion of your converted amount that escapes taxes is based on the ratio of nondeductible contributions to the total balance in all of your IRAs. If your total balance is $100,000, for instance, of which $20,000 represents nondeductible contributions, 20% of any conversion would be tax-free.

Bottom line: A Roth conversion could still pay off handsomely in tax-free retirement income. But you may pay a higher price to get access to the Roth IRA.

Most Popular

How a Third Stimulus Check Could Differ From the First and Second Payments
Coronavirus and Your Money

How a Third Stimulus Check Could Differ From the First and Second Payments

There's a big push in Washington for a third round of stimulus payments. But the amount and eligibility rules for your third stimulus check could be d…
January 27, 2021
Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer
Coronavirus and Your Money

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer

The IRS has an online tool that lets you track the status of your second stimulus check.
January 18, 2021
Biden's Stimulus Plan Includes $3,000 Child Tax Credits
Coronavirus and Your Money

Biden's Stimulus Plan Includes $3,000 Child Tax Credits

The president is calling for a temporary tax credit of $3,000 per child (more for younger children).
January 27, 2021

Recommended

When Roth Conversions Are the Right Move – and When They Aren’t
Roth IRAs

When Roth Conversions Are the Right Move – and When They Aren’t

Converting a traditional IRA to a Roth IRA can be a smart tax- and estate-planning strategy for some people, but it can be a mistake for others.
January 15, 2021
A Retiree’s Guide to Key Dates in 2021
Basics

A Retiree’s Guide to Key Dates in 2021

It's critical -- and financially sound -- to hit these important financial deadlines spaced throughout the year.
January 8, 2021
10 Things Social Security Recipients Need to Know About Their Second Stimulus Check
social security

10 Things Social Security Recipients Need to Know About Their Second Stimulus Check

It's a bit more difficult for Social Security recipients to learn the ins and outs of second-round stimulus checks, since there are a few special rule…
January 4, 2021
6 Money-Smart Ways to Spend Your Second Stimulus Check
Coronavirus and Your Money

6 Money-Smart Ways to Spend Your Second Stimulus Check

If you don't have to use your second stimulus check for basic necessities, consider putting the money to work for you. You'll thank yourself later.
December 28, 2020