IRAs

Taxes When Using the Back Door Into a Roth IRA

The new tax law still allows high earners to contribute indirectly to a Roth IRA. But the tax bill for doing so will depend partly on whether they have other money in a traditional IRA.

Question: I read your column How to Undo a Roth Contribution If Your Income is Too High. But if your income is too high, can you -- under the new tax law -- still make backdoor Roth contributions by converting money from a traditional IRA to a Roth? If so, would this be a tax-free conversion if you immediately transfer your traditional IRA contribution to a Roth?

Answer: The new tax law didn't change your ability to make a "backdoor" Roth IRA contribution if your income is too high to contribute to a Roth directly. But the conversion will only be tax-free if you don't have any other money in a traditional IRA.

You can only contribute to a Roth IRA in 2018 if your modified adjusted gross income is less than $135,000 if you're single or $199,000 if married filing jointly. (The contribution amount starts to phase out if you earn more than $120,000 if you're single or $189,000 if married filing jointly.) But there's no income limit for converting money from a traditional IRA to a Roth. Some people who earn too much to contribute directly to a Roth make a nondeductible contribution to a traditional IRA, then quickly roll the money over to a Roth. This is called a backdoor Roth contribution. If the nondeductible contribution is the only money you have in a traditional IRA, then you won't owe taxes on the conversion, except on any gains that occurred between the time you made the contribution and the time you converted to the Roth.

But if you had any other money in a traditional IRA -- whether from tax-deductible contributions or rollovers from a 401(k) -- you may have to pay more in taxes. The tax-free portion of the conversion is based on the ratio of your nondeductible contributions to the total balance in all of your traditional IRAs. If you have $50,000 in traditional IRAs and you make $5,000 in nondeductible contributions, then 10% of your conversion will be tax-free and the remaining 90% will be taxable. See How to Calculate Tax-Free and Taxable IRA Withdrawals for more about figuring the tax consequences.

For more information about the procedure for making a backdoor Roth contribution, see How High Earners Can Set Up a Roth IRA.

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