Back-Door Roth IRAs

Posted by Lee Reams Sr. on

High-income taxpayers are limited in the annual amount they can contribute a Roth IRA. In 2016, the allowable contribution phases out for joint-filing taxpayers with an AGI between $184,000 and $194,000 (or an AGI between $0 and $9,999 for married taxpayers filing separately). For unmarried taxpayers, the phase-out is between $117,000 and $132,000. 

However, AGI limitations can be circumvented by what is frequently referred to as a back-door Roth IRA. Anyone who is under age 70.5 and who has compensation can make a contribution to a traditional IRA (for which only deductibility is limited by AGI), and this contribution can be designated as nondeductible. To accomplish a back-door IRA, first, a nondeductible contribution is made to a traditional IRA, which is then converted into a Roth IRA. Assuming the taxpayer has no other IRA accounts, the only taxable amount would be the IRA earnings between the time of the traditional contribution and time of the Roth conversion.

BIG PITFALL: The issue often overlooked by investment counselors and taxpayers is that, for distribution purposes, all a taxpayer’s IRAs (except Roth IRAs) are considered as one account. Thus, if a taxpayer is attempting to circumvent the Roth IRA AGI limitations and has other traditional and/or SEP IRAs, the conversion will include a prorated taxable and nontaxable distribution that takes into account the total of all of the taxpayer’s IRAs. This could result in an unexpected taxable event upon conversion.

There is a possible, although complicated, solution. IRA rollovers into qualified plans are permitted. In addition, a rollover to a qualified plan is limited to the taxable portion of the IRA (Code Sec. 408(d)(3)(H)). If an employer’s plan permits, a taxpayer could roll the entire taxable portion of his or her IRA into the employer’s plan, leaving behind only nondeductible IRA contributions which can then be converted into a Roth IRA tax-free.