Back door Roth IRA conversion question

Investing Strategies Retirement Investing
1

My daughter cannot contribute to Roth IRA since her income exceeds the limit, and she cannot contribute to traditional IRA since she’s covered by a retirement at work. Can she do a back door Roth IRA by:

  1. make a non-deductible contribution to traditional IRA (by not claiming it on the tax form)
  2. then next day transfer that same amount to a Roth IRA account

Thanks

2

Sorry, that’s not correct. As long as she has earned income, she can contribute to an IRA. Because she is covered by a retirement plan at work and makes more than the Roth IRA income limit, she also makes more than the limit for deductibility, so she can’t deduct the contribution.

So what your statement should have said was:

she cannot make a deductible contribution to traditional IRA since she’s covered by a retirement at work.

She can, but she may end up being taxed again on most/all of the conversion, if she has any other Traditional IRA accounts (including, but not limited to - rollover, SIMPLE, SEP and self-directed). She needs to understand the pro-rata rule for Roth conversions, which is figured on IRS Form 8606 f8606.pdf (irs.gov) Here are the instructions for that form: i8606.pdf (irs.gov)

Basically, if she makes a $5000 non-deductible contribution to an IRA account, and has a total of $45,000 in other pre-tax (Traditional) IRA accounts, she has a total of $50,000 in her IRA (Individual Retirement Arrangement - not Account), of which $5,000 (10%) has basis (i.e. has already been taxed). If she does a $5,000 conversion, only 10% ($500) will be considered to have been already taxed, and she will be taxed on $4,500 of the conversion. She will then have a Roth IRA with $5,000 and a Traditional IRA with $45,000, with a $4,500 basis.

She could do a couple of things to resolve this so that she can do back door Roth contributions without having to use the pro-rata rule:

  • Convert all of her Traditional IRA holdings to Roth IRAs
  • Roll all of her Traditional IRAs into her employer’s plan (Note - she won’t be able to roll any basis (after tax contributions) that she already may have in those Traditional IRAs into her employer’s plan. But that means that after she does the rollover, she will have a Traditional IRA that has 100% basis, and can be converted into a Roth IRA without paying any additional taxes.)

AJ

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