How do you do a backdoor Roth IRA conversion?

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Asked on January 23, 2018 10:51 pm
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Answered: December 17, 2018 1:18 am
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Posted by Rahul Sharma (MONEY FORUMS: 0, Answers: 3)
Answered: December 14, 2018 2:20 am
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Not all taxpayers are eligible to contribute to a Roth IRA. For the 2017 tax year individuals with Modified Adjusted Gross Income over $133,000 are not eligible to contribute to a Roth; for taxpayers filing as married the limit is $196,000. These numbers will be slightly higher for next year.

But some people with incomes over these limits may wish to get money into a Roth – and that is where the “back door” comes into play.

A taxpayer can use the backdoor method in one of two ways.

If the taxpayer has money in a traditional IRA they can convert this to a Roth IRA, bypassing the income limits. Note that the conversion is a taxable event.

Secondly, a taxpayer who does not have a traditional IRA can contribute to a traditional IRA and then convert the traditional IRA into a Roth. Again, the conversion is a taxable event.

There are two very important factors to keep in mind. One, conversions have no dollar limit, so persons with existing qualified money are only limited by the amount they have – and their willingness to pay the tax up front.

Second, if any portion of your IRA account was funded with non-deductible contributions you must pay taxes on the pro-rata basis of your deductible portion to your total. This means you can’t simply convert a small account which has post-tax contributions and avoid the tax.

Then the big question becomes the why -why would someone want to convert.

The logical, but unlikely, reason to convert is despite an income which precludes you from making a Roth contribution now you expect to have a higher tax burden in retirement and want to have some tax-free Roth money available.

The more likely reason is for estate purposes. If you have done reasonably well and accumulated more than you will spend in your retirement you might want to have Roth funds to pass on. First, unlike your traditional IRAs, you will have no required minimum distributions on your Roth IRAs. Second, you may see an advantage to passing Roth funds on to your children (or another beneficiary). You can pay a small amount of tax now to start the account – they get the whole thing income-tax free when you kick the bucket. That is some major leverage.

So, back to the original question, the mechanics of doing a backdoor Roth are straightforward. You need to have an account to convert, or fund a traditional account, keeping present contribution limits in mind.

Then it is merely a matter of conversion.

Most IRA custodians will be able to help with specific forms for your accounts.

Two last cautions. One is that recharacterizations seem to have gone away with the new tax reform, so be careful not to contribute anything thinking you can change your mind later. The second is that while the backdoor is open, it may eventually get shut. The opportunity to use the backdoor to fund a Roth is there – but you can’t count on it not getting closed in the future.

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Posted by Peter Neeves (MONEY FORUMS: 1, Answers: 59)
Answered: January 24, 2018 5:21 pm