The Backdoor Roth IRA

With the expected increase in income tax rates next year due to the Medicare Surtax and the possible sunsetting of the Bush tax cuts, now may be a great time to set up a Roth IRA.  Unlike a regular IRA, a ROTH is completely tax-free when funds are withdrawn (assuming you meet certain requirements on how long the account is open, etc.).  However, when you contribute to a ROTH, you do not get a current deduction.

Farmers age 50 and over can put $6,000 into a ROTH IRA this year, but if your total gross income exceeds $183,000 for a married couple, then you cannot contribute to a ROTH.

There is a “backdoor” way to contribute to the ROTH and assuming you have no regular IRA accounts, it should not cost you much tax.

First, you contribute the maximum amount to a regular non-deductible IRA.  Second, you then convert this regular IRA to a ROTH IRA after waiting a couple of weeks or so.  The only tax owed is on the interest earnings that have accumulated in the IRA account.

If you have large balances in a regular IRA account, this conversion will most likely largely taxable since the non-deductible IRA balance is compared to all of the regular IRA balances and only the non-deductible fraction is used on the conversion.

If you have no regular IRA accounts, your income is over $200k, and you want to make a ROTH IRA contribution, this is the way to go.