Back Door Roth IRA

Submitted by Julie Brangenberg on Fri, 2019-10-18 14:37

Hello. Can you explain the best scenario for use of the Back Door Roth IRA, and when it may be too tricky. Thanks.



Submitted by Alan - IRA critic on Fri, 2019-10-18 15:28

  • The “back door” allows a taxpayer whose MAGI is too high for a regular Roth IRA contribution to use a two step process which avoids the income limit. First, a non deductible TIRA contribution is made, and then it is converted to a Roth IRA. No tax is due as long as the taxpayer does not have other pre tax money in any SEP, SIMPLE, or traditional IRA. In other words, the only non Roth IRA balance must be the current contribution.
  • But if the taxpayer DOES have other pre tax IRA amounts, the conversion will be mostly taxable as calculated on Form 8606 (pro rates IRA basis with total value). To avoid this, the client can roll over the pre tax balances to an accepting employer plan leaving only the ND contribution amount in the TIRA. The conversion is then tax free. 
  • Because conversions can no longer be recharacterized, the rollover of the entire pre tax IRA balance to a 401k or other qualified plan should be done prior to converting to make sure that rollover is complete. Obviously, the process is shorter and easier if the taxpayer does not have any pre tax IRA balance to start with. They can then just make the ND contribution (no income limits apply here) and convert right away. The IRS has now clarified that they consider this strategy legitimate.
  • Once in the Roth IRA, the taxpayer has made a regular Roth IRA contribution without paying taxes, however since this was done by conversion, any distribution from the Roth IRA following the ordering rules requires all regular Roth conversions and older conversions to come out before the current non taxable conversion. For this particular conversion, there is no conversion 5 year holding requirement because the 10% penalty only applies to the taxable portion of a conversion if that conversion needs to be withdrawn from the Roth.

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