Roth IRAs allow for annual non-deductible IRA contributions which grow tax-free and there are never any required distributions as with a tax deductible IRA. This makes Roth IRAs a very appealing savings option for those who are looking for additional retirement savings. However, if you earn more than $125,000 in 2012 ($183,000 Married Filing Jointly), you do not qualify to make a direct Roth IRA contribution. Fortunately, there is a way to work around this. It is a technique known as a “backdoor Roth.”
With this strategy you first open a traditional IRA, make a non-deductible contribution ($5,000 in 2011 and 2012 or $6,000 with catch-up if 5o or over), and then convert it to a Roth IRA. If you have previously converted your tax deductible IRAs to Roth IRAs, this is a no-brainer as there will be no taxable income due on the conversion. However, if you have other holdings in a traditional IRA, this technique needs to be carefully considered as some of the money converted may be subject to current tax by virtue of the “pro-rata rule.” When you convert IRA accounts to a Roth, you must factor in all your IRA assets (not just the new non-deductible contribution) to determine taxability. For example, if you have $90,000 in a traditional IRA from a 401(k) rollover, and you make two nondeductible $5,000 contributions (2011 and 2012) to a new IRA, the conversion would be 90% taxable.
If you have questions about this technique or how it might affect you personally, please discuss this with your CPA or contact us for further assistance.