Backdoor Roth: Contributing to Roth IRAs for High Income Earners

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.

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Larry Maddox, CFP®, CPA
Larry Maddox, CFP®, CPA
Larry founded Horizon Advisors, LLC in Houston, Texas in 1999 with fellow business partner Joe Thomson. He collaborates with our wealth management team and other external advisors to provide comprehensive wealth management services.

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