Back Door Roth Conversion Strategy

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What is a Back Door Roth?

A Back Door Roth is a way to make a contribution to a Roth IRA even if you are above the income limits and still take advantage of the tax-deferred savings.  This strategy is typically used by High Net Individuals.

How it Works

You make a contribution to a traditional IRA.  Due to income limitations you will not be able to deduct this contribution.  You then convert it to a Roth IRA because there are no income limitations on these conversions.  Tada!  You have successfully made a Roth IRA contribution even though your income would have limited a deposit directly into a Roth.  Boy, that was easy!

Not so fast....Aggregation Rules

The IRS requires you to aggregate all of your IRA accounts so that when you convert your IRA into a Roth IRA, you have to do so in a pro rata fashion.  For example, if you have no IRAs, you can open a non-deductible IRA, contribute $5,000, and then as soon as the money clears, rollover the $5,000 into a Roth and pay NO tax.  However, if you already have an IRA with $5,000 of pre-tax contributions, open a $5,000 non-deductible IRA, and then try to rollover funds into a Roth IRA, you will have to pay tax on half of the contributions.  The IRS sees $2,500 coming from your first IRA and $2,500 coming from the second IRA.  Since one of the IRAs has pre-tax dollars, the conversion requires you pay taxes on it.  Get it?!

"But Phil, I already have a lot of pre-tax money saved up in my IRA account so I won't get much benefit from this strategy, right?"

Wrong!  We just have to do a little more work and remove your pre-tax IRA dollars from the equation.  How do we do that?  Find out in my next blog post....