The traditional contribution ("front door") for Roth IRAs is currently not available for higher income earners. Married couples earning $193,000 or more and singles earning $131,000 or more in 2015 are still barred from contributing directly to Roth IRAs.
In 2010, Congress changed the rules and since then anyone can convert a traditional IRA to a Roth IRA. However, higher income earners are still ineligible to contribute to a Roth IRA.
A Backdoor Roth IRA is a strategy for some higher income earners to participate in Roth IRAs. It is a way for higher income earners to put money into a traditional IRA and then roll that into a Roth IRA, getting all the benefits. While this strategy sounds simple, there are several rules that you must know and follow to make sure you do not incur unintended tax consequences. This is where working with a knowledgeable financial or tax professional can provide some great guidance and value.
One of the primary benefits of a Roth IRA is that any money contributed grows tax-free and is withdrawn without any further income taxation. In addition, unlike a traditional IRA, Roth IRAs have no required lifetime minimum distributions. Another benefit of a Roth IRA is it can be passed on to your heirs income tax free. This allows your funds to grow and compound tax free over many years.
There's one big caveat: This strategy works best tax-wise for people who don't already have money in traditional IRAs. That's because in conversions, earnings and previously untaxed contributions in traditional IRAs are taxed—and that tax is figured based on all your traditional IRAs, even ones you aren't converting.
If you choose to, you can contribute to a non-deductible IRA for 2015 (the maximum is $5,500 or $6,500 for those age 50 or older). Remember, you must contribute to your IRAs prior to the April 15 2016 tax deadline. This non-deductible IRA can then be used for your backdoor Roth IRA conversion (please call us or your tax professional prior to doing so because the rules for Roth conversions can be complicated).
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.
Email questions to [email protected] or call us at 541-574-6464. Julia Carlson is a registered Principal with, and securities are offered through, LPL Financial. Member FINRA/SIPC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.