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Entering into a Roth IRA through the “Backdoor”

The Roth IRA offers tax-free retirement growth opportunities that are attractive to many taxpayers. However, some find themselves ineligible to contribute because their income is too high. The IRS has provided a way to avoid the income limitation rules by enabling taxpayers to roll traditional IRA contributions into a Roth IRA through a “backdoor.”

Roth IRAs and Limitations
A Roth IRA is a beneficial retirement tool where already taxed dollars can be contributed to a retirement account and are allowed to grow tax-free. Withdrawals can be taken from a Roth IRA, on or after age 59½, free of tax, assuming funds have remained in the Roth IRA for five years. However, Roth IRAs come with certain limitations:

  • Income Limitation – Taxpayers wishing to make a 2017 Roth IRA contribution are not eligible to contribute if filing a joint return with modified adjusted gross income (AGI) of $196,000 or more. Taxpayers who do not file jointly cannot contribute to a Roth IRA if modified AGI is $133,000 or more.
  • Contribution Limitation – Taxpayers eligible to contribute to a Roth IRA for 2017 cannot contribute more than $5,500 ($6,500 if age 50 or older). Other contribution limitations are based on annual taxable compensation and phase-out for eligible high income taxpayers.

The Backdoor Roth IRA
Taxpayers can fund a Roth IRA by making nondeductible contributions to a traditional IRA and then rolling amounts from the traditional IRA into a Roth IRA, known as the backdoor Roth IRA contribution. The backdoor Roth IRA contribution is allowed because there are currently no income limitations for nondeductible contributions to a traditional IRA or limitations on conversions from a traditional IRA to a Roth IRA.

The Aggregation Rule
The backdoor Roth IRA is not without complications. Taxpayers interested in funding a backdoor Roth IRA must be careful of the IRA aggregation rule, which may create an unexpected tax bill on amounts deemed to be converted from pre-tax and previously deducted contributions in other IRA accounts. The aggregation rule states that all IRA balances must be combined and the nondeductible portion prorated to determine taxation of the conversion amount. Even if nondeductible contributions are made to a separate IRA and then converted to a Roth IRA, a portion of the conversion is deemed to have been made from a currently taxable amount of all IRAs. The aggregation rule is best illustrated by example.

Example 1 – Backdoor Roth IRA with No Taxable Aggregation:

Hillary does not have any IRA accounts and wants to open a Roth IRA. Hillary files a joint tax return with husband Bill and has modified AGI of $300,000 in 2017. She is not eligible to contribute to a Roth IRA because her joint AGI is over $196,000. Instead, Hillary makes a $5,500 nondeductible contribution to a traditional IRA and then rolls it into a Roth account. Since Hillary has no other IRA balances for aggregation, none of her conversion is taxable and the Roth IRA balance can be withdrawn free of tax, on or after age 59½, if the account has remained open for at least five years.

Example 2 – Backdoor Roth IRA with Taxable Amounts from Aggregation:

Donald wants to contribute to a Roth IRA, but he is filing a 2017 joint return with modified AGI over $196,000 and is not eligible to contribute to a Roth IRA. Donald already has several IRA accounts totaling $95,000, which were funded with pre-tax and previously deducted contributions. Donald makes a $5,000 nondeductible contribution to a traditional IRA in 2017, bringing his total IRA balances to $100,000. Donald wants to make a $5,000 backdoor Roth IRA conversion at the end of 2017. The aggregation rule requires that 95% of Donald’s backdoor Roth IRA conversion is taxable because $95,000 of the $100,000 total IRA balance is from pre-tax and previously deducted IRA contributions. Donald will be taxed on $4,750 of his $5,000 Roth conversion on his 2017 tax return even though he made a $5,000 nondeductible IRA contribution during the year. Donald’s $5,000 Roth IRA balance can grow and be withdrawn free of tax, on or after age 59½, if the account has remained open for at least five years.

Example 3 – Backdoor Roth IRA with Taxable Aggregation and a Workplace Retirement Plan:

Using Donald in example 2, suppose he has a workplace retirement plan that accepts rollovers. During the taxable year, Donald first rolls all of his pre-tax IRA accounts to his employer’s plan. He then executes the backdoor IRA strategy outlined above. Because he has no pre-tax IRA accounts at the time of the contribution to the Roth IRA, he has no taxable income on the conversion.

The backdoor Roth IRA provides high-income taxpayers a way to fund Roth IRAs, but can come at a price if the taxpayer already has pre-tax or deductible balances in other IRAs. Roth conversions should be coordinated carefully with a tax advisor to produce intended results. New laws and limitations could close this backdoor without warning.

If you have questions or would like more information, please contact Tim Suarez at or 844.4WINDES (844.494.6337).
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