Six figure wage earners often wonder if there’s a way that they can somehow benefit from the advantages of a Roth IRA. The short answer is yes, but there are some extra steps that must be taken.
Almost everyone can make nondeductible contributions to a traditional IRA, which is a great savings vehicle but not as great as a Roth IRA. According to a recent article in Kiplinger, “How High Earners Can Set Up a Roth IRA,” there is a “backdoor” approach to a Roth that starts with a contribution to a traditional IRA, and then converts it into a Roth.
There’s no income limit for converting money from a traditional IRA to a Roth IRA. If you don’t have a retirement plan at work, you may be able to deduct the IRA contributions. You have until April 18, 2017 to contribute to an IRA for 2016. After that date, you can convert the money to a Roth almost right away.
Experts who use this strategy, suggest that you wait a day after making the IRA contribution to convert the money into a Roth. This helps clearly show the IRS that the original contribution was to a traditional IRA not a Roth, while providing the least amount of time for the IRA to generate earnings before the conversion.
There will be taxes due on the conversion, except for any part that is from nondeductible IRA contributions. If this nondeductible IRA is your only traditional IRA, you’ll be liable for taxes only on any earnings in the account after you made the contribution and before you made the conversion to the Roth. The whole conversion is taxable, if all the funds in your traditional IRA were from tax-deductible contributions.
You may need some help, as things get more complex if there are other IRAs in your name. Remember that taxes are based on the ratio of nondeductible contributions to the total of all of your traditional IRAs, including funds in SEPs and SIMPLE IRAs. Your estate planning attorney will be able to help you navigate these rules and ratios.
Reference: Kiplinger (February 24, 2017) “How High Earners Can Set Up a Roth IRA”