Backdoor Pro Rata

You are correct that your income exceeds the Roth limit. The limit for single filers is $127k (phase out starts at $112k) and for married filers is $188k (phase out starts at $178k). See the full Roth contribution Income Limits Table.

The Backdoor Roth IRA

Despite exceeding the limit, you can still contribute to a Roth IRA due to a loophole. High earners cannot contribute directly to a Roth IRA, but they can contribute to a Traditional IRA and they can convert a Traditional to a Roth, which accomplishes the same thing as opening a Roth directly.

Traditional contribution + Traditional-to-Roth Conversion = Roth (Backdoor) Contribution

It may seem like a hassle, but it actually only takes a few minutes and the tax savings over the years can really add up. Here’s the step by step process.

Step 1. Contribute to a Traditional IRA (non-deductible)

Open a Traditional IRA (suggested account providers)
Contribute up to the contribution limit ($5,500 this year for those under 50)
Your contribution will probably not be tax deductible (Traditional IRA income limits for deductibility are lower than for Roth IRAs)
This creates a “cost basis” of the contributed amount

Step 2. Convert your Traditional IRA to a Roth IRA

There used to be income limits blocking high earners from doing these conversions, but the limits expired in 2010. Now anyone can convert.

Step 3. Pay any taxes on the conversion (probably close to zero)

Converting from Traditional to Roth is a taxable event
Since you already paid taxes on the money contributed (it wasn’t deductible), you now only owe taxes on any gains that you earned before the conversion
Taxes Owed = Tax Rate x (Conversion Value – Contribution Value)
If Conversion Value = Contribution Value, Taxes Owed = ZERO


Full contribution amount in a Roth IRA using post-tax dollars

An example:

Amy and her spouse earn $200k per year, making her ineligible to contribute to a Roth IRA
Amy contributes $5,500 to a Traditional IRA
The contribution is NOT tax-deductible because of her high income
The “cost basis” on her investment is $5,500
Amy contacts her IRA administrator (i.e. TD Ameritrade, E*trade, etc.) and tells them she wants to “convert” her Traditional IRA to a Roth IRA
In the few days between contribution to the Traditional IRA and converting to a Roth IRA, Amy’s account value has grown to $5,525.
Amy owes taxes on the $25 gain ($5,525 account value at conversion minus $5,500 cost basis).
Amy reports the $25 taxable gain on her taxes the following April.
Since Amy already had a Roth IRA with this IRA administrator, her “converted” amount was simply put into her existing Roth IRA. If she hadn’t already had a Roth IRA, a new account would have been opened during the conversion process.

The Pro-Rata Rule

All rollovers from Traditional to Roth IRAs must be done on a pro-rata basis. So if you have existing Traditional assets (pre-tax) and you try to do a Backdoor Roth IRA by contributing to a non-deductible Traditional IRA (post-tax), you cannot choose to only rollover the non-deductible Traditional assets. Instead, any amount you rollover will be taken proportionally from across all of your Traditional assets. For example, if you have $90k in deductible contributions and you make $10k in non-deductible contributions, intending to immediately roll it over to a Roth, when you do the $10k Traditional to Roth conversion (10% of your total Traditional assets) you will actually be converting $9k from your deductible contributions (10% of $90k) and $1k from your non-deductible contributions (10% of $10k).

The pro rata rule applies to the accounts and the amounts you hold at the end of the tax year, not on the day you do the conversion.

For those less familiar with Backdoor Roth IRAs, the pro rata rule states that if you convert any Traditional IRA assets (Traditional IRA, Simple IRA, SEP IRA) to a Roth IRA, that you cannot select to rollover only the non-deductible assets and leave the deductible assets in the Traditional IRA. Instead, you must roll them over prorata. For example, if you have $10k in a non-deductible Traditional IRA and $10k in a deductible SEP IRA you cannot choose to rollover only the $10k of non-deducbitble assets. If you do, the government will treat it as if you converted over $5k of the non-deductible assets and $5k of the deductible assets. I discuss more on the mathematics of the pro rata rule in my previous article.

But this question is less about the math and more about language. When they say you must convert “all” or a portion of “all” of your Traditional IRA assets, does that mean all at the time you did the conversion or all at any point during the tax year? The answer is the latter. All conversions done in a year are considered.

For exact details, see IRS Form 8606 – Nondeductible IRAs. You will need to fill out this form when contributing to or rolling over nondeductible IRA assets.

If you do decide to rollover all of your Traditional funds to Roth in one year and then contribute again to a Traditional in a following year, there is no need to open a “new” account. When you converted all of your Traditional assets you left the account empty. Putting new funds into the empty account is essentially the same as opening a new account. The IRS looks at all of your IRA assets across all companies so distinctions as to where the account was opened and whether or not they created a new account number for you do not matter. So if you have $5k in a non-deductible Traditional IRA at Fidelity and $5k in a non-deductible Traditional IRA at Vanguard and $10k in a deductible IRA at Schwab, the government only views this as $10k non-deductible and $10k deductible in a Traditional IRA. It may be easier to calculate taxes owed if you never co-mingle non-deductible and deductible assets, but it’s not technically necessary to have separate accounts.

Thank you to Russell Herdman for his contributions to this article.

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