How High Earners Can Set Up a Roth IRA

Q. If I earn too much to contribute to a Roth IRA, can I still contribute to a traditional IRA and then immediately convert it to a Roth? Would I have to pay taxes on the conversion?

A. Anyone can make nondeductible contributions to a traditional IRA, but you can’t make Roth IRA contributions if your modified adjusted gross income in 2016 was more than $132,000 if single or $194,000 if married filing jointly. That creates a backdoor approach to a Roth: Contribute to a traditional IRA and then convert it to 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 (see Deducting an IRA Contribution on Your Tax Return for more information about the income limits). You have until April 18, 2017, to contribute to an IRA for 2016, and then you can convert the money to a Roth almost right away.

Maura Cassidy, vice president of retirement products at Fidelity, says she uses this strategy, and she usually waits a day after making the IRA contribution to convert the money to a Roth. That timing makes it clear to the IRS that the original contribution was to a traditional IRA rather than a Roth, while providing the least amount of time for the IRA to generate earnings before the conversion.

You have to pay taxes on the conversion, except for any part that’s from nondeductible IRA contributions. If this nondeductible IRA is your only traditional IRA, you’ll have to pay taxes only on any earnings in the account after you made the contribution and before you converted the money to the Roth. The entire conversion would be taxable if all the money in your traditional IRA was from tax-deductible contributions.

The calculation is more complicated if you have other money in IRAs. Your tax liability is based on the ratio of your nondeductible contributions to the total balance of all of your traditional IRAs (but not money already in Roths) when you make the conversion. This includes money in SEP and SIMPLE IRAs, says Jeffrey Levine, director of retirement education for Ed Slott & Co., which provides IRA advice. For example, if you have a total traditional IRA balance of $20,000 and $5,000 is from nondeductible contributions, then one-fourth of your conversion will be tax-free and three-fourths of the conversion will be taxed at your income-tax rate.

For more information about Roth conversions, see IRS Publication 590-A, Contributions to Individual Retirement Arrangements. Also see Levine’s Definitive Guide to the Back-Door Roth.