Kiplinger’s recent article, “How High Earners Can Set Up a Roth IRA,” says that anyone can make nondeductible contributions to a traditional IRA, subject to certain limits. For example, you can’t make Roth IRA contributions if your modified AGI (adjusted gross income) last year was over $132,000 if single or $194,000 if married filing jointly.
Experts say there’s a backdoor approach to a Roth: contribute to a traditional IRA and subsequently convert 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.
It gets a bit more complicated if you have other money in IRAs. Your taxes are based on the ratio of your nondeductible contributions to the total balance of all your traditional IRAs (not money already in Roth IRAs), when you make the conversion. This would include money in SEP and SIMPLE IRAs.
Reference: Kiplinger (February 24, 2017) “How High Earners Can Set Up a Roth IRA”