Why the Backdoor ROTH is not being pushed for many of our clients
The Common Question: Because my income is too high, should I make a non-deductible contribution of $6,000, then you convert it into a ROTH?
This is a common question for Index Gurus so this post addresses why many of our high net-worth clients should tread with caution.
Some of our clients are asking about a strategy called a “Backdoor ROTH IRA.” ROTH IRA accounts have income limits so not everyone is able to participate. When a person makes too much money to contribute directly to a ROTH IRA, he can use the “backdoor.” This starts off as a non-deductible (after-tax) contribution that is made to a traditional IRA. Then those dollars can be immediately converted to a ROTH. Since these are after-tax dollars that are converted, there is no tax due on the conversion (assuming no earnings on the after-tax dollars).
It is important to note that you cannot segregate the after-tax dollars in your IRA and only convert those. If you have any pre-tax (deductible) dollars in any IRA, SEP or SIMPLE plan, those dollars must be considered under the pro-rata rule. Pro-rata dictates that any conversion will include a proportionate share of pre- and after-tax dollars. The only way a ROTH conversion can be 100% tax-free is if you have no pre-tax dollars in any of your IRAs, SEP or SIMPLE plans.