Rebecca Katz: Let’s take another question. This one is from Robert in Zanesfield, Ohio, who says, “For an upper-level tax bracket investor, when does it make sense to convert from a Roth to a regular IRA, and explain a ‘back-door’ IRA.” We’ve talked a little bit about the upper-level tax bracket issue, but what is a back-door IRA? Maria?
Maria Bruno: The back-door IRA is sometimes also likened to a contribute-and-convert strategy. In essence, for high-income earners who really make too much earned income to be able to contribute to a Roth IRA outright, there’s always the option to invest in a traditional IRA. Anyone can do that, as long as you have earned income of course. The question is whether the contribution would be deductible or not. With this back-door Roth feature, what you could do is contribute to a traditional IRA and then shortly thereafter convert it to a Roth. So it’s really a two-step process to get to a Roth, where you wouldn’t be able to do it directly because your earned income is too high.
So it’s a two-step strategy and there’s a couple of things to keep in mind. One is you want to do the conversion relatively quickly after the original contribution, so that the account doesn’t accumulate earnings, because if it does, then you might have a small tax burden there. So you want to consider that.
Also, if you have other IRAs that you’re not converting, traditional IRAs that you’re not converting, for the purpose of calculating the basis or any tax consequences—so you may not have consequences specifically on the back-door—but if you have other IRAs you’re not converting, the IRS requires you to aggregate all of those IRAs and potentially, you could be triggering some taxes. So the strategy works most seamlessly if someone does not have any other traditional IRAs they’re not converting.
Joel Dickson: What we have seen also is, investors will actually do conversions of traditional IRAs to make the back-door easier and to facilitate that in the future—again if it makes sense instead of—we always have to think about partial conversions or so forth. But there may be cases where it makes sense to convert all of the traditional IRA and now that back-door opportunity is available to you each year, if done for new money, without doing this.
Just so it’s clear, the reason that this back door is open, is that—as Maria mentioned—there are income limits on Roth IRA contributions directly. However, there are not any income limits on doing conversions. So you might have income that doesn’t qualify you for direct Roth contributions, but you can still do a conversion, and that’s where this “contribute to a non-deductible traditional IRA” comes in, and then convert it.
Maria Bruno: Right, so this really wasn’t a strategy prior to 2010, but now it is a strategy. We have information on vanguard.com if someone wants to go and take a look at that in terms of what the income limitations are and things like that, to help determine whether you can contribute outright or whether you need to do some type of back-door strategy.
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