A potential downside of tax-deferred saving through a traditional retirement plan is that you’ll have to pay taxes when you make withdrawals at retirement. Roth plans, on the other hand, allow tax-free distributions; the tradeoff is that contributions to these plans don’t reduce your current-year taxable income.
Unfortunately, your employer might not offer a Roth 401(k) or another Roth option, and modified adjusted gross income (MAGI)-based phaseouts may reduce or eliminate your ability to contribute to a Roth IRA. Fortunately, there is a solution: the “back door” Roth IRA.
Are you phased out?
The 2017 contribution limit for all IRAs combined is $5,500 (plus an additional $1,000 catch-up contribution if you’ll be age 50 or older by December 31). You can make a partial contribution if your MAGI falls within the applicable phaseout range, but no contribution if it exceeds the top of the range:
- For married taxpayers filing jointly: $186,000–$196,000.
- For single and head-of-household taxpayers: $118,000–$133,000.
(Note: Married taxpayers filing separately are subject to much lower phaseout ranges.)
Using the back door
If the income-based phaseout prevents you from making Roth IRA contributions and you don’t already have a traditional IRA, a “back door” IRA might be right for you.
How does it work? You set up a traditional account and make a nondeductible contribution to it. You then wait until the transaction clears and convert the traditional account to a Roth account. The only tax due will be on any growth in the account between the time you made the contribution and the date of conversion, which should be little, if any, assuming you’re able to make the conversion quickly.
More limited tax benefit in some cases
If you do already have a traditional IRA, the back-door Roth IRA strategy is still available but there will be more tax liability on the conversion. A portion of the amount you convert to a Roth IRA will be considered attributable to deductible contributions and thus be taxable. It doesn’t matter if you set up a new traditional IRA for the nondeductible contributions; all of your traditional IRAs will be treated as one for tax purposes, according to https://www.pancardapply.in.
Roth IRAs have other benefits and downsides you need to factor into your decision, and additional rules apply to IRA conversions. Please contact us for assistance in determining whether a backdoor Roth IRA is right for you.
Read also: History Of PAN.