On the surface, the income limits for Roth IRA contributions make it look like you can't get money into a Roth IRA if you make too much money. However, through a backdoor, you can still get money into a Roth IRA without incurring any penalties no matter how much you make.
No Conversion Income Limits
Since 2010, the IRS has not imposed income limits on who can convert from a traditional IRA to a Roth IRA. In addition, the IRS has never placed a time limit on how long the money must stay in a traditional IRA before you can convert it to a Roth IRA. As a result, the removal of the income limits allows everyone to contribute to a traditional IRA and then immediately convert to a Roth IRA.
When you convert from a traditional IRA to a Roth IRA, you have to include the amount of the conversion that you would have been taxed on had you taken the money as a distribution. For example, if you converted $5,000 from a traditional IRA to a Roth IRA, and the entire distribution would have been taxable if you had taken it as a distribution, you would have to include that $5,000 as taxable income in the year of the conversion.
Nondeductible Contribution Effects
If you make nondeductible contributions to your traditional IRA, you create a basis in the account. If you took a distribution from the account, you would not have to pay income taxes on the portion of the distribution that comes from the nondeductible contributions. Similarly, when you convert from a traditional IRA to a Roth IRA and you've made nondeductible contributions, the portion of the conversion that comes from those nondeductible contributions is tax-free. For example, if your traditional IRA's value is 20 percent nondeductible contributions, 20 percent of your conversion is tax-free.
The downside to getting money into a Roth IRA through a traditional IRA contribution and conversion is that the five-year holding period is counted separately than the five-year period for the account as a whole. As a result, at least five years have to pass from the date of the conversion before you can take qualified distributions. For example, if you convert to a Roth IRA on July 15, 2014, you can't take qualified distributions from that conversion until July 15, 2019.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."