Backdoor Roth IRAs

By rolling his or her pre-tax individual retirement account dollars into a 401(k), taxpayers can convert new nondeductible IRAs to Roth IRAs with little to no tax cost—even if a large pre-tax IRA exists. Most taxpayers believe that the pro rata rule acts as a barrier to backdoor Roth IRA. The pro rate rules state that a taxpayer must aggregate all his IRAs to determine how much income tax he owes when he converts. However, taxpayers can remove the pretax IRA by transferring it to a 401(k).

In fact, many employer plans allow “roll-ins” of IRA money to 401(k)s. Typically, employees must simply ask for a “roll-in form” to fill out and send to their IRA custodian. After the taxpayer transfers the pre-tax dollars and earnings into a 401(k), the IRA is left with no taxable income. If the taxpayer then converts the 401(k) to a Roth, he will pay no tax.

Taxpayers who are self-employed can see similar results by setting up a solo 401(k) and rolling-in pre-tax IRA funds. Some solo 401(k) providers do not accept roll-ins, so it is important that the taxpayer verify that roll-ins are accepted before signing with a provider.  

See Ashlea Ebeling, The Backdoor Roth IRA, Advanced Version, Forbes, Jan. 23, 2012.

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.