If your income is too high and you cannot contribute to a Roth IRA, you may still have options. First you can open a traditional nondeductible IRA and then you can convert that IRA to a Roth IRA. The money that you put into the Roth IRA will grow income-tax free. This strategy is particularly useful to individuals looking long-term and expecting higher tax rates in the future. Individuals who are younger and have time to see the investment grow are ideal candidates for this approach. With a traditional IRA, you have to take money out at a certain age and those distributions count as income. A Roth IRA is not subject to those requirements. Other benefits of a Roth IRA include keeping a lower income for medicare premiums purposes and avoiding an income tax hit for children that you might pass your Roth account down to.
The major concern with backdoor Roths however, is the pro rata rule, which states that when you are calculating taxes on a conversion, you have to consider all of your IRA assets, not just the nondeductible IRA. Be sure to figure out how this rule effects your desired conversion before deciding what move to make.
See Ashlea Ebeling, The Serial Backdoor Roth, A Tax-Free Retirement Kitty, Forbes, Jan. 20, 2012.
Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.
