I earned too much in 2013 to contribute to a Roth IRA. Can I
contribute to a traditional IRA for 2013 and immediately convert it
to a Roth? Do I have to pay taxes on the conversion?
Your plan is a perfectly legal backdoor entry to a Roth IRA. For
2013, direct Roth contributions are banned for singles with
adjusted gross income over $127,000 and couples filing a joint
return reporting AGI over $188,000. But there's no income limit on
contributions to a traditional IRA or for converting one to a Roth.
You have until April 15, 2014, to contribute up to $5,500 to a IRA
for 2013 (or up to $6,500 if you were 50 or older in 2013).
There's no legal requirement for how long the money needs to be
in the traditional IRA before moving it to a Roth. But Ken Hevert,
vice-president of retirement products for Fidelity, notes that it
could take a few days before the money is available for the
rollover. Check with the traditional IRA sponsor about timing.
Jim Blankenship, a certified financial planner in New Berlin,
Ill., generally advises clients to wait at least a few days for
recordkeeping purposes (and even as long as a month) before making
the conversion. If the contribution and the conversion are on
separate monthly statements, he says, it is clear that the original
contribution was to a traditional IRA rather than a Roth.
The tax issue is trickier. I'll assume you make a nondeductible
contribution to the traditional IRA (if you or your spouse have a
retirement plan at work, the fact that your income is too high for
a Roth means it's also too high to deduct contributions to a
traditional IRA). If the new contribution is the first and only
money you have put in a traditional IRA, you'll owe tax only on any
earnings between the time of the contribution and the conversion.
But if you have other money in traditional IRAs, your tax bill will
be based on the ratio of your nondeductible contributions to the
total balance in all of your traditional IRAs. So if you make a
nondeductible contribution of $5,500 this year and that brings your
total in traditional IRAs to $50,000, converting $5,500 to a Roth
would trigger a tax on $4,895. Because $5,500 is 11% of $50,000,
11% of the conversion ($605) is considered tax-free; the other 89%
($4,895) is considered pretax money moving from your traditional
IRAs to the Roth. If you convert the traditional IRA to a Roth now,
you'll report the conversion on your 2014 return next spring. After
the conversion, the money grows tax-free in the Roth. See
Why You Need a Roth IRA
for more information about the benefits of Roth IRAs.