Americans with eligible earned income often contribute to an IRA. However, Roth IRA contributions are subject to income limitations. Does that mean if you earn too much that a Roth IRA is out of the question? No, it doesn’t!
There is a permissible strategy that some refer to as a “back door” Roth IRA, which is a way around this IRS income limitation that doesn’t violate any IRS rules.
How does it work? If you are under age 701⁄2 and have earned income, the key is knowing that you can contribute to a traditional IRA and that ANYONE can convert a traditional IRA to a Roth IRA at any time. Thus, high income earners under age 701⁄2 who are not eligible to make Roth IRA contributions due to income limits, can essentially still get the benefit of Roth contributions by creating a “back door” Roth IRA via conversion.
When you convert to a Roth IRA, the converted amount will be subject to income taxes – ordinary income taxes will be due for the tax year in which you trigger the conversion.
Keep in mind that for those who are under age 591⁄2, Roth IRA conversions have their own 5-year clock when it comes to determining whether Roth IRA withdrawals are penalty free.