You can make a non-deductible IRA contribution each year and then convert it into a Roth IRA using the clandestine method. You'll pay taxes on any converted amount that exceeds your base at the time of the conversion. . You won't have to pay taxes on your account contributions, but account earnings will be taxable at the time of conversion.
If you have deductible and deductible IRAs, you must prorate the taxable and non-taxable portions to determine what part of your conversion is taxable. While there are income limits for contributions to a Roth IRA, there are no income limits for contributing to a non-deductible IRA. A non-deductible IRA is simply a regular contribution to the IRA without an income deduction, also known as an “after-tax.”. However, don't confuse income limits with contribution limits.
There are still contribution limits for non-deductible IRAs. When you make contributions to a Roth, you do so with after-tax money. By converting non-deductible IRA contributions to a Roth, you're also converting after-tax money. And once the conversion is complete, any investment growth within the account can be withdrawn as a qualified tax-free distribution.
However, it should be noted that, while this strategy of making a contribution to a Roth IRA through the back door by making a contribution to the traditional IRA (potentially non-deductible) followed by a conversion to the Roth IRA seems relatively simple, there are some important caveats to consider when implementing the strategy. So, in the end, what is a clandestine contribution from Roth? A clandestine contribution to a Roth IRA simply consists of making a contribution to the IRA (usually not deductible), followed by a subsequent conversion to Roth, even if you exceed income limits to make a normal contribution to the Roth IRA, all without violating the doctrine of tiered transactions. People who contribute to a non-deductible IRA usually do so because their incomes are too high to contribute to a Roth IRA or deduct their contributions to a traditional IRA. If you have a non-deductible IRA, you can convert it to a Roth IRA and enjoy the benefits of the Roth, such as tax-free withdrawals and the absence of mandatory minimum distributions (RMDs) during your lifetime.
The prorated rule is there so that people cannot avoid taxes by converting only their non-deductible IRAs and not their deductible IRAs, which would normally result in taxes. All IRA assets (including SEP and SIMPLE) must be aggregated and converted proportionally, based on the percentage of after-tax IRA assets in pre-tax IRA assets. So, by bringing the two together, people with higher incomes who can't make a contribution to a Roth IRA can effectively get around income thresholds by making a non-deductible IRA contribution (allowed even at high income levels) and then convert it to a Roth IRA (also allowed even at high income levels). The prorated rule prevents people from only converting non-deductible (after-tax) IRAs into Roth IRAs and therefore avoid taxes that would normally entail the conversion process.
In addition, existing Roth IRAs, and associated after-tax contributions that go to Roth accounts, are also not added. In addition, the reality is that current reporting systems on IRA contributions and conversions generally do not record (in automatic reports to the IRS on Forms 1099-R and 549) the exact days when a non-deductible IRA contribution and a conversion to Roth occurred, nor from which accounts (and if it was related to the same account). In this case, the strategy of making a non-deductible contribution to the IRA and immediately converting it to a Roth one can be effective. Instead, Betsy decides to follow the “clandestine” Roth contribution strategy and makes a non-deductible contribution to the IRA on July 1, followed by a conversion to a Roth IRA on July 2 (as soon as the funds have been officially deposited in the IRA account and are available for transfer to the Roth IRA account).
If you have stopped contributing to a Roth IRA and are considering converting it to a Roth IRA, proceed with caution. On the other hand, those with a 401 (k) plan that allows funds to be transferred to the plan can avoid the aggregation rule by diverting their pre-tax funds to a 401 (k) plan and then converting the rest of the IRA, which is now right after taxes. A clandestine Roth IRA refers to a two-step maneuver that people with high incomes can use to get around the income limits of Roth IRAs. .