NEW YORK (MainStreet) The Roth IRA is the ticket to tax-free income for life after work. Pay your government dues now, and then never again. That's great until you bump into the barrier of ineligibility. With strict restrictions on the amount of money you can make and still qualify to contribute, the Roth can have a closed-door policy on participation. Unless you go through the back door.
If you make more than $129,000 as a single taxpayer, or $191,000 as a married couple filing jointly, you can't make a Roth contribution. But there is a legal loophole.
First, you put the money into a traditional IRA. Of course, you won't likely be able to deduct this contribution because of your above-average income. Uncle Sam says deductions aren't allowed if you are covered by an employer-sponsored retirement plan, or if you make more than $116,000 on a married-filing-jointly return, or $70,000 as a single taxpayer. But the deduction is not what we're looking for the tax-free retirement income is.
So say you and your income-earning spouse put in your full $5,500 contributions each and we'll also make you over 50 years old so you both get the $1,000 catch-up contributions, too. That's $13,000 total all nice and tidy in your old-school IRA.
Now, here's the loophole. The IRS doesn't have restrictions on the amount of assets that you can convert from a traditional IRA into a Roth -- you just have to pay the tax on the growth of the investment. And since you just stashed the cash in the traditional IRA, there's not likely to be anything to tax.
Sweet deal. You just contributed to a Roth IRA, even though technically you aren't supposed to be able to, and did it all with just a little bit of paperwork and your wily resourcefulness.
This works best when you start a new traditional IRA account just for the conversion. If you use an existing IRA with prior contributions, you'll have to pay the tax on the growth of those previous investments. But there is a potential hack for that, too. If your 401(k) allows rollovers into it, called a reverse rollover, you can put your previous IRA assets into your 401(k) and then do your backdoor Roth.
Man, it's fun when you find a legal tax loophole.
--Written by Hal M. Bundrick for MainStreet