The Tax Cuts and Jobs Act (otherwise known as tax reform) has brought with it many changes, however, the “backdoor” Roth IRA is still available. The “backdoor” Roth IRA rules allow you to recharacterize your traditional IRA as a Roth IRA tax-free in order to by-pass the Roth IRA contribution limits.

A Roth IRA is an individual retirement account in which you only pay taxes on contributions and all future growth is tax-free. The theory is that by paying taxes now, you can avoid higher tax rates in the future when you start using your retirement funds. However, if you earn more than what is allowable under the tax law, you cannot directly contribute to a Roth IRA. According to the IRS:

  • To contribute to a Roth IRA, you must have earned income.
  • You must be under age 70½ in 2018 because traditional IRA contributions cannot be made in a year that you are 70½ or older.
  • The modified adjusted gross income amount for contributing to a Roth IRA in 2018 phases out from $189,000 to $199,000 if you’re married filing jointly, and between $120,000 to $135,000 if you’re single.
  • If you’re under 50 years old, you can only contribute up to $5,500, and if you’re over 50 the IRS gives you a $1,000 catch up.

If your income is over this threshold, this is where the Roth IRA “back door” strategy comes in. You simply make a non-deductible contribution to a traditional IRA, then convert the contribution to a Roth IRA. Next, you’ll need to use the income phase-out rules above to determine how your conversion will be taxed.

Essentially, if you don’t already have an IRA prior to doing a backdoor Roth IRA conversion, your after-tax contributions will be the same, regardless of whether you receive a deduction for the initial traditional IRA contribution or not.

In addition, any funds in a Roth IRA aggregated through the back door conversion strategy are classed as converted funds, not Roth IRA contributions. This means that if you are under age 59½, you must wait five years to access those funds penalty-free. This stipulation does not apply if you make direct Roth IRA contributions, which are immediately available, tax and penalty-free.

If you have any questions about the back door Roth IRA strategy or other New York State or New York City tax questions, please contact our NYC accountant.