What if you are above the income limits to contribute to a Roth IRA? Ugh, right? Mo' money, mo' problems. You can't even get a tax deduction if you contribute to a traditional IRA! Fret not, for all is not lost. You CAN get a Roth IRA, and it's called the Backdoor Roth IRA.

Sound shady? Sure it does, but I assure you it is totally legit, and I will show you how to do it. The reason this is possible is because there is no income limit for converting a traditional IRA into a Roth IRA. Once this "loophole" is terminated, then you will be sad you didn't do it when you had the chance. I should suggest you only do this if you do not qualify to contribute to a Roth IRA because you exceed the income threshold, otherwise you are just unnecessarily adding steps and possibly taxation). 

What Are The Income Limits to Qualifying to Contribute to a Roth IRA?

Conveniently (I guess?), the income limits to qualify for contributions to a Roth IRA are the same as qualifying for tax deductions in a traditional IRA. Basically, it would seem that you are out of luck either way for a traditional IRA or a Roth IRA. However, despite not qualifying for a tax-deductible traditional IRA, you can still make contributions to a traditional IRA that is NOT tax deductible. This is also referred to as a non-deductible traditional IRA. This is an important step in creating your backdoor Roth IRA, which I guide you through below.

Before diving in, please read all of the steps, because there is a caveat if you have any money in a tax-deferred traditional IRA.

Step-by-Step Guide to Creating a Backdoor Roth IRA

1. Make your maximum contribution into a traditional IRA. You may have to create a new traditional IRA account if you do not already have one. I have one just for this purpose, and for most of the year the account balance is $0. For 2017, the full contribution is $5,500 ($6,500 if over 50 years old). This is a non-deductible contribution if you are above the income limits. You are allowed to make a contribution to an IRA up until April 15 of the following year).
2. Wait until your transaction clears your bank account. This might take 2-5 days.
3. Roll over the entire amount into a Roth IRA (it can be an existing Roth IRA). You will get a warning that this is a TAXABLE event. This would be a taxable event if you are converting tax-deferred money into a Roth. However, in step 1 we noted that this is a non-deductible contribution, meaning you have already paid all taxes on it. Thus, it is a tax-free conversion***
4. File a Form 8606 when filing season comes. If you do your taxes yourself using tax software, I know H&R Block software will include these automatically when you specify that you had contributed to a Traditional IRA and then rolled it into a Roth IRA. The fact that it is built into the software lets you know it is legit and commonly done!
5. Repeat every year that your income limits are above the threshold to contribute to a Roth IRA.

*** Tax Caveat

If you already have tax-deferred money in a traditional IRA, then the taxes get tricky. I will illustrate this with the following example:

Say you have $16,500 combined in one or more tax-deferred traditional IRAs.

You then make a non-deductible contribution of $5,500 to a traditional IRA. This means 75% of your traditional IRA is tax-deferred and 25% is non-deductible, per below:

You then want to rollover the $5,500 you just contributed into a Roth IRA.

BUT WAIT!

You cannot specify that you want to rollover just the non-deductible portion. The conversion will be proportional to the amounts you have as non-deductible and tax-deferred.So in this example, your entire traditional IRA portfolio is 25% non-deductible. When you convert any amount to a Roth IRA, only 25% of it will not be taxed, while the other 75% will be taxed.

Continuing our example:

By rolling over $5,500 to a Roth IRA, you now owe taxes on 75% of it, or $4,125. This is quite the opposite of what our goals were!

The remaining balance on your traditional IRAs become $16,500, of which $4,125 is non-deductible and $12,375 is tax-deferred. You will encounter the same problem every year so long as you keep non-deductible and tax-deferred balances in your traditional IRA.

How do you get around this?

Roll over the entire amount of your traditional IRA (while you are in a low tax bracket) to a Roth IRA.You will pay the entire tax bill on the conversion this year, but never have to worry about this nonsense again.

If you are a medical student or a resident and have money in a traditional IRA, you should think ahead and convert your traditional IRA to a Roth IRA while you are in a low tax bracket.