Q: Our income is too high this year, so we can’t do a Roth IRA. I heard that we can contribute to a non-deductible IRA, then convert to a Roth IRA (backdoor). My spouse and I currently have rollover IRAs with high balances, so when we convert to the Roth IRA we will be taxed on most of the $6500. Is this correct and would you recommend doing this? We are both 55 years old.
A: The IRS uses a pro-rata rule when calculating tax on Roth IRA conversions. As such, most of the conversion would be taxable if you already have a sizable IRA account. Also, if you are in a very high tax bracket relative to what your tax bracket will be in retirement, then the Roth IRA conversation doesn’t really make sense.
For example, if you pay 30% in taxes today, and in retirement you’ll be in a 10% bracket, then the Roth IRA doesn’t help nearly as much in the future.
So it boils down to taxes today versus taxes tomorrow. If your tax rate will be similar (or higher) in the future than the conversion then it might make sense. If your tax rate will drip in the future than the conversion may not be beneficial.