A “backdoor” Roth IRA is a strategy that allows individuals who are above the income limits for a Roth IRA to still add money to a Roth IRA. It is a two-step process:
The individual makes a non-deductible contribution to a traditional IRA. Anyone can make a non-deductible contribution as long as they have earned income.
The individual then converts the funds in their traditional IRA to a Roth IRA. If the individual does not have any other pre-tax IRA balances (in a traditional IRA, rollover IRA, SEP IRA, or SIMPLE IRA) and immediately converts the funds before any interest is earned, the conversion will not trigger any income tax.
By doing this, the individual is able to put money in a Roth IRA even if they are above the income limits for a direct Roth IRA contribution. However, it is important to note that the conversion could trigger taxes if the individual has other pre-tax IRA balances in a traditional IRA, rollover IRA, SIMPLE IRA, or SEP IRA, as the conversion is pro-rata across all of the individual's IRA accounts. The pro-rata calculation does not include balances inside a 401(k) plan.
Also, if the individual has made non-deductible contributions to traditional IRA in the past and has not done proper tax filing, this could trigger additional taxes and penalties. Therefore, it is important to consult with your Domain Advisor if you have any questions about a Roth IRA.