Why would someone want to do a traditional IRA if it cannot be deducted? They probably wouldn't want to do it. 

Getting Started

The first thing to do is open up a traditional IRA account then make a non-deductible contribution. It is very important to mark the contribution as non-deductible when it is made. 

Post year end contributions can be made up until April 15th (tax deadline). For married couples, each spouse can make a separate non-deductible post contribution of $6,500 for the prior tax year.  BONUS - you can also make a 2nd contribution for the current tax year (which will result in increased compound interest for the full year).

To take advantage of this strategy will now require the conversion to of the traditional IRA over to a Roth IRA. A few days after the traditional IRA account is set up and the non-deductible contributions have been made, open a separate Roth IRA account. Finally, you will process a "Roth Conversion" in the account which should be as simple as a few clicks.

This is a 100% tax-free move because the contributions were marked "non-deductible" when they were put into the traditional IRA account which means that when your tax return is prepared, that contribution will not be deducted. **Please see the Pro Rata rule below if you have multiple IRA accounts.**

It is important to do the the conversion as soon as possible to prevent any investment gains on the traditional IRA, which would be taxable when the Roth IRA conversion is done. 

The Pro Rate Rule to Double Check: 
This important rule is for taxpayers that have multiple IRA accounts, some with pretax and some with post tax dollars. 

Example:

Traditional IRA with pre-tax contributions: $40,000
Traditional IRA with after-tax contributions: $10,000 (This is the account you want to convert to a Roth IRA after speaking with us)
Goal: You want to convert the $10,000 in after-tax contributions to a Roth IRA.

Application of Pro Rata Rule:

Calculate Total IRA Funds: Add up all the money in all of your IRAs. In this case, $40,000 (pre-tax) + $10,000 (after-tax) = $50,000 total.

Determine the Percentage of After-Tax Contributions: Calculate the percentage of your total IRA funds that your after-tax contribution represents. Here, $10,000 (after-tax) / $50,000 (total) = 20%.

Apply the Percentage to the Conversion Amount: When you convert $10,000 to a Roth IRA, only 20% of this amount ($2,000) will be tax-free, as it represents the after-tax portion. The remaining 80% ($8,000) is considered pre-tax money and will be taxable.

Result: In converting $10,000 from a Traditional IRA (with after-tax contributions) to a Roth IRA, you would owe taxes on $8,000 of the converted amount.

Why Make an Early in the Year Non-Deductible Contribution?

Making an early in the year (Jan/Feb) non-deductible contribution takes advantage of the power of compounding. By making the non-deductible contribution early in January versus in December, it could mean about $900 to $1000 in earnings, based on typical inflation and growth rates, because that money can grow over a longer period of time. If you do this every year at the beginning of the year versus the end of the year, it is going to equate to substantial savings and growth.

EXAMPLE:  Assuming the maximum 2024 non-deductible contribution of $6,500 is made, implementing this strategy and making a non-deductible contribution of $6,500 starting in 2024, converting it to a Roth IRA, and continuing to do this for the next 20 years could mean a growth to about $245,000 in a 100% tax-free Roth IRA on about $130,000 of contributions!  You can even Self Direct these funds into business, real estate, crypto and more...

Considerations

A Roth IRA is great vehicle for retirement savings, however a direct contribution to a Roth is limited based on income. Therefore, a lot of people cannot make direct Roth contributions. But everyone can has the opportunity to use this non-deductible contribution strategy to have tax-free growth forever.

There are "five-year rules" associated with Roth IRAs that should be taken into consideration when using this strategy in the event a withdrawal needs to be taken from the Roth IRA. Following is a brief description of these rules:

• Five-year Rule #1 — Withdrawals of contributions are usually allowed from a Roth IRA at any time, free of penalties or taxes. However, in general, withdraws of Roth IRA earnings would be free of taxes (and often penalties) only if your first contribution to a Roth account was made at least five years ago. 
• Five Year Rule #2— Specific to Backdoor Roth conversions, this second five-year rule limits access to funds of conversions. Because a backdoor Roth IRA is categorized as a conversion, rather than a contribution, any funds held in the converted Roth IRA cannot be accessed for the first five years after conversion without penalty.
  • If you do a backdoor Roth IRA conversion every year, you must wait five years to tap each portion you convert, or risk penalties. 
  • There are exceptions to this requirement, though, if you’re 59 ½ or older or if you become disabled or die.

It may be beneficial for you to speak with your financial advisor or representative that is setting up the new traditional IRA account to understand these and other considerations related to your situation from a financial perspective.

As always, reach out to your Anomaly Project Manager on Soraban with questions!

The Backdoor Roth IRA is one of our favorite strategies to save for retirement tax-free. As mentioned above, we do suggest doing this at the beginning of the year rather than waiting until the end of the year to take advantage of the growth.

If you missed out on 2022, it's not too late to do this. You have until April 15, 2023, to make your 2022 non-deductible traditional IRA contribution and convert to a Roth IRA. While you're doing that, throw in the money for 2023 to get that extra earnings and see that grow tax-free into the future!

If you have any questions about this strategy or any of the strategies we have talked about, please reach out to your team in Soraban.