It has been five years since the income limits on IRA conversions were lifted, effectively putting Roth IRA investments within reach of higher-income individuals who had previously been shut out because they earned too much to make a direct contribution.
The maneuver is simple enough and should be tax-free in many cases. An investor who earns too much to make a direct Roth IRA contribution (the income limits are here) simply opens a Traditional nondeductible IRA--available to investors regardless of income level. Shortly thereafter--and here's where the backdoor part comes in--he converts it to a Roth IRA, another move now unrestricted by income limits. Assuming he has no other IRA assets, the only taxes due on the conversion would be any appreciation in the investments since he opened the account. That taxable amount should be limited, assuming he converts the money promptly and/or leaves the money in cash until the conversion is finalized.
That sounds straightforward--and, in most cases, it is. However, there are a few potential snags that would-be backdoor Roth IRA contributors should bear in mind before they execute this move. Some fall into the category of fairly minor mistakes, while others are costly errors....
Backdoor Roth IRA? Avoid these six mistakes.