'Should I convert my IRA into a Roth?'

@Money July 31, 2012: 11:43 AM ET

(Money magazine) -- I have an IRA but can't fund a Roth. Can I do a nondeductible IRA and convert it to a Roth? -- Lucy H., St. Louis, Mo.

The maneuver you're contemplating -- known as a backdoor Roth IRA -- will let you put money in a Roth if you earn too much to contribute to one. But it's not always your best approach.


That's because of a wrinkle to the backdoor route. Since you fund a nondeductible IRA with already-taxed dollars, you might figure you wouldn't pay any income taxes on the conversion. But you wouldn't just owe tax on the funds you're converting; you'd also have to take the pretax contributions and gains in all your non-Roth IRAs into account.

So, for example, if you have $75,000 in a traditional IRA and contribute $5,000 to a nondeductible IRA, roughly 94% ($75,000 pretax divided by your total IRA balance of $80,000) of the $5,000 conversion would be considered taxable. Assuming a 28% tax rate, you would have to shell out $1,313 in taxes to get $5,000 into a Roth.

You may be better off with one of two alternatives. The first: If your current company's 401(k) accepts IRA funds (as most do), roll your IRA into your plan. That would leave you with only one IRA -- the nondeductible IRA -- so you could convert that account right after opening it and avoid taxes altogether (assuming you have no investment gains in your nondeductible IRA).

With both the backdoor and 401(k) routes, however, you'll be able to put only $5,000 a year into a Roth IRA ($6,000 if you're 50 or older).

Another option would let you get more dough into a Roth without shelling out more cash: a straight conversion.

Take the money you would have put in a nondeductible IRA plus the tax you would have owed -- $6,313 in this scenario -- and use that sum to pay the tax to convert as much of your existing IRA as possible. As the graphic to the left shows, this will give you a much larger Roth balance, which could pay off handsomely if your tax rate when you withdraw the money is higher than it is now.

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