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My income is close to the Roth IRA limit. I like to do my IRA contributions early in the year, before I know exactly how much I will make due to bonuses and such. So I am thinking about doing a backdoor Roth IRA contribution by contributing to a traditional IRA (non-deductible) and then immediately converting to a Roth. Since I currently have no money in a traditional IRA I should not owe any taxes on this. So I am wondering, are there any downsides to doing this as opposed to contributing directly to a Roth IRA? In particular, how much more paperwork will there be come tax time? Is it worthwhile to wait until the following year to make sure my income is below the limit and if so doing a full Roth contribution, otherwise a partial traditional/partial Roth or full traditional followed by Roth conversion?

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Hi Craig, welcome to Money.SE! –  C. Ross Jan 24 '13 at 22:03
    
@C.Ross Thanks! –  Craig W Jan 24 '13 at 23:23
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2 Answers

up vote 5 down vote accepted

Like JoeTaxpayer said, I don't know of any difference between the backdoor and a regular Roth IRA contribution besides the issue with existing pre-tax IRA money. So if it is your practice to contribute at the beginning of the year (good for you, most people wait until the last minute), then doing a backdoor seems like the safe choice. Some people have speculated that, hypothetically, the IRS could use the "step transaction doctrine" to treat it as a single direct contribution to a Roth IRA (which then would be disallowed and cause you a penalty until you take it out), but I have never heard of this happening to anyone.

As for the paperwork, you just need to fill out one extra form at tax time, Form 8606 (you need to complete two parts of it, one for the non-deductible contribution, and one for the conversion). It is pretty straightforward. (Although I've found that it is a pain to do it in tax software.)

Another option would be for you to contribute to a Roth IRA now, but when you discover that you're over the limit at the end of the year, re-characterize it as a Traditional contribution and then convert it back to Roth. But this way is not good because then there is a long time between the Traditional contribution and the Roth conversion, and earnings during this time will be taxed at conversion.

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The downside of the conversion for some, as you note, is the proration of existing pretax IRA money. You've already considered this, and it's not an issue for you. It's a simple bit of paperwork, nothing to scare you away from this approach.

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