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By Christine Benz | 01-27-2016 03:00 PM

'Backdoor' Roth IRA May Be Closing for Investors

Those who are interested in this maneuver should be aware of the stumbling blocks and understand that its days are probably numbered.

Note: This video is part of Morningstar's February 2016 Tax Relief Week special report.

Michael Kitces is a partner and the director of research for Pinnacle Advisory Group, and publisher of the financial planning industry blog Nerd's Eye View. You can follow him on Twitter at @MichaelKitces or connect with him on Google+.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Many affluent investors have jumped at the chance to get into a "backdoor" Roth IRA. Joining me to discuss what you need to know before you do is financial planning expert Michael Kitces.

Michael, thank you for being here.

Michael Kitces: Thanks for having me.

Benz: It's IRA contribution season as we approach April 18, the deadline for making 2015 contributions. One hot topic among our Morningstar.com readers and viewers is this idea of the "backdoor Roth IRA" contribution. Let's discuss how that works.

Kitces: The basic idea of this is pretty straightforward. We're going to make a contribution to a traditional IRA and then we are going to do a conversion from an IRA to a Roth, and get money into a Roth.

The primary scenario where this matters is folks whose income is too high to make a Roth contribution in the first place. Obviously, if we were allowed to just contribute to a Roth, we would just put the money into the Roth, and that would be that. But once you get above income thresholds, you can no longer do new dollar contributions to a Roth, and this workaround strategy emerged. While at higher income levels you can't contribute to a Roth, you can always contribute a traditional IRA. There are actually no upper income limits. You may lose the deduction for your IRA contribution, but you can always contribute to it. And since 2010, there are no income limits for doing a Roth conversion--moving the money from a [traditional] IRA to a Roth. So, we get these scenarios for higher-income folks where we can't put money into the Roth, but we can put the money into a traditional IRA and then covert it into the Roth in a two-step process, and that's why it gets called a "backdoor Roth" contribution strategy. We are not going to make a Roth contribution; we're going to make a traditional contribution and convert it, and end up with a Roth contribution.

Benz: One stumbling block for this backdoor Roth IRA maneuver is that if a person has a lot of traditional IRA assets elsewhere in their portfolio, they can inadvertently run into a bigger tax bill than would otherwise be the case.

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