A non-deductible IRA can be converted to a Roth IRA. So, the non-deductible IRA gives you the benefit of tax-deferred growth, but so can the Roth IRA, and the Roth IRA also offers other valuable tax and estate planning benefits. If you have a non-deductible IRA, you can convert it to a Roth IRA. You won't have to pay taxes on your account contributions, but account earnings will be taxable at the time of conversion.
If you have deductible and deductible IRAs, you must prorate the taxable and non-taxable portions to determine what part of your conversion is taxable. You can make a non-deductible IRA contribution each year and then convert it into a Roth IRA using the clandestine method. You'll pay taxes on any converted amount that exceeds your base at the time of the conversion. Your base should be calculated using a prorated or proportional formula if you have other IRA accounts.
A clandestine Roth IRA refers to a two-step maneuver that people with high incomes can use to get around the income limits of Roth IRAs. However, you must use Form 8606 to declare the amounts you have converted from a traditional IRA, SEP, or simple IRA to a Roth IRA. If the IRA contribution is deductible, the end result will be a contribution to an IRA that generates a tax deduction, followed by a conversion to Roth that will cause the IRA's income to be recognized for tax purposes. People who contribute to a non-deductible IRA usually do so because their incomes are too high to contribute to a Roth IRA or deduct their contributions to a traditional IRA.
However, it should be noted that, while this strategy of making a contribution to a Roth IRA through the back door by making a contribution to the traditional IRA (potentially non-deductible) followed by a conversion to the Roth IRA seems relatively simple, there are some important caveats to consider when implementing the strategy. Non-deductible IRAs can be useful for those whose adjusted gross income (AGI) is too high to make contributions to the Roth IRA. So, in the end, what is a clandestine contribution from Roth? A clandestine contribution to a Roth IRA simply consists of making a contribution to the IRA (usually not deductible), followed by a subsequent conversion to the Roth IRA, even if you otherwise exceed income limits to make a normal contribution to the Roth IRA, all without violating the doctrine of tiered transactions. President Obama's budget recommendations earlier this year included, in the so-called Treasury Green Book, a proposal that would categorically prevent any after-tax fund in a retirement account from becoming a Roth, which would “put an end to most forms of Roth's clandestine strategies” (although it should be noted that it would still be possible if the owner of an IRA did not participate in an employer's retirement plan and followed making a contribution to the pre-tax IRA (to convert it).
A traditional deductible IRA is the most common type and is probably what most people consider an IRA. For example, due to administrative burdens, many IRA trustees don't allow IRA owners to invest IRA funds in real estate. Since the standard rule for IRA distributions (and Roth conversions) is that any after-tax contribution is obtained together with any pre-tax asset (whether from contributions or growth) proportionally, when all the accounts are added together, it is impossible to simply convert the non-deductible IRA. Non-deductible IRAs don't offer the income tax-exempt withdrawals offered by a Roth IRA or a Roth 401 (k).
So, by bringing the two together, people with higher incomes who can't make a contribution to a Roth IRA can effectively get around income thresholds by making a non-deductible IRA contribution (allowed even at high income levels) and then convert it to a Roth IRA (also allowed even at high income levels). The only divorce-related exception for IRAs is if you transfer your interest in the IRA to a spouse or former spouse and the transfer is made under an instrument of divorce or separation (see section 408 (d) () of the IRC. .