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 IRAs.
Your tax bill for a conversion to Roth will depend on the ratio between your non-deductible contributions and the total balance of all your traditional IRAs. First, they contribute to a traditional IRA (which has no income limits) and then convert that IRA into a Roth one. This rule is also important to consider if you earn too much to contribute to a Roth IRA and you want to make a non-deductible contribution to a traditional IRA and immediately convert it to a Roth IRA (see How to Bypass the Income Limits of a Roth IRA). If you have a non-deductible IRA, you can convert it to a Roth IRA and enjoy the benefits of the Roth, such as tax-free withdrawals and the absence of mandatory minimum distributions (RMDs) during your lifetime.
However, they can still indirectly divert money to a Roth IRA if they first make non-deductible contributions to a traditional IRA with after-tax dollars. A traditional deductible IRA is the most common type and is probably what most people consider an IRA. The main difference between a non-deductible IRA and a traditional or Roth IRA is that you can contribute to a non-deductible IRA no matter how much you earn. While a non-deductible IRA isn't as restrictive in terms of eligibility, it also doesn't offer the same tax benefits as a traditional or Roth IRA.
Roth IRA account conversions require a 5-year retention period before earnings can be withdrawn tax-free, and subsequent conversions will require their own 5-year retention period. However, your contributions to a non-deductible IRA are made with after-tax money, while your contributions to a traditional IRA or 401 (k) can be deducted in the year in which they are made. In the future, Roth IRA distributions will also be tax-exempt, as long as you are 59 and a half years old and have held the Roth for at least five years (note that each conversion amount is subject to its own five-year retention period when it comes to tax-free withdrawals). In addition, regardless of your participation in a work plan, income that exceeds a certain threshold makes you ineligible at all to contribute to a Roth IRA.
However, Rob says that if you use this clandestine Roth strategy solely to avoid the profit limits of Roth IRA contributions, you should be aware of the risks and seek the advice and support of a tax professional.