A Roth IRA can be an important piece of many financial plans. It can be one of several buckets of funds in a retirement withdrawal planning strategy. The IRS does not require minimum distributions from a Roth IRA; and a Roth IRA can be tapped, under certain conditions, for qualified education expenses.

Savers under age 50 can contribute $5,500 to a combination of Traditional and Roth IRAs; savers over 50 are entitled to a catch-up contribution of $1,000, for a total of $6,500. Unfortunately, many savers are precluded or limited from contributing to a Roth IRA because of their income. Eligibility is determined by the IRS and can be found at this link. As of this writing, someone who is married and filing jointly with joint income above $189,000 would be able to contribute a reduced amount; above $199,000, no Roth contribution is allowed.

Some savers affected by these income limits choose to perform backdoor Roth IRA conversions, in which a taxable contribution is made to a Traditional IRA and later converted to a Roth IRA, conversions to which are not subject to income tests. What’s more, as the Traditional IRA contribution is made with after-tax funds, so long as the contribution does not grow, there is no tax upon conversion.

One easily-overlooked consideration that could cause a tax headache is the IRA Aggregation Rule. This rule says that, for the purposes of distributions from an IRA, the value of all IRAs must be considered. In Michael Kitces’ blog post, “How To Do A Backdoor Roth IRA (Safely) And Avoid The IRA Aggregation Rule And Step Transaction Doctrine,” he gives the following example (emphasis added.)

Jeremy has $200,000 of existing IRA assets, accumulated from years of deductible IRA contributions plus growth when he was younger, along with a rollover from an old 401(k) plan. Jeremy is now a high-income earner and wishes to make a $5,500 contribution to a non-deductible IRA, with the plan to convert that $5,500 into a Roth IRA.

However, due to the IRA aggregation rule, Jeremy cannot just convert the $5,500 non-deductible IRA contribution, even if it is help in a separate/standalone account. Instead, Jeremy must treat any $5,500 conversion from any account as a partial conversion of all of his IRA assets.

Accordingly, if Jeremy tries to do a $5,500 Roth conversion (from combined IRA funds that now total $200,000 plus new $5,500 contribution equals $205,500), the return-of-after-tax portion will be only $5,500 / $205,500 = 2.68%. Which means the net result of his $5,500 Roth conversion will be $147 of after-tax funds that are converted, $5,353 of the conversion will be taxable, and he will end out with a $5,500 Roth IRA and $200,000 of pre-tax IRAs that still have $5,353 of associated after-tax contributions (the remaining portion of the $5,500 non-deductible contributions that were not converted).

So, what to do in a case like this? One option is If one participates in a retirement plan that allows rollovers of IRAs, the extra IRA(s) can be rolled into the plan, leaving just one IRA. If that’s not an option for you, then neither is a backdoor Roth conversion.

Note: If an individual rolls the IRA into the 401(k) plan, s/he would now be subject to the 401(k) plan summary rules which may include investment limitations, withdrawals restrictions and differing cost structure.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended as authoritative guidance or tax advice. You should consult with your tax advisor for guidance on your specific situation. Future tax laws can change at any time and may impact the benefits of Roth IRAs.