In a straightforward Roth conversion, you can take any existing IRA balance — be it a traditional IRA, SEP, etc. — and convert it into a Roth IRA. When you do this, you are responsible for paying taxes on the amount you convert. You pay taxes on both the principal (the amount you contributed) and any earnings since the account was opened.
With a Backdoor Roth IRA, it’s sometimes possible to avoid this large tax responsibility because you’re not deducting the amount you contribute to the nondeductible traditional IRA. There is an exception, however: If your nondeductible traditional IRA earns any income (interest, dividends or capital gains) before you convert it to a Roth IRA, you will have to pay taxes on those earnings.
In next blogpost, we will discuss the downside of backdoor Roth IRA.