Those who make over a certain threshold of income are NOT allowed to do a Roth contribution. The way around this limitation? The Backdoor Roth technique.
The whole idea is to get money into a Roth IRA using a Roth conversion. The trick is that if you do it right, then you can do this conversion without triggering a taxable event. Here's the catch: If the objective is to do a TAX FREE conversion, then you've got to watch out for the PRO-RATA RULE.
Here's how it works:
You have $95k in a Rollover IRA
You make a $5k After-Tax Traditional IRA Contribution in a separate IRA
You immediately convert the $5k after-tax contribution to a Roth IRA
Is this a 100% tax-free conversion?...Nope.
The pro-rata rule says you have to add together ALL the IRA assets. You don't get to carve out and isolate just the after-tax assets for the Roth conversion. Therefore, $5k of $100k (5%) of your total IRA assets were after-tax....which means just 5% of your conversion is tax-free. Of the $5k you converted, $4,750 (95%) will be included in your taxable income for that year.
All that said, having other traditional IRA money on hand doesn't stop anyone from using the "Backdoor Roth" technique. You'll still be able to make after-tax Traditional IRA contributions and immediately convert to a Roth IRA. Just know that it won't be a completely tax-free conversion event.