Backdoor Roth - pro-rata question

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Topic Author
lurkman
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Backdoor Roth - pro-rata question

Post by lurkman »

Greetings! Have a question on executing the Backdoor Roth process (our first time doing it):

Background:

1. Wife has a TSP account and previously created Roth accounts (15+ years ago). She had no IRA accounts till 2018.

2. I have a TSP account, previously created IRAs, rollover IRA and previously created Roth accounts.

Actions so far:

3. Wife created an traditional IRA (non deductible contribution) in 2018. Did not convert immediately but left in money market. Created another traditional IRA (non deductible contribution) in 2020. Then converted both these IRAs into Roth IRAs in Dec 2020.

Question:

4. Since she converted both her existing IRAs into Roth, I thought the pro-rata rule would not create any additional amounts (to consider for taxes) beyond the amounts in these two IRAs. However, I do have IRAs in my name and we are married-filing-jointly. Does this mean my IRA balances are now entangled in the pro-rata rule (because of MFJ) or are they treated separately?

I need to review how 8606 was constructed in Turbo Tax in 2018 and also understand 8606 better.

Thanks for your help and any pointers.

Regards,
Lurkman
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retiredjg
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Re: Backdoor Roth - pro-rata question

Post by retiredjg »

Your IRAs do not get involved at all.

If she did the Roth conversion in 2020, it should have been handled on your 2020 tax return using Form 8606. This assumes she completed the 2018 Form 8606.
DSInvestor
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Re: Backdoor Roth - pro-rata question

Post by DSInvestor »

Form 8606 handles the calculation of the taxable amounts of IRA withdrawals and Roth conversions. If there is a partial withdrawal or partial Roth conversion AND there is IRA basis, the IRA basis will be prorated.

For example, if you had 60K in T- IRAs with 6K IRA basis and convert 20K to Roth, leaving 40K in the T-IRA, that's a partial conversion of 1/3 of the T-IRAs and 1/3 of the IRA basis will be consumed by the conversion. This results in taxable amount of 18K and non-taxable amount of 2K.

The 2020 Form 8606 line 6 asks for IRA balances as of 12/31/2020. That is used to determine if there is a partial conversion or partial Roth conversion. Note that line 6 asks for balances in Traditional IRA (includes Rollover IRA), SEP-IRA, SIMPLE-IRA as of 12/31/2020.

Since she made non-deductible contributions to T-IRA in 2018, the 2018 tax return should have included form 8606 to track the IRA basis (non-deductible contributions) from 2018. Since no withdrawals or conversions were done, that IRA basis from 2018 carries forward to future tax years to help reduce taxation of future conversions or withdrawals.

Form 8606 is per individual, so your rollover IRA assets are not counted in your wife's 8606 form.

If you would like to use the Backdoor into Roth IRA, consider a rollover of your Traditional and Rollover IRA assets into the TSP plan which hides them from form 8606. If you have IRA basis in your IRAs, that basis cannot be transferred into TSP. You may be able to isolate your basis and then rolling everything else into TSP. For example, you have 100K of TIRA and Rollover IRA with 12K of IRA basis. Convert 12K to Roth IRA and then rollover everything else in the TIRA/Rollover IRA accounts into TSP before 12/31.
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Topic Author
lurkman
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Re: Backdoor Roth - pro-rata question

Post by lurkman »

retiredjg wrote: Tue Jun 22, 2021 9:28 am Your IRAs do not get involved at all.

If she did the Roth conversion in 2020, it should have been handled on your 2020 tax return using Form 8606. This assumes she completed the 2018 Form 8606.
Thanks, retiredjg. I do the tax forms for both of us. This year, I paid an estimated amount of tax owed (slightly in excess) with an extension to file 2020 returns.

I should go back and review if 8606 was handled correctly in the 2018 return; if not, file a corrected return.
Topic Author
lurkman
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Re: Backdoor Roth - pro-rata question

Post by lurkman »

DSInvestor wrote: Tue Jun 22, 2021 9:33 am Form 8606 handles the calculation of the taxable amounts of IRA withdrawals and Roth conversions. If there is a partial withdrawal or partial Roth conversion AND there is IRA basis, the IRA basis will be prorated.

For example, if you had 60K in T- IRAs with 6K IRA basis and convert 20K to Roth, leaving 40K in the T-IRA, that's a partial conversion of 1/3 of the T-IRAs and 1/3 of the IRA basis will be consumed by the conversion. This results in taxable amount of 18K and non-taxable amount of 2K.

The 2020 Form 8606 line 6 asks for IRA balances as of 12/31/2020. That is used to determine if there is a partial conversion or partial Roth conversion. Note that line 6 asks for balances in Traditional IRA (includes Rollover IRA), SEP-IRA, SIMPLE-IRA as of 12/31/2020.

Since she made non-deductible contributions to T-IRA in 2018, the 2018 tax return should have included form 8606 to track the IRA basis (non-deductible contributions) from 2018. Since no withdrawals or conversions were done, that IRA basis from 2018 carries forward to future tax years to help reduce taxation of future conversions or withdrawals.

Form 8606 is per individual, so your rollover IRA assets are not counted in your wife's 8606 form.

If you would like to use the Backdoor into Roth IRA, consider a rollover of your Traditional and Rollover IRA assets into the TSP plan which hides them from form 8606. If you have IRA basis in your IRAs, that basis cannot be transferred into TSP. You may be able to isolate your basis and then rolling everything else into TSP. For example, you have 100K of TIRA and Rollover IRA with 12K of IRA basis. Convert 12K to Roth IRA and then rollover everything else in the TIRA/Rollover IRA accounts into TSP before 12/31.
Thanks! Appreciate the detailed reply.

Yes, I should take the steps you suggest to enable backdoor Roth contribution for myself. This is something I had identified based on reading the Wiki and older threads but haven’t acted on it yet.
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Eagle33
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Re: Backdoor Roth - pro-rata question

Post by Eagle33 »

lurkman wrote: Tue Jun 22, 2021 11:25 am
retiredjg wrote: Tue Jun 22, 2021 9:28 am Your IRAs do not get involved at all.

If she did the Roth conversion in 2020, it should have been handled on your 2020 tax return using Form 8606. This assumes she completed the 2018 Form 8606.
Thanks, retiredjg. I do the tax forms for both of us. This year, I paid an estimated amount of tax owed (slightly in excess) with an extension to file 2020 returns.

I should go back and review if 8606 was handled correctly in the 2018 return; if not, file a corrected return.
No need to send in an amended 2018 return. You should be able to just send in the new or corrected Form 8606. There is a place for your wife to sign on the form.

Once you both are doing backdoor Roth conversions in the same year, then there will be 2 Form 8606 - one for each of you.
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retiredjg
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Re: Backdoor Roth - pro-rata question

Post by retiredjg »

If the Form 8606 was filled out at all, it is probably correct. If not, I agree that a corrected return is not necessary (unless it changes your taxes which it should not do). The IRS will accept the form alone if it is signed.
Topic Author
lurkman
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Re: Backdoor Roth - pro-rata question

Post by lurkman »

Thanks, Eagle 33 and retiredjg.

I checked the 2018 return and the 8606 was filed with the contribution under my wife's SSN. Looks correct to me. I do taxes using TurboTax every year but have not dealt with this form in previous years and am not really familiar with it (am studying it now). Line 14 shows the basis for 2018 and prior years correctly. There was no 8606 filed in 2019, it seems. Was that something I missed? No t-IRA contributions were added that year; but does 8606 have to be filed every year to track the t-IRA basis as a running score? TurboTax may not have generated the 8606 in 2019 based on how I answered some of the higher-level questions and I may have missed catching it.

When I file this year's returns (i.e. for Tax Year 2020, when the Roth conversions were completed for the two IRAs created in 2018 and 2020), I expect I would have to report the basis for the two t-IRAs on the form 8606 and report the conversion of both to Roth. Does this sound correct?

Thanks!

Lurkman
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Duckie
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Re: Backdoor Roth - pro-rata question

Post by Duckie »

lurkman wrote: Tue Jun 22, 2021 4:16 pm There was no 8606 filed in 2019, it seems. Was that something I missed? No t-IRA contributions were added that year; but does 8606 have to be filed every year to track the t-IRA basis as a running score?
Form 8606 only needs to be filed in years where there is a non-deductible contribution, a conversion, and/or a withdrawal with a basis.
When I file this year's returns (i.e. for Tax Year 2020, when the Roth conversions were completed for the two IRAs created in 2018 and 2020), I expect I would have to report the basis for the two t-IRAs on the form 8606 and report the conversion of both to Roth. Does this sound correct?
Yes. Part I will cover the 2020 non-deductible contribution and Part II will cover the conversions.
Topic Author
lurkman
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Re: Backdoor Roth - pro-rata question

Post by lurkman »

Thanks, Duckie. Sounds straightforward.
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retiredjg
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Re: Backdoor Roth - pro-rata question

Post by retiredjg »

lurkman wrote: Tue Jun 22, 2021 4:16 pm There was no 8606 filed in 2019, it seems. Was that something I missed?
No. The old form is good until something happens. If TurboTax is acting right, it will just pick up from the old form.

When I file this year's returns (i.e. for Tax Year 2020, when the Roth conversions were completed for the two IRAs created in 2018 and 2020), I expect I would have to report the basis for the two t-IRAs on the form 8606 and report the conversion of both to Roth. Does this sound correct?
Yep. And line 14 should be $0. Let us know how it goes.
Topic Author
lurkman
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Re: Backdoor Roth - pro-rata question

Post by lurkman »

retiredjg wrote: Tue Jun 22, 2021 5:22 pm
lurkman wrote: Tue Jun 22, 2021 4:16 pm There was no 8606 filed in 2019, it seems. Was that something I missed?
No. The old form is good until something happens. If TurboTax is acting right, it will just pick up from the old form.

When I file this year's returns (i.e. for Tax Year 2020, when the Roth conversions were completed for the two IRAs created in 2018 and 2020), I expect I would have to report the basis for the two t-IRAs on the form 8606 and report the conversion of both to Roth. Does this sound correct?
Yep. And line 14 should be $0. Let us know how it goes.

Will do, thanks.

I have a feeling I missed filing 8606 (twice) some 20+ odd years ago (back when I was single, t-IRA limits were $2000 and I did taxes on paper). I’m sure I treated them as non-deductible since I had a 401k then but I never tracked the basis! So I’ll probably end up eating that and paying tax on the after-tax contributions a second time. (It’s only $4k so it’s not a huge hit.)

Encouraged by the very friendly and helpful responses from all of you on this thread, I may post some other review questions on our portfolio and financial-life-choices on a separate thread. I’m sure there are a few sub-optimal items to be straightened out and members here would surely be able to suggest new ideas that I have not thought of.

Many thanks.
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retiredjg
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Re: Backdoor Roth - pro-rata question

Post by retiredjg »

lurkman wrote: Tue Jun 22, 2021 6:09 pm I have a feeling I missed filing 8606 (twice) some 20+ odd years ago (back when I was single, t-IRA limits were $2000 and I did taxes on paper). I’m sure I treated them as non-deductible since I had a 401k then but I never tracked the basis! So I’ll probably end up eating that and paying tax on the after-tax contributions a second time. (It’s only $4k so it’s not a huge hit.)
Yes, I did the same with a non-deductible contribution back in the 80's.

I didn't know it, but you can fill out the Form 8606 now for those old years. The form is available on the internet. If you are sure which years and the amounts, you can still claim that basis if you want. The IRS will accept the signed form alone (no 1040 needed).
Topic Author
lurkman
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Re: Backdoor Roth - pro-rata question

Post by lurkman »

retiredjg wrote: Tue Jun 22, 2021 6:26 pm
lurkman wrote: Tue Jun 22, 2021 6:09 pm I have a feeling I missed filing 8606 (twice) some 20+ odd years ago (back when I was single, t-IRA limits were $2000 and I did taxes on paper). I’m sure I treated them as non-deductible since I had a 401k then but I never tracked the basis! So I’ll probably end up eating that and paying tax on the after-tax contributions a second time. (It’s only $4k so it’s not a huge hit.)
Yes, I did the same with a non-deductible contribution back in the 80's.

I didn't know it, but you can fill out the Form 8606 now for those old years. The form is available on the internet. If you are sure which years and the amounts, you can still claim that basis if you want. The IRS will accept the signed form alone (no 1040 needed).

That’s good to know. My case would date back to the late 90s. However, while I can guess the years (I know the amounts were $2k both times), I cannot confirm without some detective work. It would involve calling Janus to pull up old records of closed accounts that were transferred to Vanguard not long after the dot-com bust. Might be possible—even crimes have been solved after decades of the case having gone cold. :)

This brings back a few memories.

During the dot-com rise, I was saving for a down payment on a house and kept that money out of the market; I had not read Bogle yet but had read Malkiel’s “Random Walk...” and Peter Lynch’s books (One Up on Wall Street and a couple of others). I found Malkiel to be the more persuasive of the two (and applicable to my temperament) and that led me to Bogle’s book, “Common Sense on Mutual Funds.”

Of course, before the complete transition to index funds, I had a taste of Fidelity Magellan (well after Lynch left as manager), Janus Fund, and Janus 20 (where I invested ‘long term’ money). All of them took a bath.

I came upon Bogle’s book emphasizing index funds, costs, only after this. But those lessons stuck. I must be one of the few people around who hasn’t bought an individual stock at all at any point. (My wife has during her dot-com adventures but not since.)

Now this thread is definitely off topic!
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