Back door Roth IRA question

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
Indexfan89
Posts: 39
Joined: Mon Jan 09, 2012 1:02 pm

Back door Roth IRA question

Post by Indexfan89 »

Another back door Roth IRA question.

My spouse has both Traditional IRA and Roth IRA accounts.

The Trad IRA has both deductible and non-deductible contributions. It also has some Roth to traditional recharacterized money. So the money in this account is all mixed from previous years. Lets call this Trad IRA 1.

For 2021, she is not eligible to contribute to Roth IRA due to income limits. What our plan is, we can open a new Trad IRA for her and contribute $6,000 to it for 2021. Lets call this Trad IRA 2. We can immediately convert this into Roth thru back door option.

Can we able to do this? Will the existence of IRA 1 is going to cause any issues for converting newly opened IRA 2 from Trad to Roth thru back door option?

The other day I was talking to Vanguard retirement rep, she said, I can able to do this without any issues. I just wanted to seek your opinion. Can someone who is more knowledgeable in this space answer this question please?

Thanks
Silk McCue
Posts: 8954
Joined: Thu Feb 25, 2016 6:11 pm

Re: Back door Roth IRA question

Post by Silk McCue »

The IRS views your various Traditional IRAs as if they were all one. So no you can’t setup a new IRA account for the purposes of performing a Backdoor Roth and not run afoul of the pro-rata rule. The VG rep was wrong.

Cheers
w5000
Posts: 302
Joined: Mon Feb 10, 2020 8:33 pm

Re: Back door Roth IRA question

Post by w5000 »

Right -- you can do it, it's perfectly legal, but what you'd be doing is making a $6K nondeductible contribution to a tIRA, and then doing a $6K conversion that will be considered a mix of your basis (nondeductible contribution) and your pretax contribution. The pro-rata rule determines the breakdown of the $6K conversion. You'll still have some basis in your tIRA. And of course you'll owe additional income tax on the conversion for the portion that is pretax money.

If you want to do a Backdoor Roth, you'll need to do a reverse rollover of the pretax money in the tIRA to a 401(k) or other qualified plan.
an_asker
Posts: 4903
Joined: Thu Jun 27, 2013 2:15 pm

Re: Back door Roth IRA question

Post by an_asker »

Agree with previous respondents. The best bet is to convert all those old monies into Roths (I don't even think if it is possible to move them into an existing 401k). Then you can convert the new traditional IRA to Roth.

Just to clarify, there is no issue as such with opening the traditional IRA. The only issue is that you (or she) cannot really turn right around and convert it all to a Roth without paying any taxes.
User avatar
FiveK
Posts: 15742
Joined: Sun Mar 16, 2014 2:43 pm

Re: Back door Roth IRA question

Post by FiveK »

And the higher the fraction of non-deductible contributions (aka "basis") in the traditional IRA, the more it makes sense to convert it all to Roth now.

Whether it makes absolute sense or not is a different question, but the higher the non-deductible fraction the more likely it does.
somekevinguy
Posts: 202
Joined: Mon Jan 16, 2017 8:23 pm

Re: Back door Roth IRA question

Post by somekevinguy »

Agree that this runs afoul of pro rata rules and so you’ll need to pay taxes if you convert or try to do a typical backdoor Roth. That being said, I believe one option is opening a solo 401k that accepts rollovers (ie fidelity) using some
Nominal income (ie I did medical surveys). Then use this solo 401k as a bucket to move any existing traditional ira money first. Then can do the nondeductible contribution to a traditional ira (with effectively no other basis) and convert that to a Roth IRA (ie the next day) without paying additional taxes. Would that be a reasonable option?
User avatar
celia
Posts: 16774
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Back door Roth IRA question

Post by celia »

Sure, you can do what is proposed in the original post, but the pro rata rule will still apply.

Sometimes I think people think about this the wrong way when the amount of the contribution and conversion are the same. It might be easier to understand if you instead plan to make a non-deductible $6,000 contribution, then convert $10,000 in the same year. Most people would expect to pay some taxes in this case, but it is not because of taxing the difference ($4,000).

What is happening instead is that if you calculate the ratio of non-deductible contributions (basis) in the TIRAs to the total value of the IRAs, you will see that the there is still a ratio even when another non-deductible contribution is added to the ratio’s numerator (and denominator). As long as that ratio is close to 0.00, more taxes will be owed. The closer it gets to 1.00, the more basis there is and the more will be converted tax-free. (The ratio indicates what percentage of the conversion will be tax-free.)

For example, if the basis is $27k in a $54k-valued IRA, that means that 27/54 (50%) of any conversion would be tax-free. But if $6k is added to the basis (a non-deductible contribution), then (27+6)/(54+6) = 33/60 (55%) of any conversion would then be tax-free, whether you convert $1,234, $6,000, $10,000, or even $60,000.

Note that the pre-tax amount of the IRA can change later in the year after the conversion is done. So it is the year-end balance (plus any withdrawals that year) that determines the actual denominator for that year.

As far as Vanguard or any other custodian, they don’t know if you have any basis in your IRA (or what your salary or SS is). That is between you and the IRS (and a tax preparer, if you had someone else do your taxes).
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
Topic Author
Indexfan89
Posts: 39
Joined: Mon Jan 09, 2012 1:02 pm

Re: Back door Roth IRA question

Post by Indexfan89 »

Thank you all for your responses. Now I got it. As always Bogleheads are the best resource for any thing related to money.

I have a follow-up question if you don't mind. How can I find my basis in the t-IRA? This one was opened more than 10 years ago, I remember it has few thousands of deductible money and the rest is non-deductible money. The account balance is around 35k. It is with Vanguard. The previous poster says Vanguard doesn't know the basis. Is there a way to contact IRS and find out the basis info?

I have some tax records of previous years, but I am not sure I have all of them for the last 20 years. I will have to check.

Any easier way to find out the basis?

Thanks
w5000
Posts: 302
Joined: Mon Feb 10, 2020 8:33 pm

Re: Back door Roth IRA question

Post by w5000 »

It's entirely up to you to track the basis in your tIRA. The IRA custodian does not know what contributions are pretax versus after-tax. You should have filed a form 8606 with your federal taxes every year that you made a nondeductible contribution to the IRA to update your basis in the tIRA. Not sure how to fix it if you haven't been filing the 8606 forms. Maybe someone else has experience with that?
User avatar
FiveK
Posts: 15742
Joined: Sun Mar 16, 2014 2:43 pm

Re: Back door Roth IRA question

Post by FiveK »

w5000 wrote: Wed Dec 08, 2021 8:54 am Not sure how to fix it if you haven't been filing the 8606 forms.
If those forms haven't been filed, one first needs to figure out what should have been entered. In short, the non-deductible contribution for each tax year is (the amount contributed to the traditional IRA) minus (the amount deducted for traditional IRA contributions on that year's tax return).
User avatar
celia
Posts: 16774
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Back door Roth IRA question

Post by celia »

FiveK wrote: Wed Dec 08, 2021 3:33 pm
w5000 wrote: Wed Dec 08, 2021 8:54 am Not sure how to fix it if you haven't been filing the 8606 forms.
If those forms haven't been filed, one first needs to figure out what should have been entered. In short, the non-deductible contribution for each tax year is (the amount contributed to the traditional IRA) minus (the amount deducted for traditional IRA contributions on that year's tax return).
Yes, you need to look at previous tax returns for each year.

For Deductible IRA contributions, there is a line on Form 1040 for how much you are deducting that year. (For 2021, the ‘IRA Deduction’ is on Schedule 1, line 20.) You then need to compare that to your total contribution for that year. Note that you can contribute for any year up until the following April 15.

Once you reconcile all of it, if a Form 8606 was not filed that year, you need to download a blank 8606 for that year and fill it out manually. Start with the earliest year since the basis is cumulative if you were not also converting each year as you went along.

When you (or your spouse) are done filling them out, sign and date each one. Save a copy with your tax return for each year. Then send them to the IRS address your regular return would be mailed to.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
User avatar
Chip Munk
Posts: 881
Joined: Fri Feb 22, 2019 3:01 pm

Re: Back door Roth IRA question

Post by Chip Munk »

Indexfan89 wrote: Wed Dec 08, 2021 8:06 am How can I find my basis in the t-IRA? This one was opened more than 10 years ago, I remember it has few thousands of deductible money and the rest is non-deductible money. The account balance is around 35k. It is with Vanguard. The previous poster says Vanguard doesn't know the basis. Is there a way to contact IRS and find out the basis info?

I have some tax records of previous years, but I am not sure I have all of them for the last 20 years. I will have to check.

Any easier way to find out the basis?
If you filed Form 8606 as part of your tax returns for the years you made non-deductible contributions and you did your own taxes back then and continue to do so now, your tax program may be holding your basis for you. I use Turbo Tax and made some non-deductible contributions many years ago and filed Form 8606 each time, as required. Each year I save a copy of my tax return "with key worksheets" as a PDF. In that PDF is an "IRA Information Worksheet" and on that sheet is my IRA Basis that Turbo Tax has carried along from year to year, to have that information available the next time it's needed.

If you use Turbo Tax but didn't save the key worksheets in a PDF, then open last year's tax return with Turbo Tax and go to Forms View and find the IRA Information Worksheet in your return.
Post Reply