Backdoor IRA with Existing Rollover IRA in Account Pro-Rata

[nsch25]

Hello,

I have a question regarding the tax implications of a recent backdoor Roth IRA I made, and I'm seeking some guidance as I prepare to file my taxes using TurboTax.

Background: I have around $10,000 in a Traditional IRA resulting from a rollover from a previous employer that has been there for 3+ years. In April 2023, I executed a backdoor Roth IRA strategy by contributing $6,500 to my Traditional IRA and promptly transferring it to my Roth IRA. 

My Concern: Given the existing contributions in my Traditional IRA from the previous rollover, I am curious about the pro-rata rule and whether it will impact my taxes for this scenario. Will I be subject to additional taxes, and if so, how can I address this before the upcoming April 15th deadline? I'm also wondering if any actions can be taken to reverse this, or if the opportunity has passed since December 31, 2023, has already elapsed.

Thank you in advance!

[DanaB27 · Accepted solution]

Yes, the pro-rata rule will apply since you had pre-tax funds in your traditional IRA on December 31, 2023. Therefore, part of your conversion will be taxable. TurboTax will calculate the taxable part on Form 8606 (and use the Taxable IRA Distribution worksheet if applicable).

You won't be able to take any actions to prevent the pro-rata rule for 2023. But if you plan on doing Backdoor Roth in the future you have two options:

• A reverse rollover where you rollover IRA money to a company plan, like a 401(k). Only pre-tax funds can be rolled from an IRA to a company plan. Therefore, you would isolate the basis and could start the Backdoor Roth procedure fresh. But it only works if your employer allows it, not all plans do.
• Convert the rest of the pre-tax funds in the traditional IRA to Roth IRA in 2024 (with any nondeductible contribution you make in 2024) and pay the taxes on the pre-tax funds. Your gains then can grow tax-free in the Roth IRA and your traditional IRA will be empty.  Then you can use the Backdoor Roth procedure without any issues in the future.

[dmertz]

Given the numbers involved, your Roth conversion will be roughly 40% nontaxable and 60% taxable.  about 60% of your basis in nondeductible traditional IRA contributions remaining in your traditional IRAs to be applied to future traditional IRA distributions and Roth conversions.  Nothing is permitted to be done to change these tax consequences.

In 2024, it would seem to be sensible to make your full nondeductible traditional IRA contribution for 2024 and convert all of your traditional IRA money to Roth.  Pay the tax on the pre-tax money now and let it grow, with the growth being tax-free instead of tax-deferred once the requirements for qualified distributions from your Roth IRAs have been met. 

[nsch25]

Am I able to convert the pre-tax money to Roth even if I am above the income limit? 

[nsch25]

Schwab's experts keep telling me that with the 8606 form I will not have to pay the penalty and be taxed additionally in this instance. That the whole point of the 8606 is to not have to pay taxes even in this situation. Wouldn't line 6 on the 8606 form where I specify my balance in the Traditional IRA handle this issue? Or does the pro-rata rule still apply regardless? 

[dmertz]

Schwab's "experts" are apparently not taking into account that you have $10,000 of other funds in traditional IRAs.  Because you had $10,000 in traditional IRAs at the end of 2023 (Form 8606 line 6), only about $2560 of your $6,500 Roth conversion will be nontaxable with about $3,940 your basis in nondeductible traditional IRA contributions remaining in your traditional IRAs to be applied to future traditional IRA distributions (Form 8606 line 14).

[fanfare]

A true backdoor Roth contribution i.e. tax-free, doesn't work if your Trad IRA already is funded.

You just did a regular conversion to Roth which by current law cannot be undone.

@nsch25 

[nsch25]

Thanks again for your response. I just filed my taxes and had to pay the penalty but am working on fixing this for the future. I still want to perform the backdoor IRA in 2024, but want to prevent any issues this time.

The first option of the reverse rollover sounds good. I am checking with my employer to see if it is possible. 

I prefer the second option since schwab charges less fees for the investment options I want to select. With that in mind, I have a follow-up question on the second option: Converting the rest of the pre-tax funds in the traditional IRA to Roth IRA.

• Is this conversion considered to be part of the backdoor ira or am I able to convert the existing funds into my roth ira and also do the $7k for the backdoor ira?