Backdoor Roth IRA question

[saiyen]

I'm trying to do a backdoor Roth conversion since my wife and I make too much for our contributions to be tax deductible. I read about the process and am not sure if the pro-rata rule applies to us. The non deductible contributions were all made into new accounts, ie those accounts contain just the non deductible contributions and their earnings. Can we convert these directly to a Roth without incurring the wrath of the pro-rata rule?

To be specific, my pretax IRA accounts consists of:
Vanguard Rollover IRA (old 401k rollover to IRA)
Fidelity Traditional IRA (contains non deductible contributions for 2022 & 2023)

My wife's pretax IRA accounts are just a Vanguard Traditional IRA with non deductible contributions from 2022, 2023, 2024

1. Can I convert my Fidelity Traditional IRA and my wife's Vanguard Traditional IRA directly to a Roth with no pro-rata rule calculation?
2. If not, does the pro-rata consider my Vanguard Rollover IRA into calculation or the pro-rata rule only applies to the earnings in the traditional IRA?

[dmertz · Accepted solution]

1. No.  With any basis in nondeductible traditional IRA contributions involved, the pro rata calculation on Form 8606 must always be done even if the result is that the Roth conversion is entirely nontaxable.

2. All of the traditional IRAs owned by the individual, including rollover, SEP and SIMPLE IRAs, must be included in the pro rata calculation on that individual's Form 8606 (or Worksheet 1-1 from IRS Pub 590-B, when applicable).

In your case you apparently have a substantial amount in your traditional IRAs in excess of your basis due to having a rollover IRA.  Only a fraction of your basis from your traditional IRAs would apply to your Roth conversion with the the rest of your basis remaining in your traditional IRAs to be applied to future distributions or Roth conversions.

In your wife's case, with the balance in your wife's traditional IRAs consisting mostly or entirely of basis in nondeductible traditional IRA contributions, it would probably make sense to convert everything and pay the tax on any amount in excess of the basis.  The pro rata calculation would still be required on her Form 8606, but the result would be that all of the basis would be applied (limited to the amount converted if investment performance in her traditional IRAs has dropped the value in her traditional IRAs has dropped below her basis).

[Opus 17]

The pro-rata rule applies to the combined balance of all your traditional IRAs, it is not calculated per account or per brokerage.  However, your accounts are not combined with your spouse, since IRAs are "individual" accounts.

To make the "backdoor" Roth work, you would have to convert all your traditional IRA balance to a Roth IRA and pay the tax.  Likewise, your wife would (separately from you) convert all her traditional IRA balance to a Roth IRA.

As @dmertz suggests, you might start by converting all your wife's pre-tax IRAs to a Roth IRA.  There would seem to be less tax owed if she only has 3 years of contributions.  Then, for every year in the future, she can do a "backdoor Roth" tax-free, since her pre-tax balance in traditional IRAs will be zero after the first conversion.

In your case, the only way to do a true backdoor Roth would be to convert all your IRA balances to Roth IRA.  You might do that spread out over several years, but you would have to balance the immediate tax impact against the long term growth potential and tax-free future.   Alternatively, you can make non-deductible contributions to a traditional IRA and just leave it there until you retire.  You will keep track of the non-deductible basis in the account using form 8606 on each year's tax return, and when you start withdrawing from the IRA in retirement, part of your withdrawal will be non-taxable.  It's more complicated to keep track of, but it avoids paying a large tax bill for conversion now.

Another idea that surfaced in this forum a couple of days ago was a person who had the ability to rollover their IRA into the 401k plan at their current employer.  If you could rollover all your pre-tax IRAs into your current 401k, then your balance of traditional IRAs is zero, and you could then make a true backdoor Roth conversion.  However, since any rollover to empty your IRAs won't happen until calendar year 2024 (it can't be made retroactive), you could only do a backdoor Roth in 2024, not for 2023.  

You might want to take advice from a professional financial planner who can run some numbers for you.

Incidentally, remember that in 2026, all tax rates are scheduled to increase, unless Congress passes a new tax reform law, so any conversion that you might want to do will probably be cheaper in 2024 and 2025.  

[saiyen]

Thanks for replying!

It seems that I can rollover my IRA into my current 401k. So I'll do that for my Rollover IRA and convert the traditional to Roth! Is it possible to also rollover to 401k the earnings in the traditional IRA as well? Would it be difficult to calculate that basis and do a true backdoor Roth conversion?

"

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@Opus 17 wrote:

 However, since any rollover to empty your IRAs won't happen until calendar year 2024 (it can't be made retroactive), you could only do a backdoor Roth in 2024, not for 2023.  

Is there a difference between converting into a Roth for 2024 vs 2023? My wife has already made her nondeductible IRA contribution for tax year 2024, I have not.

[dmertz · Accepted solution]

"Is it possible to also rollover to 401k the earnings in the traditional IRA as well?"

Yes.  The only requirement is that you roll over to the 401(k) no part of your basis in nondeductible traditional IRA contributions.  In other words, upon making the distribution from your IRA for the rollover to the 401(k), the balance in your traditional IRAs must be at least as much as your basis in nondeductible traditional IRA contributions.

There is no such thing as converting to Roth for a particular year, only converting to Roth in a particular year.  The conversion is reportable on the tax return for the year in which the distribution from the traditional IRA occurs.

[Opus 17]

@saiyen 

"Is there a difference between converting into a Roth for 2024 vs 2023? My wife has already made her nondeductible IRA contribution for tax year 2024, I have not."

Let me address your spouse separately.  A "backdoor Roth" has two steps.  First, a non-deductible contribution to a traditional IRA.  Then second, a conversion of the IRA to a Roth IRA.  The contributions can be made any time.  Conversions are not retroactive, they happen on the date they happen. Since we are in 2024 now, any conversion she does will be reported in 2024.  

Taking your original statement: "My wife's pretax IRA accounts are just a Vanguard Traditional IRA with non deductible contributions from 2022, 2023, 2024".

Your wife can do a traditional IRA to Roth IRA conversion at any time.  If the contributions for 2022, 2023 and 2024 were all non-deductible, then the only taxable portion of the conversion will be any earnings or growth in the account.  The 2022 non-deductible contribution should have been reported on your 2022 tax return and generated a form 8606 in your wife's name (which is separate from any form 8606 in your name).  The 2023 non-deductible contribution should be reported on your 2023 tax return that you are working on now, and will generate a new form 8606 in your wife's name.  Any conversion she does will happen in 2024, so the non-deductible contribution for 2024 and the conversion will both be reported on her 2024 tax return, and she will pay income tax on the earnings portion of the conversion (and this will also create a new form 8606 for her).

Once that is done, then for 2025 and later, she can contribute up to the annual limit as a non-deductible contribution to a Trad IRA, wait a few days for the transaction to settle, then do the rollover to her Roth IRA.  Assuming the investment is kept in cash for those few days in the traditional IRA, the only taxable event might be a few dollars of interest.  

[Opus 17]

@saiyen 

Now addressing your IRA's specifically, you wrote:

"To be specific, my pretax IRA accounts consists of:
Vanguard Rollover IRA (old 401k rollover to IRA)
Fidelity Traditional IRA (contains non deductible contributions for 2022 & 2023)"

If the Vanguard IRA only contains non-taxable 401k contributions and their earnings, you can rollover the entire Vanguard IRA to your current 401k.

Then, assuming your Fidelity IRA only contains non-deductible contributions, you can convert it to a Roth IRA any time you want.  Since the conversion will happen in 2024, it will be reported on your 2024 tax return.  Only the earnings will be taxable, not the original contributions.  (But, a reminder that the non-deductible contribution for 2022 should have been reported on your 2022 tax return and generated a form 8606 in your name, and the 2023 non-deductible contribution will be reported on your 2023 tax return and generate a new form 8606 in your name.)

When you prepare your 2024 tax return, your 2023 form 8606 and the information about the rollover to 401k and the information about the conversion will all be reported in Turbotax, there will be no problem calculating your basis or determining the taxable portion of the Roth conversion.

Then additionally, you can make a new non-deductible contribution to the Trad IRA for 2024 and roll it over to the Roth IRA.  You could do this later, separately; or do it now together, and it won't change the taxes.  (In other words, you could convert the Fidelity IRA to a Roth in February, and then make a new contribution to a trad IRA in March, and convert that to a Roth in April; or you could make a 2024 non-deductible contribution to the Fidelity IRA tomorrow, and convert the entire amount to a Roth IRA next week.  Either way, the taxes will be the same at the end of the year.)

Then for 2025 and beyond, repeat the process as I described for your spouse to make new backdoor Roth IRA contributions.  

Just make sure that if you change jobs again, you either leave the money in the 401k, or roll it over into the next new company plan.  If you take it out as an IRA, you go back to being unable to do a true backdoor Roth.