I opened a ROTH IRA this year and have been contributing monthly. Turns out hubby makes too much to invest in a ROTH. Can I convert to traditional IRA w/o tax fine?

[ApDu]

I didn’t fully understand MAGI tax limits and now I’m fretting. I’ve double checked and husband makes too much to invest anything in a ROTH. whoops. I already have a traditional IRA that I had stopped investing in. So, I guess I’m looking to see if I can rollover the ROTH money to my current traditional IRA or if I need to start a new one. I don’t want to be penalized for making a mistake. TIA.

[Critter-3]

You don't "rollover" the ROTH contribution but instead you instruct the IRA custodian to recharacterize the contribution + earnings  to an IRA.  If you make too much to take a deduction for the IRA contribution then it can be considered nondeductible and a basis is tracked. 

I suggest you wait to make any IRA contribution until after the year ends so you know how much you can put into which account.  The TT program will let you know the limitations  so you know exactly how much you can put in which account.  You have until the filing deadline to make the contribution for the prior year.

https://www.fool.com/retirement/plans/401k/contribute-to-401k-and-ira/

[fanfare]

If you don't want to track a basis in your Traditional IRA for the rest of your life, because of a non-deductible contribution. you have to ask the custodian to return that Roth contribution + earnings.

The earnings would be taxable in the year  the excess contribution was made.

[Opus 17]

Here's your options,

1. withdraw the excess contributions

2. recharacterize the excess Roth contribution to a traditional IRA contribution.

3. Do a "backdoor" Roth conversion.

To withdraw the excess, you will need a special form for the trustee, and you also have to withdraw the earnings, if any.  You will pay income tax on the earnings.

If you recharacterize to a traditional IRA, your contributions will still be non-deductible because of your income.  Because of this, this creates a "non-deductible basis" in your IRA account, which you and your broker must keep track off.  Normally, your IRA withdrawals when you retire are subject to income tax.  But if (for example) 20% of your IRA contributions were non-deductible, then 20% of your withdrawals will be non-taxable.  But this is a fair amount of recordkeeping you have to keep track of, and it kind of defeats the purpose of a traditional pre-tax IRA by complicating the source of the money.  But it does allow the money to grow for retirement.

The third option is more advanced and complicated.  You first recharacterize your contribution as a regular IRA, then convert the regular IRA to a Roth IRA.  This is known as a "backdoor conversion."  The important point here is that you can't just convert this year's contributions, you have to convert your entire IRA, and you will have to pay income tax on the pre-tax portion of the IRA balance.  This might be a substantial tax bill, depending on the size of the account.  But after that, all the money is in a Roth account and you will never pay income tax again when you retire.    You can also continue to make backdoor Roth conversions every year after this even if you are barred from directly contributing to a Roth account by your income.  Each year you would open a new traditional IRA, make a non-deductible contribution, then convert it to your Roth.  It's a legal way to make Roth contributions when you are income-limited.  But for it to work, you have to convert all your traditional IRA money the first year you do it.  

Professional financial advice may be recommended if you want to try this option. 

[fanfare]

Backdoor Roth conversion does not work when you already have a Traditional IRA with a non-zero balance.

[Opus 17]

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@fanfare wrote:

Backdoor Roth conversion does not work when you already have a Traditional IRA with a non-zero balance.

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As I said, the taxpayer would have to convert the entire traditional IRA balance, which will create a taxable event.    Whether this is a good idea for this particular taxpayer depends on their age, income, and size of the IRA.  

[fanfare]

"convert the entire traditional IRA balance"

This is a taxpayer choice and has nothing to do with a backdoor conversion  Roth, so please don't call it that.

taxpayer could recharacterize and then convert $300 from traditional to Roth.

Tax would be on some amount less than $300.

(that still puts you in the situation of having a basis going forward).

The backdoor Roth, when available, is a tax-free event, and leaves no prior years basis.

[Opus 17 · Accepted solution]

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@fanfare wrote:

"convert the entire traditional IRA balance"

This is a taxpayer choice and has nothing to do with a backdoor conversion, so please don't call it that.

taxpayer could recharacterize and then convert $300 from traditional to Roth.

Tax would be on some amount less than $300.

(that still puts you in the situation of having a basis going forward).

The backdoor Roth, when available, is a tax-free event, and leaves no prior years basis.

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Step 1 is to recharacterize the disallowed Roth contribution to an allowable, non-deductible traditional IRA.  This creates a partial basis in the IRA.

Step 2 would be to convert part or all of the traditional IRA to a Roth.  If the taxpayer converts part of the IRA, then it is partly taxable (pro-rated to the amount of after-tax basis in the traditional IRA) and the remaining traditional IRA balance retains a partial after-tax basis.  This is messy and doesn't really work for most people.

However, if the taxpayer converts the entire traditional IRA balance to a Roth, they will pay income tax on the pre-tax part of the account but pay no tax on the after-tax part of the account (that was recharacterized from a Roth).  This is not a true "backdoor Roth" but it is at least a partial backdoor Roth, since it gets the original disallowed Roth contribution back into a Roth IRA.  (And since there is no such thing as a "backdoor Roth conversion" in the tax code—its a loophole created by the application of other laws—I don't see why we have to nitpick over the terminology.)

More importantly, if the taxpayer zeroes out their traditional IRA in 2021 by doing a Roth conversion and paying the tax, they can do true "backdoor Roth" contributions in every future year.  This is my main point that you keep overlooking.  

Depending on their income, employment, and other tax situations, this might ultimately benefit them in two ways: 1, never paying tax on future withdrawals, and 2, they will be able to contribute maximally to both a Roth IRA and their workplace plan without penalties. 

[fanfare]

"This is my main point that you keep overlooking.  "

Okey dokey. Point noted.

[ApDu]

Thank you to all responders. We are in our 40s. I have converted the money (less than $4k) in my ROTH to a Traditional IRA (already had an IRA account w/balance that I was not contributing to this year).

Now deciding on whether to put back into Roth or track basis. I appreciate your help.

[Opus 17]

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@ApDu wrote:

Thank you to all responders. We are in our 40s. I have converted the money (less than $4k) in my ROTH to a Traditional IRA (already had an IRA account w/balance that I was not contributing to this year).

Now deciding on whether to put back into Roth or track basis. I appreciate your help.

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The important point that both @fanfare and I have been making is that, if you want to convert your IRA funds to a Roth IRA, you have to convert the entire amount of all your IRAs (IRAs in your name, not your spouse--there is no such thing as a joint IRA).  

If you convert a partial amount, you will then have a Roth account (good) but you will still have to track the basis in your existing IRA.

If you convert the entire IRA, then you have to pay tax (bad) but all your IRA assets are now Roth IRA, and that enables you to do the "backdoor" Roth IRA in every future year, even if you are maxed out on your 401(k) and barred from IRA or Roth IRA contributions by your income.  It's the tax hit in the year of the conversion that is the sticking point.