non deductible traditional IRA contribution to Roth

[bhJogdt]

Hello, 

I have made 2023 non dudectible traditional IRA contribution and then moved to the Roth IRA.i understand that I am going to get 1099R. Do I have to pay taxes since this was non deductible contribution ?

[fanfare]

Did you have funds in your IRA account(s) before you made the 2023 contribution?

@bhJogdt 

[bhJogdt]

yes I have fund from previous years deductible IRA and this year I am not eligible for deductible IRA so I made a contribution in April 2023 and bought equities.I moved equities to Roth IRA around 6488.(2023 limit).Is it going to be an issue ? 

[Opus 17]

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@bhJogdt wrote:

yes I have fund from previous years deductible IRA and this year I am not eligible for deductible IRA so I made a contribution in April 2023 and bought equities.I moved equities to Roth IRA around 6488.(2023 limit).Is it going to be an issue ? 

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You will owe some tax.  When you do this kind of rollover, it is pro-rated.  You can't only rollover the non-deductible portion.  For example, suppose your previous balance of traditional IRA funds was $20,000.  You contributed $6500 of non-deductible funds, meaning that 24.5% of your balance was non-deductible.  When you did the $6500 conversion to a Roth IRA, 24.5% of the conversion is non-taxable ($1592)  and the other 75.5% ($4908) is a taxable conversion of the deductible balance.  Then, since you rolled over $1592 of non-deductible funds, your remaining IRA balance after the rollover still contains $4908 of non-deductible funds.  Turbotax will generate a form 8606 to track your non-deductible IRA balance, and you must keep a copy of this form for the rest of your life (or until 3 years after you have no more traditional IRAs.)  You will use your 2023 form 8606 to prepare your 2024 return or whenever you either make more non-deductible contributions, or conversions, or withdrawals, from a traditional IRA. 

[bhJogdt]

sounds like bit complex process I didn't think about that.So at this point I still have until Monday( Last day  of the tax year) and i can recharactrize that fund from Roth to traditional or please suggest me the easy way.

Going forward in 2024 how do i convert back door Roth from traditional because I will not be eligible deductible IRA next year either? please suggest. Thank you

[Opus 17]

@bhJogdt 

I think we are past the point of making moves "before April 15" because, even if we figured out exactly what you wanted to do, and put in an order with your broker over the weekend, it probably won't settle in time.  April 15 is one of their busiest days, and I doubt any move you try to make will settle in time.

So let's go back.  You asked if it would be taxable, and the answer seems to be "partly."  But we don't have all the facts, and if you want a more thorough discussion about the backdoor Roth IRA, then we need the facts.  So to start...

1. You made a non-deductible IRA contribution in April 2023 that was for tax year 2023?

2. When did you do the Roth conversion?  (2023 or 2024?).  If the conversion was in 2023, you should already have the 1099-R.  If the conversion was in 2024, you will get the 1099-R later.

3. If the non-deductible contribution was in 2023, you should have a form 8606 with your 2023 tax return.  What are the values on:

line 1 (nondeductible contributions for 2023)

line 2 (prior nondeductible basis)

line 9 (total conversions and withdrawals)

line 14 (your new non-deductible basis as of 12/31/2023).

Also what is your approximate total balance in all traditional IRA accounts today?  Include all traditional IRAs but do not include qualified workplace plans like 401k, 403b or other workplace plans.  Even though they are similar to IRAs, they are not the same as IRAs and are covered under different laws and regulations.  

[bhJogdt]

Hello again, The fidelity agent moved the security without selling and it was quick  while I was in the phone with them(traditional to Roth).To avoid taxes and confusion I spoke with fidelity agent again and I opened another traditional IRA which has zero balance so I ask them to previously converted 6500 in April 11th 2024(contribution made in traditional ira in  April 2023) contribution to back in newly opened  traditional IRA so I can keep separate deductible and non deductible.I don't know how to manage in turbotax going forward.

1. You made a non-deductible IRA contribution in April 2023 that was for tax year 2023?

Yes.

2. When did you do the Roth conversion?  (2023 or 2024?).  If the conversion was in 2023, you should already

have the 1099-R.  If the conversion was in 2024, you will get the 1099-R later.

I made conversion in April 11 2024.

3. If the non-deductible contribution was in 2023, you should have a form 8606 with your 2023 tax return.  What are the values on:

line 1 (nondeductible contributions for 2023)

$6500

line 2 (prior nondeductible basis)

zero

line 9 (total conversions and withdrawals)

zero

line 14 (your new non-deductible basis as of 12/31/2023).

650

what is your approximate total balance in all traditional IRA accounts today?

$32845 (this amount is total deductible IRA contribution) for year of 2020,2021 and 2022. I never managed this amount in turbotax software.i was just doing contribution as I was eligible but I was never entering data for previous years.

Thank you 

[bhJogdt]

sorry Line 14 is $6500

[Opus 17]

@bhJogdt 

Sorry, I think there is still some confusion, or I am confused.  

"To avoid taxes and confusion I spoke with fidelity agent again and I opened another traditional IRA which has zero balance so I ask them to previously converted 6500 in April 11th 2024(contribution made in traditional ira in  April 2023) contribution to back in newly opened  traditional IRA"

Are you saying that you converted $6500 from a traditional IRA to a Roth IRA, then you converted it back to a traditional IRA (this is called a recharacterization)?

[bhJogdt]

Are you saying that you converted $6500 from a traditional IRA to a Roth IRA, then you converted it back to a traditional IRA (this is called a recharacterization)? YES. I have asked them to put newly opened Traditional IRA.

[Opus 17]

OK, I understand. You are in stable situation, and you have until December 31, 2024 to decide your next step.

The only thing you report on your 2023 tax return is that you made a non-deductible IRA contribution.  You don't need to report the conversion or the recharacterization.  Your form 8606 shows that you have already done this.

Going forward, the most important thing to learn is that, for tax purposes, all your traditional IRA accounts are grouped together and considered one single Individual Retirement Arrangement by the IRS.  While it may be convenient to have the non-deductible contributions in a different account, it does not change the tax position in any way.

From your figures, you have about $39,000 in all your trad IRAs (remember they are grouped together for taxes).  If you converted the entire balance to a Roth IRA in 2024, $6500 of the conversion is non-taxable, and $32,845 will be taxable.  If you only convert a partial amount, it will be partly taxable, because the conversion is pro-rated, you are not allowed to only convert the non-deductible amount (because all accounts are grouped together for taxes).   Because 16.6% of your total IRA balance is non-deductible, 16.6% of any conversion amount will be non-taxable, but the other 83.3% will be taxable.  Your remaining balance in the trad IRAs will include a reduced amount of non-deductible contributions, and this is all tracked on form 8606.

If you want to be set up to do a true "backdoor Roth" in the future, you have to get your trad IRA balances to zero.  Here's one way to do that.

1. For 2024, you can make another non-deductible contribution of $6500.  That will bring your total balance to  about $45,000, with $13,000 being non-deductible contributions.

2. Convert all your trad IRAs to one or more Roth IRAs.  $32,845 will be taxable.  You will need to find that tax money someplace else.

3. Then you will start 2025 with a zero balance in trad IRAs.  In 2025, you can make a non-deductible IRA contribution, and immediately convert it to the Roth, and no tax will be owed.  You can do the same thing every year going into the future, as long as you don't make deductible IRA contributions. 

If you can't come up with $10,000 in extra income tax for 2024, here is another way to eventually get to that zero trad IRA balance.

1. For 2024, you can make another non-deductible contribution of $7000.  That will bring your total balance to  about $46,000, with $13,500 being non-deductible contributions (28%).

2. Do a partial conversion, let's say $10,000.  29% is non-taxable and 71% is taxable. The tax on $7100 would be about $2000 depending on your state, which might be more affordable. You still have $9585 of non-deductible funds in your traditional IRAs.

3. Then in 2025, make another $7000 non-deductible contribution. Your total non-deductible contributions are $16,585 and your total balance (with investment gains) is probably $46,000. Convert $10,000.  This time, 36% is non-taxable and 64% is taxable.

4. Keep doing this year over year until you get to the point where the traditional IRA is mostly composed of non-deductible funds and you can afford to convert the entire remaining balance and pay the tax on the remaining deductible portion.

5. Then you can go forward with the normal "backdoor Roth" in future years. 

[bhJogdt]

Hello, Good Morning,Since fidelity doesn't know which year I made  contribution in IRA is deductible and which contribution is non deductible I will get taxed on the how much amount I convert into Roth IRA right? and then once I file taxes, portion of the conversion I can track through form 8606 right and once I put numbers in turbotax, will turbo tax calculate deductible and non deductible portion ?  what happens if I don't convert in to Roth IRA and open an another new  traditional and Roth  IRA account with new company lets say Charles Schwab(currently I have account with Fidelity) and make traditional IRA non deductible contribution for 2024 and the convert to Roth ? Thank you very much for helping me out.I really appreciate for your help!

[Opus 17]

@bhJogdt 

Roth IRAs are completely separate.  If you want to make non-deductible contributions and you are eligible to contribute to a Roth IRA, you should do that instead of putting non-deductible money into a traditional IRA.  (Also, any workplace plan like a 401k is completely separate, they are controlled by different laws and regulations.)

All your money in any traditional IRA at any bank or broker is counted for tax purposes as being in a single IRA (individual retirement arrangement).   The broker doesn't know or care if you took a tax deduction or not.  You keep track of your non-deductible contributions on your tax return using form 8606, which will be prepared automatically.  You need to keep copies of any form 8606s from your tax return for the rest of your life, this is an exception to the general rule that tax paperwork should be kept for 3 or 7 years.   Because you made a non-deductible contribution (money that was already taxed and you did not take a deduction), that portion of your IRA will be tax-exempt when you withdraw or convert the money.  But the IRS will not keep track for you, you need to keep copies of any form 8606 that is filed with your tax return so you can prove the non-taxable portion of any future withdrawals or conversions.  

Because all your IRA accounts are considered one account for tax purposes, and because you have a mixture of deductible and non-deductible funds, any conversion will be partly taxable (due to the pro-rata rule). Even if you open a new account with a different broker and only convert that account, the IRS adds all your IRAs together and calculates the taxable and non-taxable amount of the conversion based on the total of your deductible and non-deductible funds across all traditional IRA accounts. 

Because you have deductible funds in a traditional IRA, the only way for you to do a true non-taxable "backdoor Roth" conversion, is to first convert all your traditional IRA funds to a Roth, and pay the income tax on the portion of funds that were tax-deductible.  You can do that all at once or gradually over time.

Or, leave your traditional IRA with a mixture of deductible and non-deductible funds, and keep adding non-deductible funds.  As long as you keep copies of all your form 8606s, a portion of your traditional IRA will be non-taxable when you start withdrawing funds after you retire. 

[bhJogdt]

Hello, Thanks for the good insight of how to manage traditional and Roth and how it taxed.

Just one question to came in mind if I can do traditional rollover any other type of retirement plan rather than converting to Roth that could offer by the any brokerage firms? 

[CatinaT1]

I would talk with your broker.