How does backdoor Roth IRA work?

[VAer]

Just making an example: I am not familiar with IRA(just opened traditional IRA account a few months ago). if my income exceeds certain limit and I am not able to contribute to Roth IRA directly. As I know, traditional IRA contribution does not require income limit, so I am still able to make contribution to traditional IRA. However, I am covered by employer retirement plan, and my contribution to traditional IRA is not deductible (based on 2020 tax return).  This is the only contribution to traditional IRA, and all traditional IRA is after-tax money.

If I want to move some money from traditional IRA to Roth IRA, I guess that is so called backdoor Roth IRA, correct? Now how should I do that? Since traditional IRA is already after-tax money, do I need to pay tax when moving the money?

After money being moved to Roth IRA, it is be tax free for withdrawal in the future, correct?

Another question: If I leave job one day (without job temporarily), during the career break, can I also move my roth contribution from employer retirement plan (government employee retirement plan, very similar to 401k, it is just called differently, so you may consider it as 401k for this question) to Roth IRA? I do make roth contribution to employer retirement plan, and employer matches with traditional contribution.

Thanks.

[ThomasM125]

You don't pay any tax on the money transferred from the non-deducted contributions in the traditional IRA account to the ROTH account. You would pay tax on the earnings on those funds however.

Once the funds are in the ROTH IRA account, there would be no tax on future distributions.

You can move the contributions from your employer plan to a ROTH IRA, but any pre-tax contributions and earnings would be taxable when you moved them to a ROTH IRA account.

[VAer]

@ThomasM125 Thanks. Another follow up question : if I make $6000 contribution (for 2021 contribution) to traditional IRA now, and I also made a little contribution to traditional IRA (for 2020, the contribution is not deductible, it is after tax contribution). There is no earning, they sit there as cash.

As soon as the $6000 Traditional IRA contribution(for 2021) is settled, can I move to roth ira immediately? I am not sure if my 2021 traditional IRA contribution is fully deductible, therefore I don't know if any portion of conversion to roth IRA is taxable. If any portion of conversion is taxable, should I pay the tax when filing 2021 tax return? Or should I pay tax immediately when making the conversion?

E.g. if I make traditional IRA contribution in January 2022 (but the contribution is for year 2021) and convert some money from traditional IRA to Roth IRA, then I report traditional IRA contribution in 2021 tax return and report conversion (backdoor roth IRA) in 2022 tax return, correct? How can I report the conversion (backdoor roth IRA)? Usually, I file tax return via TurboTax website, and I have never seen a question asking about backdoor Roth IRA.

Thanks. 

[ThomasM125 · Accepted solution]

You can move the 2021 traditional IRA contribution to the ROTH as soon as you want. If there is a taxable distribution, because you deducted the contribution, you would have to report that in the year it applies to,  which is 2021 in this example. You can have tax withheld when you do the rollover to cover the estimated tax burden. You could also not do a withholding and pay the tax when you file your tax return in 2022. However, in general if you owe more than $1,000 in taxes when you file your tax return, you may get penalized for underpayment of tax.

If you made the IRA contribution in 2022 but assigned it to 2021, you would need to report the rollover to the ROTH IRA on your 2021 tax return.