401K -> Traditional IRA -> ROTH IRA

[mendesl03]

How do these transfers work, & when do I pay taxes?

Most importantly, is this what is commonly referred to as a "Backdoor Roth IRA"?

Starting next year I am likely to slip into a limited Roth IRA Contribution limit due to salary increase.

How can I use 401K or Traditional IRA to still make contributions to my existing ROTH IRA?

[RyanH5]

A rollover from a 401(k) into a Traditional IRA is allowed and if done properly (funds deposited within 60 days) will be tax free. If you move funds from a 401(k) or Traditional IRA into a Roth IRA, this will be considered to be a Roth Conversion and these funds will be included in your taxable income.

A backdoor Roth is a method to circumvent the income limitations of directly contributing to a Roth IRA. It is done by making a non deductible contribution to a Traditional IRA, then transferring that into the Roth account. By making the non deductible contribution, you establish basis in that Traditional IRA. Then, whenever you transfer it, it is treated for tax purposes, as if you liquidated it, but since it is all a return of basis, it is not taxed.

If you roll over a 401(k) into a traditional IRA, this does not add to any basis established since there is no basis in the 401(k) (it was all pre tax going in). So, make sure to do this into a separate IRA account than the one used for the backdoor Roth. 

I hope this helps.
Ryan

[mendesl03]

Thank you so much!

When you say ... " A backdoor Roth is a method to circumvent the income limitations of directly contributing to a Roth IRA. It is done by making a non deductible contribution to a Traditional IRA, then transferring that into the Roth account. By making the non deductible contribution, you establish basis in that Traditional IRA. Then, whenever you transfer it, it is treated for tax purposes, as if you liquidated it, ***but since it is all a return of basis, it is not taxed.*** "

When I contribute to a Traditional IRA I'll be using post tax dollars? which is why it doesn't get taxed when converting it from a Traditional IRA to a ROTH IRA?

I think I misunderstood something here.

[mendesl03]

Are you still available for a follow up question/clarification?

[NateTheGrEAt · Accepted solution]

"When I contribute to a Traditional IRA I'll be using post tax dollars? which is why it doesn't get taxed when converting it from a Traditional IRA to a ROTH IRA?"

Correct! You would be putting after-tax funds into your Traditional IRA (taking no deduction for your contributions). Then, when you move them to the Roth IRA, they are still after-tax dollars so no taxable event occurred.

One "gotcha" to be aware of - when executing a Backdoor Roth, you must take into account any and all Traditional IRA accounts that you own, no matter where they are held. So, to give an example.

You have a Traditional IRA at Broker A with $50,000 in it. This is all pre-tax contributions and earnings. 

You fund a new Traditional IRA at Broker B with $6,000 of after-tax dollars and convert it to a Roth. 

In this scenario, you would NOT have a fully tax-free conversion to Roth. You cannot designate specific dollars to convert - it is done pro rata across all IRAs. In this example, your total Traditional IRA balance is $56,000, of which $50,000 is pretax and $6,000 is post-tax. So if you converted $6,000, your conversion would be 6/56 non-taxable and 50/56 taxable. 

The way to avoid this is to ensure you don't have any other Traditional IRA accounts in existence at any time during the year that you're doing the Backdoor Roth. If you have other Traditional IRAs, one way around this is to roll them into a 401k, because the calculation only considers IRAs, not Qualified Plans. 

[NRDW]

A follow up question to the one you answered: Post retirement, pre SSA, and needing regular IRA distributions - If you pull money out of a traditional IRA to put into a Roth IRA. You report the withdrawal as income, pay taxes, but when reporting the Roth IRA contribution you don't have to say you are putting in more than the allowed amount? 

When I answer yes to excess contributions, it looks like we are being taxed twice. Should it?

[Opus 17]

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@NRDW wrote:

A follow up question to the one you answered: Post retirement, pre SSA, and needing regular IRA distributions - If you pull money out of a traditional IRA to put into a Roth IRA. You report the withdrawal as income, pay taxes, but when reporting the Roth IRA contribution you don't have to say you are putting in more than the allowed amount? 

When I answer yes to excess contributions, it looks like we are being taxed twice. Should it?

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You can't contribute new money to a Roth IRA unless you have compensation from working (either W-2 income or self-employment).  If you are doing a rollover/conversion from an IRA to a Roth IRA, you report that only as a conversion in the IRA 1099-R section, and not as a new contribution.

Also, you can only rollover/convert amounts after you satisfy your RMD (if you are past your RMD beginning year).  You can't rollover the RMD itself.

Let's suppose you have a traditional IRA and your RMD is $5000, and you want to also do a $10,000 conversion to a Roth IRA.  You must withdraw at least $15,000 from the IRA.  When you enter the 1099-R, the program will ask if this was your RMD, and you will answer "partly RMD, partly something else."  Turbotax will then ask what the something else was, and you will tell the program that $5000 was your RMD and $10,000 was a Roth conversion.  You do not also report a $10,000 Roth contribution, because a conversion is not the same thing as a contribution.