IRA Deduction (Backdoor Roth Conversion) & Marriage Status

[VAer]

2023 IRA Deduction Limits: https://www.irs.gov/retirement-plans/2023-ira-deduction-limits-effect-of-modified-agi-on-deduction-i... 

Could someone explain more about IRA deduction and marriage status? I am not exactly sure how to ask questions, let me make up an example, then make up some questions based on example.

John is single in early 2023, he is government employee and covered by employer sponsored pension plan, his salary is $130k. In early 2023, he makes $6500 contribution to his traditional IRA (beginning balance of traditional IRA is $0 before contribution), and it is 2023 contribution. Based on above link, his AGI is more than $83k and his traditional IRA contribution is not deductible. So John immediately converts $6500 to his Roth account (immediately after contribution), and it is called Backdoor Roth Conversion. The reason John does not want to contribute to Roth IRA directly --- John is not sure about his 2023 income, he only knows his salary, but stock market income is unknown at this point. He may not be qualified for Roth contribution if making too much money from stock market( https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2023  ), that is why he chooses Backdoor Roth Conversion at this point. There is no tax withhold for Backdoor Roth Conversion, since his traditional IRA contribution is not deductible (AGI is above $83k). 

Later in 2023, John is married and his wife has no income.

Case 1: If John does not make any money from stock market and chooses Married Filing Jointly, and his family income is more than $116,000 but less than $136,000, and his traditional IRA contribution should become partial deductible. There should be some tax withhold for backdoor Roth conversion, correct? However, he has already made backdoor conversion without tax withhold(when he is single). Will it cause any issues? His traditional IRA contribution changes from non-deductible (single) to partially deductible (married), can he designate whole $6500 traditional IRA contribution as non-deductible (married)? If yes, how can he do it in tax return form? That would not mess up the whole $6500 backdoor roth conversion.

Case 2: If John chooses Married Filling Separately, his income is way above $10k, and his traditional IRA contribution is not deductible, and it is fine for him to do Backdoor Roth Conversion without tax withhold in earlier in 2023. Correct? Why deductible limit is so low($10k) for Married Filling Separately? Based on above link, the number $10k is very small; for single, it has to be $83k and more for no deduction.

Case 3: If John makes quite some money from stock market and his family income is more than $136k, then he can choose Married Filing Jointly without causing any issues to Backdoor Roth Conversion without tax withhold?

Thanks.

[DanaB27]

Yes, you can always choose to make the traditional IRA contribution nondeductible (if it isn't automatically nondeductible because you have a retirement plan at work and are over the income limit). 

If you are making a backdoor Roth conversion you should never withhold taxes to avoid the issue of replacing the taxes withheld to avoid triggering the 10% early withdrawal penalty. Please keep in mind the backdoor Roth will only work if your traditional IRA is empty.

In all cases, you would enter the backdoor Roth as described below.

To enter the nondeductible contribution to the traditional IRA:

1. Login to your TurboTax Account 
2. Click on "Search" on the top right and type “IRA contributions” 
3. Click on “Jump to IRA contributions"
4. Select “traditional IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution?”
6. Enter the amount you contributed
7. Answer “No” to the recharacterized question on the “Did You Change Your Mind?” screen
8. Answer the next questions until you get to “Any Nondeductible Contributions to Your IRA?” and select “Yes” if you had a nondeductible contribution before this tax year.
9. Enter your basis in the Traditional IRA from your 2021 Form 8606 line 14 (if you had a basis in the prior year)
10. On the “Choose Not to Deduct IRA Contributions” screen choose “Yes, make part of my IRA contribution nondeductible” and enter the amount (if you have a retirement plan at work and are over the income limit it will be nondeductible automatically and you only get a warning and then a screen saying $0 is deductible).

To enter the 1099-R conversion: 

1. Click on "Search" on the top right and type “1099-R”  
2. Click on “Jump to 1099-R”
3. Click "Continue" and enter the information from your 1099-R
4. Answer questions until you get to “Tell us if you moved the money through a rollover or conversion” and choose “I converted some or all of it to a Roth IRA”
5. On the "Review your 1099-R info" screen click "Continue"
6. Answer "yes" to "Any nondeductible Contributions to your IRA?" if you had any nondeductible contributions in prior years.
7. Answer the questions about the basis from line 14 of your 2021 Form 8606 and the value of all traditional, SEP, and SIMPLE IRAs

[VAer]

"Please keep in mind the backdoor Roth will only work if your traditional IRA is empty"

"If you are making a backdoor Roth conversion you should never withhold taxes to avoid the issue of replacing the taxes withheld to avoid triggering the 10% early withdrawal penalty"

@DanaB27 

Could you please explain these two sentences? 

What do you mean "traditional IRA is empty"? Could you please give an example?

How can Backdoor Roth Conversion related to 10% early withdrawal penalty?

Thanks.

[DanaB27]

For the backdoor Roth to work properly the traditional IRA cannot have any deductible funds. TurboTax will ask about the value of all your traditional/SEP/SIMPLE IRAs on December 31, 2022, and this will be entered on Form 8606 line 6 to calculate the taxable part. If you have deductible contributions in your traditional IRA the pro-rata rule applies (see example in link). This means that with each distribution/ conversion, you will have a taxable and nontaxable part. You can see the remaining basis on line 14 of Form 8606, this basis can be carried forward. Therefore, each distribution/conversion in the future will have a taxable and nontaxable part until the basis is all used.

If you have taxes withheld and don't replace them with other funds you will convert less than the full amount. This will be seen as taking a cash distribution from the traditional IRA which if you are under 59 1/2 will trigger the 10% early withdrawal penalty. If you replace the taxes withheld and convert the full amount this won't happen. But it is easier to avoid this in the first place by not having taxes withheld.

[fanfare]

Backdoor refers to getting money into a Roth that you would otherwise not be able to.

First step is to make a non-deductible contribution to Traditional IRA.

if you wish to convert tax free to Roth (Backdoor or not), your entire value of all your IRAs must be no more than your basis which is the non-deductible part for all years.

the only way this can be  is

A) your IRA has lost value (now worth less than your non-deductible contributions)

B) your total IRA value is exactly the amount of the non-deductible contribution you just made.

Otherwise it cannot be 100% tax free because a Traditional IRA distribution or conversion always has a basis fractional part and a taxable fractional part as calculated on Form 8606.

[VAer]

@DanaB27  Thanks for further explanation.

[VAer]

@fanfare Thank you.

[VAer]

@DanaB27 

So backdoor roth conversion has nothing to do with marriage status, and has nothing to do with pension plan.

For married couple, both person can make $6500 to traditional IRA, and choose no deduction even if it is deductible, then transfer non-deductible money from traditional IRA to Roth IRA. Correct?

The whole thing sounds silly, it does not matter income, it does not matter retirement plan, everyone can end up putting $6500 into Roth IRA. They can simply get rid of income limit on Roth contribution, and allow everyone contribute $6500 into Roth IRA directly.

[fanfare]

Congress was set to eliminate the Backdoor Roth entirely but the Build Back Better plan was squashed by Manchin.

[DanaB27]

Yes, that is correct. For a married couple, both can make $6500 to a traditional IRA, choose no deduction even if it can be deductible, then transfer non-deductible money from a traditional IRA to Roth IRA as long as they had enough taxable compensation to make a contribution.

Yes, the backdoor Roth procedure is a loophole for people with a high AGI to make Roth IRA contributions.

@ VAer