401K to traditional ira and ira backdoor roth conversion

[bluecrystal]

Hi,

I changed job last year (2021) and converted my 401k from my previous employer to a traditional IRA account. In addition, I made non-deductible IRA contributions and later converted them to roth IRA through a backdoor conversion (my income is over the IRA deductible contribution limit).

When I entered the 401k conversion by itself, it worked fine and Turbotax successfully treated it as a non-taxable conversion. When I entered the IRA backdoor conversion to roth by itself, Turbotax also treated it as a non-taxable conversion correctly. However, when I added both items, Turbotax treated them together as me taking a 5.5k income and tax me on it.

A little more detail - Turbotax asked me about the value of my traditional IRA after I enter both the 401k conversion and the roth conversion. If I enter the amount in my traditional IRA from 401k rollover, then Turbotax somehow calculates $5.5k retirement income. If I do not enter the amount in my traditional IRA from 401k rollover, then Turbotax treats everything correctly.

What should I do in this case?

Thanks!

[RaifH · Accepted solution]

When you convert a portion of your IRA to a Roth, a proportional share of your basis is allocated to that distribution.

For example, if you open a traditional IRA, make a $6,000 contribution and then convert it to a Roth, the entire distribution will be tax-free because your basis is $6,000 out of a total $6,000 in your IRA.

If you open a traditional IRA, rollover a 401(k) worth $66,000, and contribute $6,000 in after-tax dollars, your total value will be $72,000 with a $6,000 basis. If you then convert $6,000 to a Roth, 1/12 or $500 will be tax-free and the remaining $5,500 will be taxable. The remaining $66,000 in your traditional IRA still has a $5,500 basis. 

For more information, the IRS provides worksheets on calculating the taxable portion of your distribution. It does not matter if you conducted the conversion prior to rolling over your 401(k), as long as they were done in the same year. It also does not matter if you open one IRA for back-door Roths and another for rolling over your 401(k). The basis is calculated on the value of all your IRAs.

[dmertz]

Rolling the 401(k) over to an IRA before the end of 2021 has made your Roth conversion mostly taxable since now only a small portion of your basis in nondeductible traditional IRA contributions can be applied to any particular distribution or conversion from your traditional IRAs.  The rest of your basis remains in your traditional IRAs to be proportionately applied to future distributions or conversion.  There is nothing you can do to change the taxable result on your 2021 tax return.

The relative timing of the conversion and the rollover does not matter.  In the calculation of the amount of basis that applies to the conversion these transactions are treated as happening simultaneously on December 31.

[ojsosa1]

Hi -

This seems like a very similar question for my situation... however, it's still a unclear to me. I'm hoping someone could elaborate.

I had completed a backdoor Roth-IRA transaction in early January 2022 for $6,000.00   ... later in May 2022, I rolled over an old 401-k with Schwab over to a Traditional-IRA at Fidelity for $100,000.00.

Using these numbers / this situation... can someone explain what the tax implications are for these two transactions? Is there anything wrong with this? In addition to this, I also have a retirement 401-k that I contribute to at work (with a different / new employer).

Thanks in advance.

[fanfare]

A backdoor requires that you start with a zero balance, and end with a zero balance.

That's by definition.

Since you added to your IRA balance in 2022 via Rollover, you can't do a backdoor Roth conversion.

@ojsosa1 

[dmertz]

The nontaxable portion of your $6,000 Roth conversion will be $6,000 * $6,000 / ($100,000 + $6,000) = $340 with the remaining $5,660 being taxable.  Your traditional IRA will have $5,660 [Edit: not $5,666] of basis to be applied proportionately to future traditional IRA distributions and Roth conversions.

As fanfare said, to have all of your basis applied requires that your year-end balance in traditional IRAs be zero.  The only way to accomplish that now and be able to have all $6,000 of your Roth conversion be nontaxable would be to roll the pre-tax portion of your traditional IRAs back into a qualified plan like a 401(k) in 2022, leaving only the basis in your traditional IRAs.  (The tax code permits only pre-tax money to be rolled back to a qualified retirement plan, so all amounts of such a rollover come only from the pre-tax portion.)

[ojsosa1]

@dmertz  and @fanfare  and all -

Firstly, thanks for taking the time to review my question and respond.  However, I still have some confusion. Can you please further elaborate?

With regards to this busines of 'the year-end balance in my traditional IRA being zero' I'm still confused. For the record, I've asked my former employer of the 401(k) in question (the rolled-over one) and I can NOT return it to a 401(k) plan with them.

It seems to me that:

• the 401(k) money that was rolled-over into a Traditional-IRA would be treated like the 401(k) that it came from for the IRS and continue to be considered tax-deferred

Then, standing on its own would be

• the Backdoor Roth-IRA money where 
• I'm OK w/ paying that $5,660 as ordinary income tax now to get the 'tax-free growth' (etc.) benefits of the Roth over time

But it seems like that's not the case, or I'm misunderstanding your comments. Your help is much appreciated.

[fanfare]

"I'm OK w/ paying that $5,660 as ordinary income tax now "

In that case, go ahead. Just don't call it a backdoor conversion, which is tax-free.

@ojsosa1 

[ojsosa1]

@fanfare - I feel you've significantly oversimplified what I find to be the most common denominator in a reasonable description of a backdoor conversion.  Your assumption, I believe, is that the only tax that matters and is worth talking about is future (year) taxes.

In fact, "when you transfer the assets of a traditional IRA to a Roth IRA, you owe taxes in that tax year on any funds—as well as on earnings and appreciation in transferred assets—that have not been taxed previously."  I think everyone, myself included, can rationalize that you will always pay taxes on your money either now or later (the value is on how much you're taxed on how it grows).

I suppose, if it's not considered a "backdoor conversion", what should I call it?

I'm trying to confirm my understanding to be accurate. Particularly when an additional 401(k) -> to -> Traditional-IRA has been performed in the same year as a separate Backdoor Roth-IRA conversion.

Thanks again!

[fanfare]

What you did is a conversion from a Traditional IRA to a Roth IRA which is usually taxed in the tax year you do it.

A backdoor Roth IRA takes advantage of a non-deductible contribution to the Traditional IRA ahead of the conversion.

If the entire value of the Traditional IRA is basis, then the conversion is tax-free.

@ojsosa1 

[fanfare]

OK. when you make a non-deductible contribution, the contribution is taxed.

so using this method, you can't avoid the tax.

If your IRA is all basis, the entire non-deductible contribution can be converted.

Otherwise, it is pro-rated and you may pay more tax - see Form 8606.

@ojsosa1 

[ojsosa1]

@fanfare -

Excellent. Thanks again for the quick response and clarification. 👍

So my apologies in advance for "beating-this-dead-horse", but to summarize...  in my case:

• the $6,000 conversion from Traditional to Roth is allowed
• the fact that I also had the $100,000 401(k) rolled over to Traditional-IRA in this same tax year only complicated my $6,000 conversion b/c it is no longer a "tax-free" conversion to the Roth-IRA (from the Traditional)... but it, too, is allowed
• Instead, of being a tax-free IRA conversion, I will be taxed the ~$5,660
• and the rolled-over Traditional-IRA continues untaxed until a distribution is taken

I hope that's the correct understanding.

Lastly, any idea what was meant by @dmertz when he/she wrote - "Your traditional IRA will have $5,666 of basis to be applied proportionately to future traditional IRA distributions and Roth conversions."

I appreciate this tutorial and again apologize. As you can probably tell, taxes lingo is not part of my regular vocabulary. 🙄 

[dmertz]

"the 401(k) money that was rolled-over into a Traditional-IRA would be treated like the 401(k) that it came from for the IRS and continue to be considered tax-deferred"

Yes, it continues to be tax deferred, but for tax purposes it no longer has any relationship to the 401(k).  It's now IRA money and is subject to all of the rules for distributions from an IRA, including the proportionate application  of basis to distributions to determine the taxable amount of any distribution.

Sorry about my typo.  The amount of basis remaining in your traditional IRAs will be $5,660, not $5,666.

[bluecrystal]

@dmertz Reopening this thread to inquire more about rolling IRA back to 401k.

To recap, I ran into the pro-rata rule when filing for 2021 because I 1/made non-deductible IRA contributions and converted all of them to roth IRA and 2/converted my 401k from my previous employer to a traditional IRA account. Now part of my rollover IRA in 2/ is considered “post tax” money. To avoid confusion in the future, I am thinking about 1/extracting the basis through a Roth conversion and 2/roll my rollover IRA into 401k.

How do I determine the basis to convert to Roth? I was looking at my tax form from this year, and I think the basis would just be the “taxable portion” of my Roth conversion listed in 8606. Is that right? Meaning in your example, I would extract the $5,500 basis basis through a Roth conversion.

Are there any other tax implications to my plan of 1/extracting the basis through a Roth conversion and 2/roll my rollover IRA into 401k? Would extracting the basis through a Roth conversion be treated as extracting part of pre-tax and part of after-tax income?

Timing wise, would the above be doable by end of the year? 

[dmertz]

Your basis in nondeductible traditional IRA contributions is the amount shown on line 14 of your 2021 Form 8606 plus any nondeductible traditional IRA contributions you have made for 2022.

Because the rollover to the 401(k) is only permitted to consist of pre-tax money, your basis is left in the the traditional IRA to be applied to the Roth conversion.  With a zero balance in traditional IRAs at the end of 2022, all of your basis will be applied to the Roth conversion.  If the amount Roth conversion equals the amount of basis as determined above, the entire Roth conversion will be nontaxable.

To be done in 2022, the distributions from the traditional IRA must be completed by the end of 2022.  The timing is mainly based on the ability of the traditional IRA custodian to process the distributions from the traditional IRA, but also on the willingness of the 401(k) plan to accept the rollover of the pre-tax portion.