backdoor Roth question

[praasppn]

I was thinking to do backdoor roth conversion but then realized that pro-rata rule will come into play since I have a Rollover IRA from my previous employer's 401k. Is this a correct conclusion ?

Then I thought I can do the backdoor roth conversion of my spouse's non-ded traditional IRA(we are filing jointly). But she has a SEP-IRA. I think that would invoke the pro-rata rule ? Is this correct ? If she converts the SEP-IRA first to Roth and pays tax, then in the subsequent years, can she do the backdoor roth without the pro-rata rule impact ?

-- thanks in advance for your time and answers.

[macuser_22 · Accepted solution]

You are correct.

The "Backdoor Roth" does not exist in tax law. It is a procedure used by some to take advantage of a quirk in tax law that allows making a non-deductible contribution to a Traditional IRA when one cannot contribute to a Roth IRA, and the immediately converting the Traditional IRA to a Roth IRA, thereby getting the money into the Roth via "backdoor".

That "procedure" can only work of all these requirements are met:
1) No Traditional IRA account whatsoever can exist (that includes any SEP or SIMPLE IRA accounts) at the start.
2) The Tradition IRA contributions must be reported on a 8606 form as non-deductible.
3) The conversion to a ROTH must be shortly after the contribution to avoid taxable gains.
4) The entire Traditional IRA value must be zero that the end of the year of conversion.

Otherwise the conversion will be partly taxable.

You can NEVER withdraw ONLY the nondeductible part - it must be prorated over the entire value of ALL Traditional IRA accounts which include SEP and SIMPLE IRA's. (For tax purposes you only have ONE Traditional IRA which can be split between as many different accounts as you want, but for tax purposes they are all added together).

For example using rough figures: if you had $60K of nondeductible contributions in an IRA with a total value of $600K (10:1 ratio), then when you take a $60K distribution from any IRA account $6,000 would be nontaxable and $54,000 would be taxable (same 10:1 ratio) , with the remaining $54K of basis staying in the IRA for future distributions. As long as there is any money in the IRA, there will be some basis.

TurboTax will ask for your non-deductible "basis" and then the *Total Value* of *all* Traditional IRA, SEP and SIMPLE accounts as of Dec 31, of the tax year. That is so the prorating of the basis can be properly proportioned between the current years distribution and the remaining IRA value. That is done on the 8606 form.

[praasppn]

In the above requirements for the procedure to work, in first 1) - did you mean "no pre-tax traditional IRA account can exist" ?

[macuser_22]

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@praasppn wrote:

In the above requirements for the procedure to work, in first 1) - did you mean "no pre-tax traditional IRA account can exist" ?

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No.   You can always convert a Traditional IRA to a Roth but if the IRA has existed for any length of time then it will probably have some earnings and the earnings would be taxable so it would not be a *pure* backdoor Roth since it would be partly taxable.  

The real killer of a backdoor Roth is having another rollover IRA from a 401(k).