Rollover IRA impact on Backdoor roth conversion and pro rata

[moses0020]

Hi,

We are MFJ. In late 2024, my spouse got a letter from John Hancock regarding a 401k profit sharing plan from an old employer, and that we had to make an election on the vested balance (or otherwise a forced distribution would be made). Without thinking too much about it, she rolled this over from John Hancock into her active Vanguard account. Before rolling this over, I'm unclear on how this account was contributed to (i.e. it seems as though the balance was from employer contributions and she herself did not make any contributions). In any case, the balance was ~$2700. She rolled this over into vanguard, and it got rolled over and lives in her account as a  "Rollover IRA". This account sits alongside her existing vanguard traditional IRA  and roth IRA accounts, giving three accounts in total. She typically uses the existing traditional IRA and Roth IRA accounts to do yearly, planned backdoor roth conversions (e.g. contribute max amount to traditional IRA, and then immediately convert to Roth IRA). After rolling over this account, I did not realize that this separate account is considered a traditional IRA balance, and thus prohibited her from doing completely tax-free Roth IRA backdoor conversions. I've since realized (unless I'm wrong?) that this means I am subject to pro-rata rules for the years I've had this balance and have done a backdoor roth conversion (2024 and 2025). Thus, I'm hoping to get some confirmation and help on:

1. Confirmation that yes, this situation limited (and continues to limits) our ability to do completely tax free backdoor roth conversions. It seems as though Rollover IRAs are considered Traditional IRA balances, but I'm not clear on whether it matters how the original amount was contributed to when it was in John Hancock.
2. How to correct our 2024 Tax return in Turbotax (and thus how to file 2025 tax return correctly)
3. Best path forward to free us to do completely tax free roth conversions moving forward

Re: #2 (Correcting tax return in turbotax). When I filed originally, I chose the following options during the retirement 1099-R flow):

• Moved money to another qualified retiremenet account
• Combination of rolling over, converting or cashing out the money
• Amount converted to Roth IRA account: 7000
• No, Did not make and track nondeductibe contributions to IRA
• Value of Traditional, SEP, and Simple IRAs as of Dec 31, 2024: 0
  • Looking to confirm: I Assume I have to amend this to show $2700 (The balance that in the rollover IRA account?). Looks like this increases my federal tax due by $~700. Are there any other changes that need made? Since This account still lives in the account today, do I fill in this section the same way for 2025 tax return?
• Outstanding Rollovers & Characterizations: left blank

Re: #3 (Best path forward): According to my limited research, it seems my options are as follows, but hoping to confirm.

1. Convert the rollover IRA to a Roth IRA and pay taxes on that conversion one time, but then this would be free to do tax-free roth backdoor conversions moving forward?
2. Rollover back into an active 401k. She recently started a new job and will be eligible for 401k in ~2 months. So, if allowed, we could see if we can rollover from vanguard to the new, active 401k. In this option, where there be any tax implications?

Thanks in advanced!

[dmertz · Accepted solution]

1.  Correct.  The rollover IRA is a traditional IRA and the year end-balance of all traditional IRAs must be included on Form 8606 line 6 when determining the taxable amount of traditional IRA distributions when the IRA owner has basis in nondeductible traditional IRA contributions.  Assuming that no after-tax contributions were made to the 401(k), the entire amount rolled over to the IRA was pre-tax and there is no adjustment to be made to basis in nondeductible traditional IRA contributions.

2. Your understanding is correct.  Your spouse's Form 8606 needs to be corrected to show the ~$2,700 nonzero year-end balance in traditional IRAs.  The amendment must include Form 1040-X because this increases the taxable amount of the 2024 Roth conversion(s).  The amount on line 14 of the corrected 2024 Form 8606 carries forward to line 2 of the 2025 Form 8606.  The amount on line 14 of the 2025 Form 8606 will carry forward to line 2 of the 2026 Form 8606.

3. Given that the rollover IRA contains a relatively small amount, simply convert the entire balance to Roth.  With a zero balance in all traditional IRAs at the end of 2026, all basis in nondeductible traditional IRA contributions will be applied to the 2026 Roth conversions.  Given the general desire to increase the balance in the Roth IRA, rolling the pre-tax money in traditional IRAs to the current 401(k) is an unnecessary complication.  (Only the traditional IRA balance in excess of basis in nondeductible traditional IRA contributions is permitted to be rolled over to a 401(k).  The amount on line 14 of the 2025 Form 8606 represents the amount of basis carried in to 2026.)

[moses0020]

Thanks for the confirmation! Frustrating how much ($700) this small amount / situation will cost us.

[baldietax]

just to add, once you do all the basis math on Form 8606 I think you'll find you've already converted most of the $2700 in 2024-2025 due to the pro rata rule and paid tax on it.  I think most of the $2700 balance is now in your basis (401k reverse rollover doesn't help you at this point), if my math is correct:

For 2024, 7000/9700=72.165% tax free conversion; $5051 tax free, $1949 taxable, basis carried fwd is $1949

For 2025 (assuming still 2700 but probably higher due to earnings), basis after the contribution is now 7000+1949 =8,949 so 8949/9700=92.257% tax free conversion; $6458 tax free, $542 taxable, basis carry fwd is 8949-6458=$2491

For 2026 you can convert everything to Roth and only owe tax on a $209 left plus earnings.  

When you do your 2025 return the question about "made and tracked nondeductible contributions to IRA" will be Yes, and it will show the basis carried over from your (amended) 2024 return or you can you amend it if any issue.

Once you're completed the contribution and 1099-R conversion input, check the outcome on Form 8606 either in forms mode on desktop or in the PDF output to see the above calcs.

This article may also be helpful

https://ttlc.intuit.com/turbotax-support/en-us/help-article/retirement-benefits/enter-backdoor-roth-...

[dmertz]

"Frustrating how much ($700) this small amount / situation will cost us."

The ~$2,700 is taxable sooner or later, almost certainly better sooner since, once the requirements for qualified Roth IRA distributions are met, growth in the Roth IRA is tax free.

[moses0020]

I've amended the return to correct form 8606 for the 2024 return. However, when getting to the end of the amendment flow in turbotax (i.e. after putting in the reason for amendment), it gave me option to correct account / routing number, as well as selecting a date for IRS to deduct the new owed amount.  I did this, but I kept getting a message saying "Account number invalid for electronic filing" Despite triple checking the number and making sure there weren't any hidden/special characters. When I hit continue, there was a screen to print forms, with step 2 saying "Send amended forms to IRS and include any relevant checks."

It's not clear whether it actually e-filed the amendment or not. There is a "Check E-file status", and it says 2024 Federal amended return was accepted, however this is the second time I've amended, so it's not clear if thats referring to the first time or this most recent time.

[RobertB4444]

Did your payment come out of the bank?  If not then you should print the forms and wait until after the 26th to see if your payment is processed after filing opens for the year.  If your payment is still not processed by the 27th or so then you should mail in your return and a check for payment.

If your payment already processed then the return processed and you're set.

@moses0020 

[moses0020]

Thank you so much for this information. This is very straightforward to amend for my federal return, however its not clear whether this amendment (adjusting form 8606) also applies to the PA state return. When I make the adjustment during the questionnaire (enter the balance as of end of the year), it automatically updates my amount owed at the federal level, however it doesn't impact the amount for the State.

Do I have to manually update anything at the state level (or does this change not effect the state), and thus I don't need to amend my PA return?

[DianeW777]

No. IRA or 401(k) amounts were never deductible on your Pennsylvania (PA) return so for this reason there is nothing to report on your PA return. As long as nothing is withdrawn from the account that might include earnings, before you reach retirement age, then there is nothing to report on your state return.

@moses0020