Another ROTH IRA Conversion Question

[14k]

Hello,

Thank you for helping me think this through!

• I have approximately $30k in a Traditional IRA.

• Approximately $24k of this was rolled over from a workplace 401k in March 2019 (therefore pre-tax money)

• $6k of this is post-tax money (non-deductible) which I mistakenly deposited (2 weeks ago) thinking I could convert just this amount into my ROTH IRA (I subsequently learnt about the pro-rata rule which subsequently gave me a headache for days)

• I have an available 403b with TIAA (currently empty)

So having reviewed all the BH Wikis and read through a few of the forum posts I understand I have two options:

[Option A] "Convert the entire Traditional IRA to Roth, and pay tax on the pre-tax amount of the conversion. For a small Traditional IRA this may be the easiest and best option, but if the Traditional IRA is large, this will result in a large tax bill. If you are making Backdoor Roth IRA contributions, you are in a middle or high tax bracket, so this might be undesirable."

[Option B] "Roll the pre-tax portion of the Traditional IRA into your 401(k) or 403(b) at work, assuming it accepts rollovers. If the employer plan has poor investment options and/or high fees, this may be undesirable. However, if the employer plan is large and well-managed, it may have access to institutional share classes with even lower expenses than are available in the IRA."

I'm leaning towards Option A. The increase in “income” should not put us in a higher tax bracket + I will be able to retain this money within my Fidelity portfolio. I’m in my late 30’s so it makes sense to up my tax free growth buckets.

Option A Question: How do I determine what the amount is that I pay tax on? Do I need to request a statement from my old 401k provider to determine the contributions. Is the taxable amount the contributions + gain? What about the $2-$3 of interest on $6k of post-tax money?
Fidelity also asked me what I will be "Withholding" during the transfer/conversion. I don't even know what that means...

Option B Question: How do I determine how much I’m legally allowed to transfer? Is it everything except the $6k?

I just wanted to ask there if there is anything I am missing before I go ahead with Option A. What would you do?

[kaneohe]

A) Just to clarify Option A.......when you say it is post tax money, do you mean you are not eligible to deduct the contribution because your income is too high? Are you also not eligible for a Roth contribution because your income is too high? Assuming both are true, the amount that is not taxable (which you need to file F8606 to document) is your non-deductible contribution (basis). Everything else is taxable so if you keep track of your basis, everything else is known.

B) You cannot roll TIRA basis into a workplace retirement plan. You also need to ask workplace if they will accept the rest since you have commingled them.

Since the conversion will be taxable, some may not have separate funds available to pay the taxes. Fidelity,it sounds like, will withhold
funds if you want to pay the taxes. That means less gets into the Roth and also the funds that are withheld will have an early withdrawal penalty since you are < 59.5 y.o.

[14k]

Thank you for your comments.

A) Just to clarify Option A.......when you say it is post tax money, do you mean you are not eligible to deduct the contribution because your income is too high? Are you also not eligible for a Roth contribution because your income is too high? Assuming both are true, the amount that is not taxable (which you need to file F8606 to document) is your non-deductible contribution (basis). Everything else is taxable so if you keep track of your basis, everything else is known.

Correct, We are not eligible to deduct the contribution due to our income level. We have been doing nondeductible contributions to a tIRA then backdoor converting it to a ROTH for the last few years. I messed up this year, because of the rollover from a previous employers 401k into the tIRA account and then mistakenly comingling with post-tax money.
So this appears a clean option to me. Everything in that tIRA except the $6k will be taxed at our income tax rate..?

B) You cannot roll TIRA basis into a workplace retirement plan. You also need to ask workplace if they will accept the rest since you have commingled them.

Since the conversion will be taxable, some may not have separate funds available to pay the taxes. Fidelity,it sounds like, will withhold
funds if you want to pay the taxes. That means less gets into the Roth and also the funds that are withheld will have an early withdrawal penalty since you are < 59.5 y.o.

Per the above Wiki comment and talking to TIAA it appeared there would be no issue rolling the tIRA into the 403b (this is a supplemental 403b plan that my employer does not contribute towards and is separate to my retirement plan with them)
I would prefer to pay the taxes with taxable cash in my savings account to ensure more $ goes into the ROTH AND to ensure I don't get fined for early withdrawal, therefore I should select do not withhold.. correct?

Thank you so much.

[kaneohe]

A) Correct...everything except the 6K will be taxed. I assume your comment about withholding belonged here? Correct....do not withhold else less gets in Roth and EWP results (penalty). I assume you have documenting your non-deductible contributions each yr on Form 8606?

and the basic conversion question is: are you converting at a tax rate now that is less than your retirement tax rate ?

[Klewles]

At the risk of stating the obvious. You could choose to split the tIRA rollover: the basis (6K) to the Roth IRA, the remainder (24K) to the 403b. That would be completely tax free. In subsequent years you can roll from the 403b into the Roth IRA in amounts that are tax efficient, meaning in amounts that keep your tax rate low compared to what you expect it to be in retirement.

[kaneohe]

At the risk of stating the obvious. You could choose to split the tIRA rollover: the basis (6K) to the Roth IRA, the remainder (24K) to the 403b. That would be completely tax free. In subsequent years you can roll from the 403b into the Roth IRA in amounts that are tax efficient, meaning in amounts that keep your tax rate low compared to what you expect it to be in retirement.

I suspect OP already knows this......in response above OP states:
"We have been doing nondeductible contributions to a tIRA then backdoor converting it to a ROTH for the last few years. I messed up this year, because of the rollover from a previous employers 401k into the tIRA account and then mistakenly comingling with post-tax money. "

[14k]

At the risk of stating the obvious. You could choose to split the tIRA rollover: the basis (6K) to the Roth IRA, the remainder (24K) to the 403b. That would be completely tax free. In subsequent years you can roll from the 403b into the Roth IRA in amounts that are tax efficient, meaning in amounts that keep your tax rate low compared to what you expect it to be in retirement.

Would I need to do these two diverging transfers on the same day to avoid any IRS red flags or tax reporting complications?

[14k]

A) Correct...everything except the 6K will be taxed. I assume your comment about withholding belonged here? Correct....do not withhold else less gets in Roth and EWP results (penalty). I assume you have documenting your non-deductible contributions each yr on Form 8606?

and the basic conversion question is: are you converting at a tax rate now that is less than your retirement tax rate ?

Correct, the witholding comment belongs in the Option A converting pre-tax tIRA money into a Roth scenario.
I'm hoping my CPA has been documenting the 8606 form appropriately I just send him all our bank/brokerage "tax documents" every year!
I have no idea what my retirement tax rate is gonna be, probably same or lower (it's likely to go up over the next decade or two before coming back down if/when we retire), but with overall tax rates likely to go up in the future to pay for the baby boomers and our national debt problems who knows.
Thank you for you feedback

[Alan S.]

At the risk of stating the obvious. You could choose to split the tIRA rollover: the basis (6K) to the Roth IRA, the remainder (24K) to the 403b. That would be completely tax free. In subsequent years you can roll from the 403b into the Roth IRA in amounts that are tax efficient, meaning in amounts that keep your tax rate low compared to what you expect it to be in retirement.

Would I need to do these two diverging transfers on the same day to avoid any IRS red flags or tax reporting complications?

No, you would not. In fact, you should complete the pre tax IRA amount to 403b rollover before you convert the remainder. The reason for that is to be sure the plan in fact has accepted the IRA rollover and deposited it. If you converted the IRA basis to Roth before the 403b accepted the pre tax rollover, and they refused it for whatever reason, then you would be stuck with a mostly taxable conversion.

As for tax reporting, as long as both rollovers get done in any order, the tax reporting is the same. When you roll pre tax IRA money into an employer plan, you should include an explanatory statement describing the rollover because the employer plan does not issue a 5498 reporting receipt of the IRA rollover. So the IRS indicates in the 1040 Instructions to provide an explanatory statement.

Note that if you own multiple IRA accounts, the total pre tax amount of all of them is deemed to be rolled over before ANY IRA basis is distributed from the IRA accounts. In other words, all IRA accounts are treated as a single account.