The 'Correct' BackdoorRoth order: Rollover pretax to 401k first, or convert TIRA to Roth IRA first?

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Topic Author
ducknickelson
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Joined: Tue Jan 12, 2021 3:47 am

The 'Correct' BackdoorRoth order: Rollover pretax to 401k first, or convert TIRA to Roth IRA first?

Post by ducknickelson »

Hi all,

I'm in a bit of a chicken or egg situation trying to do a Backdoor Roth to avoid the prorata rule and would love your expert advice. I have a traditional IRA currently worth $40,672 (rounded). $22,400 are nondeductible contributions, $7500 are deductible/pre-tax, and the rest are (pretax) earnings. I am ready to do the 2-step in which I rollover the pretax total from my Schwab TIRA to my pretax Vanguard 401k to rid TIRA of pretax balance, but I'm wondering if there's a 'correct' or 'safe' order in which to do the sequence without penalty or unforeseen 'gotchas'. Should I rollover my pretax to 401k first, or can I convert the aftertax basis to Roth first? If converting to Roth first, will there be a tax or IRS penalty, assuming my pretax balance is zeroed out by 12/31/2021?

Asking because it is easier to convert a 'rounded' and known basis ($22.4k) to Roth first and then move the remaining balance to the penny to 401k, than it is to rollover a pretax balance to 401k first whose 1) exact balance is unknown due to market fluctuations over the time it will take Schwab to generate and send me a check, 2) because of said market fluctuations the pretax balance might 'eat' into the aftertax $22.4k balance if markets go up and I unknowingly rollover more 'pretax' money than I should, then the rollover would've consisted of some aftertax money, which Vanguard 401k cannot accept. 3), being out of the market for a week or more is something I want to avoid.

Am I being paranoid? Page 21 of Publication 590-A says "a special rule treats a distribution you roll over into an eligible retirement plan as including only otherwise taxable amounts if the amount you either leave in your IRAs or don’t roll over is at least equal to your basis." Sounds like the IRS wants you to do the pretax rollover first followed by the Roth conversion, but the order is not explicit. FWIW I *would* just convert the entire TIRA to Roth since the taxable amount is only $18,272, but I'm already in a high tax bracket for 2020 and if my math is right I fear this would push me into an even higher bracket.

Any advice is highly appreciated! Thank you in advance.
Last edited by ducknickelson on Wed Jan 13, 2021 11:53 pm, edited 1 time in total.
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FiveK
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Re: Backdoor Roth 2-step order: Rollover pretax to 401k first, or convert aftertax to Roth IRA first?

Post by FiveK »

If you know for sure that the 401k will accept the incoming rollover, doing the conversion first makes sense for the reasons you give.

That does run the small but non-zero risk that you think the 401k will accept the incoming rollover but in fact does not. In that case you'll pay the pro-rata tax, which isn't the end of the world.
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FiveK
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Re: Backdoor Roth 2-step order: Rollover pretax to 401k first, or convert aftertax to Roth IRA first?

Post by FiveK »

ducknickelson wrote: Tue Jan 12, 2021 5:48 am ...I'm already in a high tax bracket for 2020 and if my math is right I fear this would push me into an even higher bracket.
Only the amount in the higher bracket gets taxed at that rate. Amounts up to that bracket limit are taxed at their own, lower, rates.
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anon_investor
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Re: Backdoor Roth 2-step order: Rollover pretax to 401k first, or convert aftertax to Roth IRA first?

Post by anon_investor »

ducknickelson wrote: Tue Jan 12, 2021 5:48 am Hi all,

I'm in a bit of a chicken or egg situation trying to do a Backdoor Roth to avoid the prorata rule and would love your expert advice. I have a traditional IRA currently worth $40,672 (rounded). $22,400 are nondeductible contributions, $7500 are deductible/pre-tax, and the rest are (pretax) earnings. I am ready to do the 2-step in which I rollover the pretax total from my Schwab TIRA to my pretax Vanguard 401k to rid TIRA of pretax balance, but I'm wondering if there's a 'correct' or 'safe' order in which to do the sequence without penalty or unforeseen 'gotchas'. Should I rollover my pretax to 401k first, or can I convert the aftertax basis to Roth first? If converting to Roth first, will there be a tax or IRS penalty, assuming my pretax balance is zeroed out by 12/31/2021?

Asking because it is easier to convert a 'rounded' and known basis ($22.4k) to Roth first and then move the remaining balance to the penny to 401k, than it is to rollover a pretax balance to 401k first whose 1) exact balance is unknown due to market fluctuations over the time it will take Schwab to generate and send me a check, 2) because of said market fluctuations the pretax balance might 'eat' into the aftertax $22.4k balance if markets go up and I unknowingly rollover more 'pretax' money than I should, then the rollover would've consisted of some aftertax money, which Vanguard 401k cannot accept. 3), being out of the market for a week or more is something I want to avoid.

Am I being paranoid? Page 21 of Publication 590-A says "a special rule treats a distribution you roll over into an eligible retirement plan as including only otherwise taxable amounts if the amount you either leave in your IRAs or don’t roll over is at least equal to your basis." Sounds like the IRS wants you to do the pretax rollover first followed by the Roth conversion, but the order is not explicit. FWIW I *would* just convert the entire TIRA to Roth since the taxable amount is only $18,272, but I'm already in a high tax bracket for 2020 and if my math is right I fear this would push me into an even higher bracket.

Any advice is highly appreciated! Thank you in advance.
I had a similar situation but with 6 figure amount a couple of years ago. I decided I was willing to pay the taxes if it did not work, I sold my entire TIRA to cash. Then converted the exact dollar amount of my cost basis (non-deductable contributions) to roth. Then initiated a transfer of my entire TIRA balance to my 401k. My 401k plan accepted any pre-tax funds from a TIRA, regardless of the source (so not just 401k rollovers, etc.), as long as the funds were pre-tax. Luckily there were no issues and the rollover completed in less than 2 weeks and required me to only printout sign and scan/upload forms to both Vanguard and my 401k plan website (Vanguard mailed the check directly to my 401k plan administrator). At least with Vanguard, they said the TIRA has to be sold to cash prior to initiating the transfer, because I needed to request they transfer a dollar amount. Similarly, my 401k plan required that the form I submitted to them list a dollar amount that was being transfered.
Topic Author
ducknickelson
Posts: 2
Joined: Tue Jan 12, 2021 3:47 am

Re: Backdoor Roth 2-step order: Rollover pretax to 401k first, or convert aftertax to Roth IRA first?

Post by ducknickelson »

Thank you both for the replies. I realize this is a niche question so appreciate any insight.
FiveK wrote: Tue Jan 12, 2021 5:14 pm If you know for sure that the 401k will accept the incoming rollover, doing the conversion first makes sense for the reasons you give.

That does run the small but non-zero risk that you think the 401k will accept the incoming rollover but in fact does not. In that case you'll pay the pro-rata tax, which isn't the end of the world.
@FiveK- I called Vanguard 401k who said they do not and cannot distinguish between contribution sources in a TIRA when I started to explain my situation - that I had pre- and after-tax money in my TIRA. He said anything that rolls in from a TIRA they consider 'pretax' money... though, I know answers can vary quite a bit depending on the rep and people in my company said they've experienced more clerical errors with Vanguard (our 401k admin) rollovers lately.
Which is why I wanted to be extra cautious and ask this forum first.
anon_investor wrote: Tue Jan 12, 2021 5:33 pm
Luckily there were no issues and the rollover completed in less than 2 weeks and required me to only printout sign and scan/upload forms to both Vanguard and my 401k plan website (Vanguard mailed the check directly to my 401k plan administrator).
@anon_investor, did you get any tax forms like a 1099-R from the IRS after you did the backdoor conversion? Funny that your situation is the reverse of mine; I'm trying to roll over funds INTO Vanguard. Did your 401k plan administrator question if your rollover included any aftertax bases? Or did you not tell them you did the Roth conversion first?

99% sites I've read like physicianonfire.com/backdoor and even my company say to roll pretax to 401k first,... :confused so if anyone had any similar experiences where they thought it'd be easier to convert their known aftertax basis to Roth first, I would appreciate you sharing! Thanks in advance
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FiveK
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Re: Backdoor Roth 2-step order: Rollover pretax to 401k first, or convert aftertax to Roth IRA first?

Post by FiveK »

ducknickelson wrote: Wed Jan 13, 2021 11:49 pm Thank you both for the replies. I realize this is a niche question so appreciate any insight.
FiveK wrote: Tue Jan 12, 2021 5:14 pm If you know for sure that the 401k will accept the incoming rollover, doing the conversion first makes sense for the reasons you give.

That does run the small but non-zero risk that you think the 401k will accept the incoming rollover but in fact does not. In that case you'll pay the pro-rata tax, which isn't the end of the world.
@FiveK- I called Vanguard 401k.... He said anything that rolls in from a TIRA....
That is strong circumstantial evidence that the 401k will accept the incoming rollover. Good luck!
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anon_investor
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Re: Backdoor Roth 2-step order: Rollover pretax to 401k first, or convert aftertax to Roth IRA first?

Post by anon_investor »

ducknickelson wrote: Wed Jan 13, 2021 11:49 pm
anon_investor wrote: Tue Jan 12, 2021 5:33 pm
Luckily there were no issues and the rollover completed in less than 2 weeks and required me to only printout sign and scan/upload forms to both Vanguard and my 401k plan website (Vanguard mailed the check directly to my 401k plan administrator).
@anon_investor, did you get any tax forms like a 1099-R from the IRS after you did the backdoor conversion? Funny that your situation is the reverse of mine; I'm trying to roll over funds INTO Vanguard. Did your 401k plan administrator question if your rollover included any aftertax bases? Or did you not tell them you did the Roth conversion first?
I did get a 1099-R from Vanguard, and it indicated my TIRA was rollover to another qualified account (non-taxable event).

My 401k plan had a form I signed where I checked a box indicating it was pre-tax funds only and I certified the form was accurate. I had called Vanguard, and they said they would not state the TIRA funds were only pre-tax, only that it was funds from a TIRA. My 401k plan accepted whatever info Vanguard included with the check. I felt it was cleaner converting the exact dollar amount to Roth first, no chance for Vanguard to make a mistake and rollover too much.
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