Backdoor Roth and Traditional IRA

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Topic Author
Mrxyz
Posts: 744
Joined: Wed Feb 29, 2012 6:12 am

Backdoor Roth and Traditional IRA

Post by Mrxyz »

Hi,
I remember converting my Traditional IRA to Roth IRA before doing Backdoor Roth for the last 3 years. Today, I get a letter from CapFed that there is a $3591.95 traditional IRA in DW account! They included a form 5498 IRA contribution information, and tells me that "it is not to be used when filing your 2016 taxes".
I am sure there was not new contribution to this IRA in the last 10 years.

So, what next?

How much of a problem is this as I have contributed to backdoor Roth?
Do I have to inform the IRS? I have already filed my taxes and they have been accepted by Fed/state.
How much of a penalty am I looking at?
Do I convert this IRA to a Roth?
Thanks
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celia
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Location: SoCal

Re: Backdoor Roth and Traditional IRA

Post by celia »

I hope you mean that your DW got the letter today, rather than you. (If it was addressed to you, I am very confused. :? )

IRAs are "Individual" Retirement Accounts. What you do in your IRAs has nothing to do with what your spouse does or doesn't do in hers, although since there can be tax impacts, you should coordinate with each other.

The past Roth conversion and the more recent backdoor traditional IRA contribution followed by Roth conversions in your name are fine. You are good to continue future backdoor Roths, as long as you don't have any non-Roth IRAs.

Your wife, on the other hand, is good to keep contributing to her traditional IRA. Your joint income needs to be under a certain amount to be eligible for a deductible contribution. She can also make non-deductible contributions, but to then convert them, the pro rata rule would apply unless she converted everything and paid taxes on the newly found IRA.

In summary, to get future money into a Roth, she would have to follow your historical plan of:
1. Convert this newly discovered TIRA and any other non-Roths IRAs she has OR move them to an employer's plan.

2. Then she can do backdoor Roths.

I don't see any problem unless one of you has other non-Roth IRAs lying around somewhere.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
Topic Author
Mrxyz
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Joined: Wed Feb 29, 2012 6:12 am

Re: Backdoor Roth and Traditional IRA

Post by Mrxyz »

celia wrote:I hope you mean that your DW got the letter today, rather than you. (If it was addressed to you, I am very confused. :? )

IRAs are "Individual" Retirement Accounts. What you do in your IRAs has nothing to do with what your spouse does or doesn't do in hers, although since there can be tax impacts, you should coordinate with each other.

The past Roth conversion and the more recent backdoor traditional IRA contribution followed by Roth conversions in your name are fine. You are good to continue future backdoor Roths, as long as you don't have any non-Roth IRAs.

Your wife, on the other hand, is good to keep contributing to her traditional IRA. Your joint income needs to be under a certain amount to be eligible for a deductible contribution. She can also make non-deductible contributions, but to then convert them, the pro rata rule would apply unless she converted everything and paid taxes on the newly found IRA.

In summary, to get future money into a Roth, she would have to follow your historical plan of:
1. Convert this newly discovered TIRA and any other non-Roths IRAs she has OR move them to an employer's plan.

2. Then she can do backdoor Roths.

I don't see any problem unless one of you has other non-Roth IRAs lying around somewhere.
Sorry for my confusing post.

So we both have backdoor Roths in the last few years.
I don't have any Traditional IRAs.
My DW has Trad. IRA as per the CapFed IRA letter.
So, there is a problem as my DW has a Trad. IRA and has backdoor Roth.
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Earl Lemongrab
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Re: Backdoor Roth and Traditional IRA

Post by Earl Lemongrab »

So she forgot about the account? She hasn't been getting account statements? I'd make sure that this account exists, and that it contains pretax money, then go from there. If so, then you'll need to file amended returns for each year as far as needed and possible.
Topic Author
Mrxyz
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Joined: Wed Feb 29, 2012 6:12 am

Re: Backdoor Roth and Traditional IRA

Post by Mrxyz »

Earl Lemongrab wrote:So she forgot about the account? She hasn't been getting account statements? I'd make sure that this account exists, and that it contains pretax money, then go from there. If so, then you'll need to file amended returns for each year as far as needed and possible.
Thanks.
So do I convert this Trad. IRA to Roth? And then file the amended returns?
Is there a specific form to fill out ?
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Earl Lemongrab
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Re: Backdoor Roth and Traditional IRA

Post by Earl Lemongrab »

Mrxyz wrote:So do I convert this Trad. IRA to Roth? And then file the amended returns?
Is there a specific form to fill out ?
If you were doing backdoor Roth for her, then the conversions were partially taxable. So you need to redo the taxes with the pretax amount involved and the pro-rata calculations. This will affect how tax should have been due and the calculations on form 8606 regarding the basis. At this point, she will then have a TIRA that is part pretax and part after-tax. Nothing you do with a conversion this year affects any of that.
retiredjg
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Re: Backdoor Roth and Traditional IRA

Post by retiredjg »

It sounds like she used the back door for tax year 2014, 2015, and 2016. If that IRA existed all those years, it means her part of your joint taxes will have to be amended for 2014, 2015, and 2016.

I think this is how it should work...some verification would be nice.

Her conversion for 2014 will have to be pro-rated with the amount in that IRA at the end of 2014, something you'll have to find out. I think a 2014 Form 1040X and a new form 8606 will be all you have to do. This will leave some basis in the IRA and on Her 2014 Form 8606.

Her conversion for 2015 will have to be pro-rated with the amount in that IRA at the end of 2015, another something you'll have to find out. Again, a 2015 Form 1040X and a new 2015 Form 8606 should work. Again, some basis will be left in the IRA and on her 2015 Form 8606.

Her conversion in 2016 will have to be pro-rated with the amount in that IRA at the end of 2016. Same as above.

All this can come to an end next spring if the entire IRA (the secret one and the back door one) is converted to Roth in 2017. This should zero out line 14 on the 2017 Form 8606.

You will owe a little tax for 2014 and 2015 and 2016 and probably some penalty. I don't know how you find out about how much penalty to pay. In the long run, I don't think you'll own more tax than other than the penalty.


It sounds like neither you nor she knew she had this IRA? Were there no Forms 5498 each year, possibly arriving the first week of May (like this one did)?

Did they not know she had this IRA? If there is some irregularity with CapFed, then maybe there is a different solution required by the IRS.

If you have a local IRS office, I think I might make an appointment and go in for a visit. It is possible they will be able to calculate the missing taxes and just give you a bill and you could maybe forgo all the amended returns.
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celia
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Re: Backdoor Roth and Traditional IRA

Post by celia »

retiredjg wrote:It sounds like she used the back door for tax year 2014, 2015, and 2016. If that IRA existed all those years, it means her part of your joint taxes will have to be amended for 2014, 2015, and 2016.
Retiredjg has the right approach. Before amending your taxes, you need to know the year-end balance in the IRA for each year. Then if you did your own taxes all three years and still have the data files for the returns you submitted, you should be able to amend each year's return rather easily after you figure out the process to amend. Each return will generate a new Form 8606 that you will use for the following year's return. So you will need to start with the earliest year, then work forward.

I do know that you will have file on paper, rather than electronically. And you will have to amend state returns if you had submitted any.
I wouldn't worry about or calculate the penalty, since your reason was that you were unaware this account existed, and you are fixing this as soon as you learned of it. Let the IRS send you a bill for the penalty fees if they disagree, then you would pay it. It should be less than the additional tax you will owe due to pro-rating the basis with the rest of this new-found IRA. The good news is that when you convert the rest of that missing IRA this year, the taxes on the conversion won't be that much since the remaining basis is also being converted. Your total taxes for conversion for the past three years and this year will be about the same as the taxes you would owe on a one-year conversion of that new account. You are just splitting the taxes owed over 4 years.

None of this has anything to do with her backdoor Roth IRA for this year. The taxes should come out the same if you convert this IRA before, during, or after your backdoor Roth process, although I would do them separately to keep things simple in your mind. The only thing that will impact the taxes in this situation is the value of this new IRA on the day it is converted. Just be sure neither of you have anything in traditional IRAs at the end of this year.

If you stand back and look at this situation, it actually is a good problem to have. Yes, it will take time to clean this up properly. But on the other hand, your wife will have more money in her IRA that you/she didn't think she had. It is like 2 additional years of her making contributions. And you were going to have to pay the taxes on it some day anyway. Now it will be able to continue growing tax-free.
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