Backdoor Roth Conversion Timeline after recharacterization

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Amy2017
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Joined: Wed Oct 11, 2017 12:02 pm

Backdoor Roth Conversion Timeline after recharacterization

Post by Amy2017 » Wed Oct 11, 2017 10:53 pm

When working on our 2016 income tax in September, I realize our income is over Roth IRA contribution limit. To avoid penalty, I did a recharactization of both my husband’s and my 2016 Roth IRA contribution of $5500 to two newly created Non-Deductible IRA accounts before the tax filing deadline. The amount actually transferred to the Non-Deductible IRA account is around $6500.

I don’t have any IRA account previously, only 401K at work. My husband does have a Deductible IRA account. To prepare for backdoor Roth IRA later, my husband opened a Solo 401K since he has a small business. We plan to rollover all the money in his Deductible IRA account to the Solo 401K in the next couple of days. So here are my questions.

1) After we rollover all the money in my husband’s Deductible IRA account to the Solo 401K, to avoid any tax issue, does my husband need to wait until next year to convert all the money in his Non-Deductible IRA to Roth IRA or he could do it now?

2) I understand that I could do the backdoor Roth IRA now since I don’t have any IRA before. But should I wait for at least getting one monthly statement of the Non-Deductible account before the Roth conversion so that the transaction looks cleaner to IRS?

3) When doing the Roth conversion, could we convert the money back to the same Roth IRA account or it is better to create new Roth IRA account?

4) If the value of Non-Deductible IRA account is $6500 before the Roth conversion, does it mean we need to pay tax on $1000 earning even if we make a direct transfer without selling any stocks?

5) We have also made the max Roth contribution for tax year 2017 earlier this year. Not sure whether our 2017 income will be over the Roth IRA contribution limit. Should we go ahead doing a characterization of our 2017 Roth IRA contribution now or wait until 2018? If doing them now, could or should we do the Roth conversion afterward or need to wait until next year?

6) We plan to make Non-Deductible contribution early next year for tax year 2018. Will this cause any problem?

Thank you so much for any guidance.

Alan S.
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Location: Prescott, AZ

Re: Backdoor Roth Conversion Timeline after recharacterization

Post by Alan S. » Thu Oct 12, 2017 12:01 am

Amy2017 wrote:
Wed Oct 11, 2017 10:53 pm
When working on our 2016 income tax in September, I realize our income is over Roth IRA contribution limit. To avoid penalty, I did a recharactization of both my husband’s and my 2016 Roth IRA contribution of $5500 to two newly created Non-Deductible IRA accounts before the tax filing deadline. The amount actually transferred to the Non-Deductible IRA account is around $6500.

I don’t have any IRA account previously, only 401K at work. My husband does have a Deductible IRA account. To prepare for backdoor Roth IRA later, my husband opened a Solo 401K since he has a small business. We plan to rollover all the money in his Deductible IRA account to the Solo 401K in the next couple of days. So here are my questions.

1) After we rollover all the money in my husband’s Deductible IRA account to the Solo 401K, to avoid any tax issue, does my husband need to wait until next year to convert all the money in his Non-Deductible IRA to Roth IRA or he could do it now?

His IRA accounts are not really deductible or non deductible. He has a basis of 5500 that applies to all his non Roth IRAs. He should roll the entire total balance less the 5500 into the solo K. That would be his first TIRA balance plus the 1000 of gains from the recharacterized Roth contribution. No reason to wait before converting the 5500 to Roth. The conversion can be done before the solo K rollover as long as you are sure that his solo K agreement allows for acceptance of IRA rollovers. Just be sure to limit the rollover to only the pre tax balance in his IRAs. Note that there IS a waiting period for reconverting recharacterized conversions, but you do did not recharacterize a conversion, you recharacterized a regular Roth contribution.



2) I understand that I could do the backdoor Roth IRA now since I don’t have any IRA before. But should I wait for at least getting one monthly statement of the Non-Deductible account before the Roth conversion so that the transaction looks cleaner to IRS?

No need to wait. The tax code does not require any waiting period and the IRS has never indicated that a wait is advisable and in addition the IRS does not get the dates of transactions. All they get is an annual total on a 1099R or 5498 form. No taxpayer has ever had an issue when converting immediately after a non deductible TIRA contribution was made.

3) When doing the Roth conversion, could we convert the money back to the same Roth IRA account or it is better to create new Roth IRA account?

You can use the one that is already open.

4) If the value of Non-Deductible IRA account is $6500 before the Roth conversion, does it mean we need to pay tax on $1000 earning even if we make a direct transfer without selling any stocks?

You would owe the tax on the 1000 if you converted that account because your basis is only 5500. In your husband's case he is doing a solo K rollover anyway so it makes sense for him to include his 1000 of gain in that rollover. But for you the 1000 of gains is small enough that it may not be worth the trouble of processing a rollover of only 1000 to your 401k even if the plan would accept it. So in your case you might as well just convert the entire 6500 and pay the tax on the 1000 of gains.

5) We have also made the max Roth contribution for tax year 2017 earlier this year. Not sure whether our 2017 income will be over the Roth IRA contribution limit. Should we go ahead doing a characterization of our 2017 Roth IRA contribution now or wait until 2018? If doing them now, could or should we do the Roth conversion afterward or need to wait until next year?

This is a coin flip. How accurately can you project your 2017 MAGI? If you are quite likely to end up in the income phaseout range or higher you would probably recharacterize now and then convert. There could be more gains on this contribution as well that might be rolled into his solo K or that you would have to pay taxes on when you convert. Probably a lot lower than 1000 though since less time in the Roth IRA.

6) We plan to make Non-Deductible contribution early next year for tax year 2018. Will this cause any problem?

No and neither would the conversion. Note that the Roth custodian must calculate the gains on both your 2016 and 2017 contributions separately when processing the recharacterizations. These will be reported on separate 1099R forms, one for each year.

Thank you so much for any guidance.

a__
Posts: 10
Joined: Sun Aug 27, 2017 12:09 am

Re: Backdoor Roth Conversion Timeline after recharacterization

Post by a__ » Thu Oct 12, 2017 2:10 am

I have almost the same question, but it my case it's due to a roll-over:

Feb 2017: I did direct roll-over from Betterment TIRA to Vanguard.
March 2017: 2016 contributions to Betterment were about $2,000, so I finished out 2016 contributions to Vanguard TIRA
April 2017: Made $5,500 contribution to TIRA

Total TIRA value now is about $24,000

I planned to deduct 2016 and 2017 contributions, but finally my income will be too high for both years. I actually still have not not finalized 2016 return, this will get submitted next week. Therefore, I would like to convert to a Roth. I understand the tax liabilities on the conversion, but I think it's worth it. Total value is relatively small, and in coming years, I don't think my TIRA contributions will be deductible anyway. So going forward, I expect to stick with Roth direct, or do backdoor conversions.

What I plan to do:
1. Now: Convert all $24,000 to Roth with Vanguard (opening a new account). This would include all previous deductible and non-deductible contributions up to 2017.
2. January 2018: Make backdoor contribution with normal procedures or 2018 tax year.

Any issue converting the Vanguard TIRA in 2017 considering that it was established in 2017 with a direct transfer? Or is this a distribution event that will cause confusion? If so, I would prefer to move the money in 2017 since moving it all in 2018 means converting with a 2018 contribution too.

Thank you!

Amy2017
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Joined: Wed Oct 11, 2017 12:02 pm

Re: Backdoor Roth Conversion Timeline after recharacterization

Post by Amy2017 » Thu Oct 12, 2017 11:30 am

Thank you so much for such detailed response. By the way, we opened our Solo 401k in TD Ameritrade, which has all the options available. The paperwork for Solo 401k initially seems overwhelmed. But turns out really not that difficult. Not sure why they make simple things appear complex.

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celia
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Re: Backdoor Roth Conversion Timeline after recharacterization

Post by celia » Thu Oct 12, 2017 11:59 am

Dear a__ :

This is what I think you are saying happened:

You made a $2,000 and $3,500 contribution to a tIRA for 2016.
You made a $5,500 contribution to the tIRA for 2017.
Both contributions are non-deductible on your taxes since your income is/was too high for the year.
The tIRA is now worth about $24,000.
You have no other non-Roth IRAs.

If all of this is true, you are good to do your conversion and will pay taxes on the amount over $5,500 + $5,000 = $11,000 for the year the conversion is done. It is best if you convert into a new (empty) Roth now in case you find that the markets drop and you want a "do-over" on this 2017 conversion. That would involve a recharacterization first, then a new conversion after 30 days. Be sure you recharacterize into a tIRA different that where you put your 2018 non-deductible contribution.
a__ wrote:
Thu Oct 12, 2017 2:10 am
Any issue converting the Vanguard TIRA in 2017 considering that it was established in 2017 with a direct transfer? Or is this a distribution event that will cause confusion? If so, I would prefer to move the money in 2017 since moving it all in 2018 means converting with a 2018 contribution too.
There's no issue with doing the conversion now. In fact, I recommend it, since the longer you wait, the more growth you will earn that will be taxable when the conversion happens. Get that growth to happen while the funds are in the Roth!

This is "clean" as far as the IRS sees it. (The transfer of custodians is irrelevant.) Continue to make all further IRA contributions to a tIRA, then immediately convert. If it ends up that you could have made a deductible contribution, you can claim that, but then the entire converted amount will be taxed. So it will be a wash whether to deduct the future contributions or not. But if your future income drops or the ceiling for the deductible tIRA eligibility increases in the future, you would make deductible contributions if you don't want to convert.

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celia
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Re: Backdoor Roth Conversion Timeline after recharacterization

Post by celia » Thu Oct 12, 2017 2:22 pm

Amy, You have a lot of good questions. Let's take them one at a time.
Amy2017 wrote:
Wed Oct 11, 2017 10:53 pm
1) After we rollover all the money in my husband’s Deductible IRA account to the Solo 401K, to avoid any tax issue, does my husband need to wait until next year to convert all the money in his Non-Deductible IRA to Roth IRA or he could do it now?
There is no such thing as a "Deductible IRA" but there is such a thing as a traditional IRA that has non-deductible contributions in it, plus growth, which is what you have. The custodian doesn't know (or care) if you deducted the contributions or not.

Let's back up and talk about the 401K first:

Most 401Ks will accept a rollover from other employer plans or from a Rollover IRA that contains a previous employer plan rollover.
Some 401Ks will accept contributions and growth from traditional IRAs containing deductible contributions and their growth.
No 401K is permitted to accept nondeductible contributions. They may or may not accept the growth on those contributions.

You can either find out if the 401K will accept the $1000 growth on the nondeductible contribution or else just convert it with the nondeductible contributions (after you transfer the rest to the 401K) assuming they accept tIRAs.
2) I understand that I could do the backdoor Roth IRA now since I don’t have any IRA before. But should I wait for at least getting one monthly statement of the Non-Deductible account before the Roth conversion so that the transaction looks cleaner to IRS?
Since you don't have any money in any non-Roth IRAs, you can convert now. Wouldn't you want the future growth to occur inside the Roth instead of paying more taxes on it by allowing more growth in the tIRA?
3) When doing the Roth conversion, could we convert the money back to the same Roth IRA account or it is better to create new Roth IRA account?
Theoretically it doesn't matter, but since you also have a 2017 contribution in there, that contribution will be harder to unwind if you convert more money into the existing Roth and you probably will have to recharacterize a larger amount than if you converted the 2016 money into a new Roth.
4) If the value of Non-Deductible IRA account is $6500 before the Roth conversion, does it mean we need to pay tax on $1000 earning even if we make a direct transfer without selling any stocks?
You will have to pay tax on any amount over the nondeductible contribution when you CONVERT (not transfer).
5) We have also made the max Roth contribution for tax year 2017 earlier this year. Not sure whether our 2017 income will be over the Roth IRA contribution limit. Should we go ahead doing a characterization of our 2017 Roth IRA contribution now or wait until 2018? If doing them now, could or should we do the Roth conversion afterward or need to wait until next year?
I would go ahead and recharacterize now AND make all future contributions to a traditional IRA, followed immediately by a conversion. By waiting, you will have more growth that you will have to pay more taxes on for the year of conversion. In other words, be pro-active and always do the contribution to the traditional IRA. If you find in the future that it can be deducted, you will have the opportunity to recharacterize it back to a tIRA, then roll it over to a 401K (if you don't want to keep the Roth conversion for that year). This would be a good reason for always converting into a new (empty) Roth. After October 15 of the following year, when the conversion can no longer be recharacterized, the assets in the new Roth can be rolled over to your primary Roth.
6) We plan to make Non-Deductible contribution early next year for tax year 2018. Will this cause any problem?
You can do this early next year. But you should avoid having transactions on top of each other that you might want to "un-do". It is easy to un-do the last one but previous ones will not be "un-done" as you expect, causing you to come back and ask why. The answer involves using the IRS rules for calculating the amount to be withdrawn that takes into account all the transactions between the contribution/conversion and its recharacterization.
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.

Amy2017
Posts: 12
Joined: Wed Oct 11, 2017 12:02 pm

Re: Backdoor Roth Conversion Timeline after recharacterization

Post by Amy2017 » Thu Oct 12, 2017 3:04 pm

Thank you so much for the clarification. The reason I am hesitant to recharacterize our 2017 Roth contribution to IRA is because if it turns out our income is below the income limit, then we could keep the money in Roth instead paying tax on earning as non-deductible IRA. To make things simpler, it seems we should just take the hit, recharacterize 2017 Roth Contribution to the same IRA account that currently holds our 2016 Contribution, then convert all the money in the IRA account back to our current Roth account asap. If it turns out our 2017 income is below the income limit, could we recharacterize our 2017 IRA contribution back to Roth IRA? I understand we need to get all these straight before we start to contribution for tax year 2018, which I plan to do an immediate backdoor Roth. So not much earning to worry about.

a__
Posts: 10
Joined: Sun Aug 27, 2017 12:09 am

Re: Backdoor Roth Conversion Timeline after recharacterization

Post by a__ » Thu Oct 12, 2017 7:49 pm

celia wrote:
Thu Oct 12, 2017 11:59 am

This is "clean" as far as the IRS sees it. (The transfer of custodians is irrelevant.) Continue to make all further IRA contributions to a tIRA, then immediately convert. If it ends up that you could have made a deductible contribution, you can claim that, but then the entire converted amount will be taxed. So it will be a wash whether to deduct the future contributions or not. But if your future income drops or the ceiling for the deductible tIRA eligibility increases in the future, you would make deductible contributions if you don't want to convert.
Perfectly clear...thank you!

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