Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

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orthros
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Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by orthros » Fri Nov 15, 2019 10:12 am

I have a combined Rollover IRA that contains IRA contributions (when I didn't have a 401k) plus 401k rollover contributions from jobs long ago.

In theory, I'd like to re-characterize some of these assets to Roth status, since I'm having a low income year, but I'm struggling with the rules related to nondeductible and deductible traditional IRAs since I have both.

Just to make it even more messy, I have a solo 401(k) :?

It seems like a mess of paperwork, since the basis calculations seem byzantine. Also not certain if this would materially increase my chances of getting audited because of said byzantine basis calculations.

Can anyone assist here?

If it helps, the general amounts we're talking about are:

Nondeductible IRAs (Wife and me): $25k
Rollover IRAs (Wife and me): $400k
Self 401k (me only): $100k

Wife and I are in our mid-to-late 40s. My dear wife is older, as I like to remind her. :D

lakpr
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by lakpr » Fri Nov 15, 2019 10:28 am

Does your wife has a 401k plan that she can roll her Rollover IRA into?

You can roll your Rollover IRA into your Solo 401(k), no problem -- AS LONG AS IT"S NOT WITH VANGUARD. Then you can convert your remaining non-deductible IRA to Roth and good to go. If your Solo 401(k) *is* with Vanguard, your road is a bit longer, you need to change the custodian of your plan to E*Trade.

Without such recourse to your wife, unfortunately she's stuck.

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orthros
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by orthros » Fri Nov 15, 2019 10:39 am

Unfortunately, all the negatives are true. Wife has no solo 401(k) and my solo 401(k) is with Vanguard. :(

Curious as to why I need to two-step this Vanguard --> eTrade --> back to Vanguard. Do you know if there is some legal restriction?

Alan S.
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by Alan S. » Fri Nov 15, 2019 10:49 am

orthros wrote:
Fri Nov 15, 2019 10:12 am
I have a combined Rollover IRA that contains IRA contributions (when I didn't have a 401k) plus 401k rollover contributions from jobs long ago.

In theory, I'd like to re-characterize some of these assets to Roth status, since I'm having a low income year, but I'm struggling with the rules related to nondeductible and deductible traditional IRAs since I have both.

Just to make it even more messy, I have a solo 401(k) :?

It seems like a mess of paperwork, since the basis calculations seem byzantine. Also not certain if this would materially increase my chances of getting audited because of said byzantine basis calculations.

Can anyone assist here?

If it helps, the general amounts we're talking about are:

Nondeductible IRAs (Wife and me): $25k
Rollover IRAs (Wife and me): $400k
Self 401k (me only): $100k

Wife and I are in our mid-to-late 40s. My dear wife is older, as I like to remind her. :D
There is no such thing as a non deductible IRA account. Each spouse has "basis" in all their non Roth IRA accounts that must be documented on Form 8606 for each spouse. Again, it does not matter which of a spouse's IRA accounts receive these non deductible contributions OR which IRA accounts of a spouse fund a conversion to Roth since Form 8606 treats all non Roth IRA accounts as one single account (for each spouse). Of course, where you indicated "non deductible IRAs", I suspect you probably meant "non deductible TIRA contributions", not accounts.

What you are asking about is a conversion, not a recharacterization. If your solo K plan allowed IRA rollovers (VG apparently does not), you could roll over no more than the pre tax balance of all your non Roth IRAs, and that includes rollover IRAs. That amount would be your total TIRA balance less the basis shown on your latest 8606 and any basis you have added this year as a 2019 ND contribution. If you can complete this process prior to year end, you can then convert the remaining TIRA basis tax free.

If you cannot roll over the pre tax TIRA balance and still want to convert some of your TIRA to Roth, Form 8606 will compute the taxable amount. Essentially, it is a pro rata calculation. If your basis is 10% of total value at year end, then 10% of your conversion is non taxable and 90% would be taxable. Completion of Form 8606 is very simple if you use a tax program which accumulates the needed data from year to year.

lakpr
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by lakpr » Fri Nov 15, 2019 10:49 am

orthros wrote:
Fri Nov 15, 2019 10:39 am
Unfortunately, all the negatives are true. Wife has no solo 401(k) and my solo 401(k) is with Vanguard. :(

Curious as to why I need to two-step this Vanguard --> eTrade --> back to Vanguard. Do you know if there is some legal restriction?
No, not back to Vanguard. Vanguard prohibits rollover of money from external sources into the prototype Independent 401k plan. The preferred Solo 401k provider on these forums is E*Trade because its prototype plan:

- provides for rollover of IRA or 401k from previous jobs into the plan (unlike Vanguard)
- provides for both Roth and Traditional employEE contributions (unlike Fidelity, which only allows traditional)
- and most importantly, allows conversion within the plan of Traditional funds to Roth. This, to my knowledge, is only offered by E*Trade not by any other competitor in the Solo 401k space. You can use this flexibility to do some last minute year-end tax planning, if you want to.

I was therefore recommending completely change the custodian to E*Trade. You can get Vanguard ETFs (not mutual funds) at no cost through E*Trade.
Last edited by lakpr on Fri Nov 15, 2019 10:53 am, edited 1 time in total.

HomeStretch
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by HomeStretch » Fri Nov 15, 2019 10:50 am

I believe you may be interested in doing a Roth “conversion” of your IRA basis of $25k (i.e., non-deductible contributions) and conversions of pretax contributions/earnings in your IRAs and 401k, rather than a “recharacterization”. Is that right?

Have you and spouse filed Form 8606 with your Federal Form 1040 to document your basis from IRA non-deductible contributions?

Converting your/spouse’s IRA basis to a Roth IRA is easy but would be subject to the “pro rata rule” if you or spouse have pretax amounts in your IRAs. One way around this would be to rollover all pretax amounts into a 401k (if it accepts rollovers in) and, when completed, rollover the remaining amount (the basis) into a Roth IRA. Here is a link to the BH wiki page about “Backdoor Roth”. The parts pertinent to you are step 2 (conversion of non-deductible IRA contributions to Roth IRA) and the pro rata rule.
https://www.bogleheads.org/wiki/Backdoor_Roth

Doing Roth conversions of IRA/401k pretax amounts in low income years can make sense. Every situation is different so you need to do an analysis of what makes sense for you.
1. Doing such an IRA conversion is easy after you clear out the IRA basis, per above. Here is a link to the BH wiki page on Roth IRA conversions:
https://www.bogleheads.org/wiki/Roth_IRA_conversion
2. The 401k conversions to Roth are dependent on whether you can access the 401k funds to do so.

My suggestion is to read the responses, find your Forms 8606, create a list of the steps you need to take to achieve the above and post the list for feedback before taking action. This seemed to work for posters in other threads contemplating the same.

ETA: I see from a later post that yours is a Vanguard Solo 401k. As lakpr points out, to avoid the pro rata rule for you, you would need to amend your Solo 401k Plan to another provider plan (Fidelity, E*Trade, Schwab) that allows rollovers in. Your spouse cannot avoid the pro rata rule if spouse has an IRA with pretax amounts and basis if spouse does not have a 401k.
Last edited by HomeStretch on Fri Nov 15, 2019 11:01 am, edited 2 times in total.

Alan S.
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by Alan S. » Fri Nov 15, 2019 10:57 am

orthros wrote:
Fri Nov 15, 2019 10:39 am
Unfortunately, all the negatives are true. Wife has no solo 401(k) and my solo 401(k) is with Vanguard. :(

Curious as to why I need to two-step this Vanguard --> eTrade --> back to Vanguard. Do you know if there is some legal restriction?
To understand the process, assume that you changed solo K providers to one that accepted IRA rollovers.
The process would then entail rolling your pre tax IRA balance (apparently with E Trade) to the new solo K provider. This leaves ONLY your IRA basis in the E Trade TIRA. You can then convert that basis to a Roth IRA at any custodian tax free.

It's a two step process to eliminate your pre tax value from your TIRA accounts by moving them to a non IRA plan that will accept the IRA rollover. If you then want to continue to do back door Roth conversions with your ND contributions from year to year, you would leave the balance you rolled to the solo K in that plan. Once you are done with back door Roths, you can generally roll the former pre tax IRA balance out of the solo K back to your TIRA. After that, if you make no more non deductible contributions, your conversions would be 100% taxable.

Spirit Rider
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by Spirit Rider » Fri Nov 15, 2019 11:15 am

You should change the post title. None of what you are talking about are recharacterizations. That refers to changing current tax year traditional or Roth IRA contributions to Roth or traditional IRA contributions respectively.

There are no non-deductible IRAs. There are only pre-tax balances and non-deductible basis in traditional IRAs. If either of you were to do a Roth conversion of any IRA. Any pre-tax balance in all traditional, SEP and SIMPLE IRA accounts are combined for pro-rata taxation with any non-deductible basis in all accounts.

The solution to this mess is to rollover ALL pre-tax balances that you DON'T want to convert to a 401k plan and the do a Roth conversion of all remaining IRA balances. Only the pre-tax amount of the conversion will be taxable. You can still do taxable rollovers of the rollover assets in the 401k at anytime.

It is preferable to rollover IRA pre-tax assets to an ERISA workplace 401k if it has good investment options. It has full ERISA asset protection, a one-participant 401k plan does not. Also, it delays when you would have to file Form 5500-EZ. This is required when plan's year-end balance is > $250K.

The only time the comingling of IRA direct contributions into a Rollover IRA matters, is if a 401k plan refuses to accept such a rollover. There are fewer and fewer plans that have such a restriction. You will have to check with any 401k plan you have to determine if they accept IRA rollovers. Vanguard's Individual 401k does not accept rollovers. Then you have to determine if the 401k plan will only accept IRA rollovers from pure Rollover IRAs.

Converting pre-tax assets to Roth assets is not so easy in a one-participant 401k plan. The only low-cost mainstream one-participant 401k provider that allows in-plan Roth rollovers is E-Trade. The only other way is to get this money to a Roth IRA is to rollover the pre-tax assets to a Roth IRA.

IRS regulations prohibit the in-service withdrawal/rollover of employee deferrals prior to age 59 1/2. IRS regulations allow but do not require the withdrawal/rollover of vested employer contributions prior to age 59 1/2. All of the low-cost mainstream one-participant 401k providers have some/complete restrictions on the rollover of vested employer contributions.

Katietsu
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by Katietsu » Fri Nov 15, 2019 11:16 am

All of the above information is accurate. But, in general, it describes a method to get the non deductible contributions to a Roth without incurring any tax liability. OP stated an interest in converting because it was a low income year.

My recommendation is to just go ahead and convert. By making non deductible contributions, you already subjected yourself to Byzantine calculations.

I would also strongly considering following the advise to move solo 401k plan to E*TRADE. Roll in most of the funds from the IRA. Leave at least the amount of the basis in the traditional IRA. Then convert 100% of what is left to Roth. That will clean this up and get you out of some of this record keeping. You can try to get this done in 2019 but you would really need to have things all go smoothly.
But waiting to 2020 for this part would be fine. It might even make it easier to keep straight in your head that way.

Spirit Rider
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Re: Advice on Re-characterization of Traditional IRAs and Solo 401(k) to Roth?

Post by Spirit Rider » Fri Nov 15, 2019 11:30 am

Katietsu wrote:
Fri Nov 15, 2019 11:16 am
All of the above information is accurate. But, in general, it describes a method to get the non deductible contributions to a Roth without incurring any tax liability. OP stated an interest in converting because it was a low income year.
My plan fully supported doing a Roth conversion of as much pre-tax balances this year as the OP wanted. The other suggestions to move to E-Trade and do IRRs accomplishes the same thing.

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