Mistake with Backdoor Roth

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KaiserSleep
Posts: 2
Joined: Wed Nov 18, 2020 1:25 am

Mistake with Backdoor Roth

Post by KaiserSleep »

Earlier this year I did a backdoor Roth for both my wife and I at Vanguard. I contributed 6k for each of us and the contribution was not tax deductible. My wife just told me this week that she remembered that she had a decades old IRA at TD Ameritrade that was opened by her parents. She had earned income from working in her father’s office as a teenager and contributed everything she earned over a few years to the IRA. I was able to find the IRA and it has a balance of 30k. On a side note, my wife and I have contributed the yearly max 57k to our employer sponsored retirement accounts.

My understanding is that I needed to have a zero balance in any other IRAs prior to doing the backdoor Roth due to the IRS pro rate rule. Do I need to pay taxes on my wife’s Roth conversion to make the IRS happy? More importantly, what the best way to deal with backdoor Roth conversions moving forward? I was considering doing a Roth conversion on the old TD Ameritrade IRA account but am hesitant as we’re in a high tax bracket.
Asyouwish
Posts: 50
Joined: Tue Aug 04, 2020 6:20 am

Re: Mistake with Backdoor Roth

Post by Asyouwish »

Look at Form 8606 in particular Part I. Line 6 is where you would list the FMV of all her IRAs. Follow down through the calculations. Then see how much is taxable. Yes, it will be taxable. If you did the conversion this year, then when you file next year is when you file the 8606 and pay tax. Unfortunately if you already executed the conversion, it can’t be undone. The TCJA eliminated recharacterization of Roth conversions. And the IRS will know because the 5498 has the FMV and they document match the 1099-R with the 8606 and 5498.

Publication 590-A and 590-B are the pubs for IRAs.

To continue with clean conversions, the TIRA would need to be emptied either through a large conversion or rolled cover to an employer plan. Does her employer plan allow rollover contributions?
retiredjg
Posts: 43194
Joined: Thu Jan 10, 2008 12:56 pm

Re: Mistake with Backdoor Roth

Post by retiredjg »

KaiserSleep wrote: Wed Nov 18, 2020 1:38 am My understanding is that I needed to have a zero balance in any other IRAs prior to doing the backdoor Roth due to the IRS pro rate rule.
Not quite. You need to have a zero balance at the end of this year in order to avoid pro-rating the conversion with that $30k IRA.

Do I need to pay taxes on my wife’s Roth conversion to make the IRS happy? More importantly, what the best way to deal with backdoor Roth conversions moving forward? I was considering doing a Roth conversion on the old TD Ameritrade IRA account but am hesitant as we’re in a high tax bracket.
1. Find out if the $30k can be rolled into her current employer sponsored plan. If that can happen by the end of the year, there will be no pro-rating.

2. If there is not enough time to accomplish that or if her currant plan will not take it, the easiest thing is to simply convert the $30k to Roth. This can be done in a matter of minutes. Taxes will be due. It's not the solution you want, but it clears the way for future backdoor Roths for her and it is easy.

3. There is nothing you can do to change her 2020 IRA situation (it cannot be undone). You could leave the $30k IRA as is and pro-rate the 2020 contribution (which means much of it will be taxable). This will leave some "basis" (already taxed money) in the small IRA. Each year in the future, her backdoor procedure will be pro-rated with that small IRA.....you don't really accomplish anything by doing this. I would choose option 2 before doing it this way.


Welcome to the forum. :happy I hope was your first "backdoor". If not, your taxes for previous years are probably incorrect. :(
McDougal
Posts: 244
Joined: Tue Feb 27, 2018 3:42 pm

Re: Mistake with Backdoor Roth

Post by McDougal »

KaiserSleep wrote: Wed Nov 18, 2020 1:38 am My wife just told me this week that she remembered that she had a decades old IRA at TD Ameritrade that was opened by her parents. She had earned income from working in her father’s office as a teenager and contributed everything she earned over a few years to the IRA.
Wouldn't your wife have received any annual statements for this account over the decades? Was it untouched all this time? I am curious what happens to untouched IRA accounts. I always assumed there was some kind of disposition by the brokerage after a period of time. Have you confirmed with TD that it still exists?
Topic Author
KaiserSleep
Posts: 2
Joined: Wed Nov 18, 2020 1:25 am

Re: Mistake with Backdoor Roth

Post by KaiserSleep »

Thanks everyone for the helpful replies. My wife and I have the same employer and they will only accept a traditional IRA rollover if it was a conduit IRA so no luck there. I think we’ll just convert the traditional IRA to a Roth before the end of the calendar year and just deal with the taxes. This should make the backdoor Roth I just did OK and not subject to taxes, correct?
shess
Posts: 957
Joined: Wed May 17, 2017 12:02 am

Re: Mistake with Backdoor Roth

Post by shess »

KaiserSleep wrote: Wed Nov 18, 2020 1:38 am My understanding is that I needed to have a zero balance in any other IRAs prior to doing the backdoor Roth due to the IRS pro rate rule. Do I need to pay taxes on my wife’s Roth conversion to make the IRS happy? More importantly, what the best way to deal with backdoor Roth conversions moving forward? I was considering doing a Roth conversion on the old TD Ameritrade IRA account but am hesitant as we’re in a high tax bracket.
As phrased, it sounds like you've already done the Roth conversion part? In that case, you can either convert the ENTIRE traditional IRA to get to $0, or you're in pro-rata country. That just means that you'll pay taxes on about 5/6 of the conversion, and you'll leave most of the after-tax contribution in the IRA. You then want to make sure you keep good records so that you don't later pay taxes on that already-taxed money.

Going forward, you can either just stop doing backdoor Roth on your wife's account (your IRA accounts are distinct from your wife's, so your account is fine if the traditional IRA is at $0), or you can keep whittling away at it. If you decide to keep whittling away at it, I suggest you convert more than you contribute every year, to make sure that the earnings don't stay too far ahead.

Another option would to take the amount you would have otherwise contributed to the Roth, and instead use it to cover taxes on converting some of the IRA to Roth.
shess
Posts: 957
Joined: Wed May 17, 2017 12:02 am

Re: Mistake with Backdoor Roth

Post by shess »

KaiserSleep wrote: Wed Nov 18, 2020 6:25 pm Thanks everyone for the helpful replies. My wife and I have the same employer and they will only accept a traditional IRA rollover if it was a conduit IRA so no luck there. I think we’ll just convert the traditional IRA to a Roth before the end of the calendar year and just deal with the taxes. This should make the backdoor Roth I just did OK and not subject to taxes, correct?
Doesn't really matter whether you get to $0 this year, or next year, or the year after, assuming your tax rates stay the same. You apply the rules and track the basis which has already been taxed, so you don't lose out or anything if you take a couple years to manage it. Of course, getting it all done this year means that the problem is done and behind you.

A few decades ago, when the income limitations were in place, we thought we were going to have a low-income year, so early in the year we topped off with an after-tax contribution for last year and then were planning to do conversions during the year. Then I got a different job which put us back over the limits, so those after-tax contributions got stuck. Later my employer offered the ability to roll traditional IRA funds into the 401k, so I did that and moved forward with backdoor Roth for myself. Still later, I retired and now we've been doing some conversions every year in my wife's account. You just keep good records and it works out fine.
retiredjg
Posts: 43194
Joined: Thu Jan 10, 2008 12:56 pm

Re: Mistake with Backdoor Roth

Post by retiredjg »

KaiserSleep wrote: Wed Nov 18, 2020 6:25 pm Thanks everyone for the helpful replies. My wife and I have the same employer and they will only accept a traditional IRA rollover if it was a conduit IRA so no luck there. I think we’ll just convert the traditional IRA to a Roth before the end of the calendar year and just deal with the taxes. This should make the backdoor Roth I just did OK and not subject to taxes, correct?
Yes.
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