Bad Case for Pro Rata rule
Hello-
I have a 49 year old person who I just took over as a client and he has $200k in his SIMPLE IRA, $75k in an IRA parked in an annuity and a $14k annuity housed in a ROTH IRA-which is separate deal here. His AGI was $221,785 so he makes too much to contribute to a ROTH directly. He wants to contribute his $6,000 to a non deductible IRA and then convert to a ROTH to start building up some ‘tax free money for retirement.’- a back door ROTH
Under my understanding of the pro rata rule, I told that only 2% (6000/275,000= 2%) would be tax free on the covnersion and the rest taxable. I also tried to explain to him that any future (after 59 1/2) withdrawals from the ROTH would only have a portion of it tax free. (assuming he puts in $7k a year hereafter, so $76k in contributions). I said that doing this might not be in his best interest, (also assuming he continues to max out his SIMPLE and that continues to grow as well).
Was I wrong in thinking the pro rata rule would bite him in the hiney or is a back door ROTH IRA a good strategy for him going forward.
Thanks.
Permalink Submitted by Alan - IRA critic on Tue, 2022-08-30 18:35
Due to back door conversion being close to 100% taxable, the back door Roth is only a good idea if client would also benefit from a taxable conversion, and a taxable conversion would only benefit client if it could be done at a lower marginal rate than what client expects in retirement. Perhaps at some point client will have a non IRA workplace plan such as a 401k and could roll the pre tax IRA dollars into that plan. Once that is accomplished, the back door conversions would be non taxable.
Permalink Submitted by David Mertz on Wed, 2022-08-31 01:45
If the 49-year-old client establishes a Roth IRA now, any distribution made after age 59½ will be tax free because the 5-year clock for distributions to be qualified distributions will have been satified by then.