Existing Roth IRA Balances & the Pro Rata Rule

Submitted by Steven Walker on Thu, 2016-01-28 21:58

I have a client who is considering the Back Door Roth IRA strategy now that his income for 2015 eliminate he and his spouse from making a Roth contribution. We have discussed the Back Door ROTH strategy, and he understands the concept of the Pro Rata Rule. He and his spouse have not made any after-tax contributions to any of their Traditional IRAs or SIMPLE IRAs. These existing account balances are substantial and will dwarf the $5,500 after-tax contribution each would make to their Traditional IRA. I have advised him that because these accounts hold only pretax contributions nearly all of it will be taxable upon the ROTH conversion. However, the client disagrees, and firmly believes that their existing holdings in their ROTH IRA accounts should be considered as “after-tax IRA contributions” for the purpose of the Pro Rata tax calculation (thereby reducing the tax on the converted amounts.). I have advised the client to consult his CPA and have her run a hypothetical 2015 Form 8606 with the proposed Back Door Roth data to get his answer. But I am frustrated personally, because I can find no resource, citation or IRS publication that specifically states that existing ROTH IRA account balances may not be counted as “after-tax IRA contributions” for the purpose of calculating the Pro Rata tax. Any suggestions to win this “argument?” Thank you.

Flag as spam

Permalink Submitted by Alan - IRA critic on Thu, 2016-01-28 22:38

I have never seen his position supported. I assume he has an on going SIMPLE IRA OR has no current employer plan in which to roll the pre tax IRA balances of each spouse. That said, his spouse may be positioned to do a valid back door even if he is not, since the 8606 is separate for each spouse.
As for his position, I take it he wants to include his Roth IRA balance to beef up his basis %. Of course, with his pre tax balances in non Roth IRAs, he would still be paying taxes on conversions. Any tax program is going to use an 8606 to report his basis and conversions, and for each section of the 8606 the IRA types appllcable are clearly are “Traditional, SEP, and SIMPLE IRA”. The form states that contributions must be made to a traditional IRA, and the total IRA balances line 6 also refer strictly to just traditional, SEP and SIMPLE IRA balances.
If he wants to pursue the tax code approach for this position instead of the forms instructions, he should note that under Roth IRA in the code it states that 408(d)(2) and therefore Sec 72 applies separately to these IRA types.