Mistake with backdoor Roth conversion?

Submitted by Ed Markowski on Mon, 2017-03-20 13:41

In my quest to consolidate all my former employer 401(k)’s, I think I made a mistake. I’d like to provide the following facts to see if (1) I made a mistake and (2) if I did make a mistake, can I correct it now. The facts and timing are as follows:

May 2016
I had no other IRA’s (Traditional or Roth)
Opened Traditional IRA and deposited $5,500
Converted the $5,500 to a Roth IRA a few days later

July 2016
I rolled over money from an old employer’s Roth 401(k) into a Roth IRA in July 2016. This Roth IRA is the same as noted in May 2016. Info on 1099-R is as follows:
BOX 1 – Gross Distribution: $#####; BOX 2a – Taxable Amount: $0.00; BOX 2b – Total Distribution box checked; BOX 5 – Employee contrib/desig Roth contrib or ins prem: $#####.14; BOX 7 – H (Direct rollover of a designate Roth account distribution to a Roth IRA); BOX 11 – 1ST year of desig. Roth: 2013

July 2016
I also rolled over money from two old employers’ Traditional 401(k)’s into a Traditional IRA in July 2016.
Info on the two 1099-R’s for these rollovers is as follows:
BOX 1 – Gross Distribution: $##### & $#####; BOX 2a – Taxable Amount: $0.00 & $0.00; BOX 2b – Total Distribution box checked; BOX 7 – G & G(Direct rollover of a distribution to a qualified plan)

March 2017
When doing my taxes in TurboTax, it asks for “The value of my Traditional, SEP, and SIMPLE IRAs on December 31, 2016”. The amount is $#####.

If I had left my previous employers 401(k) balances with the respective administrators, I would have reported $0 to this question. When modeling things out in TurboTax, it appears that my tax would also be $1,128 lower.

I feel like I made a mistake by rolling over the 401(k) balances in the same year that opened the IRA and then did the backdoor conversion.

Based on these facts, is there anything I can do now to correct or undo the backdoor Roth conversion?



Submitted by Alan - IRA critic on Mon, 2017-03-20 16:05

  • Yes, the pre tax rollover to your IRA has caused your conversion to be mostly all taxable and Form 8606 would show the math. You probably ended up with just a little less than 5500 being taxable. Not only that, but this effect will continue into the future for any back door Roths you plan. While you should be looking at this long term, and also factor in the gains that have occurred on your Roth conversion, if you want to reverse the tax bill, you can recharacterize the full conversion back to your TIRA before the deadline of 10/15/2017.
  • Further, you can also reverse the situation if you current employer plan will accept IRA rollovers. The plan can only accept the pre tax balance of your TIRA (after you recharacterize the conversion if you do)  What will then be left in your TIRA is 5500 of IRA basis assuming you are filing an 8606 to report a 2016 non deductible contribution. This 5500 can then be reconverted back to Roth tax free in 2017. Keep in mind that if you have a high expense plan with limited options it may not be worth it to roll your TIRA into that plan, but if you do go ahead with that rollover, the coast will be clear to continue doing the back door Roths into the future.
  • Your Roth 401k rollover is fine and can remain as is in the Roth IRA. That does not affect the tax bill you have or future back door Roth conversions. But you should update your accounting for the basis in your Roth IRA. The box 5 amount in the H coded 1099R is treated as regular Roth IRA contributions in your Roth IRA, just as if you made regular Roth IRA contributions of that amount in the past. That increases the amount you can withdraw anytime tax and penalty free before your Roth IRA is qualified.
  • Before you bother to recharacterize a profitable conversion due to gains, you might check to see if you think the tax rate you are paying for the conversion {1289/5500+gains} is higher than your expected marginal rate in retirement. If not higher, they you may want to keep the conversion and pay the tax bill, but still consider rolling your pre tax TIRA value into your current plan so you can future back door Roths tax free. Always think long term in making these decisions  (had your conversion lost 20%, then recharacterization would be a better option than recharacterizing gains).

Submitted by Ed Markowski on Wed, 2017-03-22 20:08

Thanks for your answer to my question. I will be filing an extension (and paying taxes) so I can recharacterize the full conversion back to my TIRA. Since I am now self employed, I will not be able to do what you suggest in bullet #2, but as business picks, I plan to open a Solo 401(k) to address retirement savings. Could you elaborate more on your comment in bullet #3 (i.e., update accounting basis)? 

Submitted by Byron Jagg on Sun, 2020-02-02 04:47

  • @Alan — You seem very knowledgeable in this area and I havent been able to find any solid answers reading around online and prefer not to have to go to a tax advisor for this little thing.  I have read this thread but still wanted to make sure that I was doing this correctly.  I realize that recharacterization of conversions is no longer allowed as of 2018.

 

  • I made a mistake and missed the point about the pro rata rule in regards to backdoor roth. In 2019 I contributed 6k (non-deductible) to IRA then converted that 6k to Roth soon after. I have 12k in another traditional IRA account…eeek. Based on the pro rata rule, the split will be approx 4k taxable and 2k (basis) non taxable. 

  

  • I will pay the taxes for 4k this year…no choice.

 Now I need to fix it by rolling it over into my Employee 401k. The dilemma here is I don’t want to rollover my IRA basis (non deductible) money into the 401k, I want to convert that to a Roth.  I don’t even think I’m allowed to rollover the basis into the 401k.  Okay so I want to make sure I do it right now. Would the steps below work to satisfy the IRS?  

  1. Rollover 8k of 12k to my employer 401k, leaving the 4k (basis) on which I already paid taxes in the IRA.
  2. Convert the 4k to Roth right away, this should not be a taxable event since I already paid taxes on this money right?
  3. Move forward with backdoor Roth as usual with no tax consequences moving forward?
  4. What forms should I expect to fill out on for my 2019 taxes to to record this rollover and conversion?  I assume 1099-R for both the rollover and conversion or is there something else?

Submitted by Alan - IRA critic on Sun, 2020-02-02 15:39

Yes, you are on target here. Re Q 4 – You will get a G coded 1099R to report the IRA to 401k rollover and a separate 1099R to report the conversion. The G coded one is reported directly on lines 4a and 4b of Form 1040 with “rollover” entered next to 4b. The conversion will be reported on Form 8606 and then transferred from the 8606 to lines 4a and 4b as well. 4b will be 0 (no taxable amount). If you make a 2020 non deductible TIRA contribution, that also goes on the same Form 8606, Part 1. If you have the funds, you can make your 6000 2020 ND contribution, and convert that 6000 plus the 4000 in a single conversion. If you need to wait for the 2020 contribution, you can contribute later and do a second conversion of that 6000 this year and report the total of the 2 non taxable conversions on your 2020 8606.

Submitted by Alan - IRA critic on Wed, 2017-03-22 21:19

Bullet 3 just refers to keeping track of your Roth IRA basis so you will know in advance the tax treatment of any non qualified Roth IRA distribution you might take. This basis must be reported on lines 22 (regular contributions) or 24 (conversions) on Form 8606 when you take such a distribution. When the Roth 401k is rolled into a Roth IRA, your regular contribution basis (line 22) is increased by the amount in Box 5 of the 1099R that reports the rollover. Once your Roth is qualified (5 years and age 59.5) you no longer need this breakdown. Some people keep track of basis on a sheet of paper, others apply a spreadsheet. Then, if you took a distribution that was less than your regular contributions total, it would be tax free but still reported on Form 8606. Your remaining regular contribution basis would then be reduced by the contribution that you reported. Most people end up not taking any non qualified Roth distributions and therefore do not need a breakdown, but others get into a position where they have to take a distribution without knowing the basis amounts at the time and end up with a research project to even be able to report the distribution properly.

Submitted by Mark Opp on Thu, 2017-03-23 14:01

 I currently have a balance in a SEP IRA and I am currently contributing to a Simple IRA. I would like to make a non-deductible IRA contribution and convert it to a Roth IRA. Where would I be able find information on the pro-rata basis rule. My accountant seems to think I do not need to worry about this and my Financial Advisor is telling me I do. Thanks. 

Submitted by Alan - IRA critic on Thu, 2017-03-23 16:26

Accountant is incorrect. You only need to look at Form 8606 (link below) and note that line 6 asks for the year end value of all your SEP, SIMPLE and TIRA accounts and then uses that total to determine a non taxable % of all distributions and conversions done that year. In other words, all these accounts are treated as one combined account for purposes of determining the non taxable amount. It does not matter which account funds the conversion or received the non deductible contribution. Because of these other IRA accounts, your conversion will have a very small non taxable portion. By your question I assume your income is too high to make a direct Roth IRA contribution.   https://www.irs.gov/pub/irs-pdf/f8606.pdf

Submitted by Justin Bloom on Mon, 2023-03-20 02:28

I was able to execute a successful back door conversion with my traditional IRA so I thought I’d do the same with my wife’s this year. The problem is she has a TIRA with money rolled over from a previous brokerage and a current simple IRA though her current employer. I already contributed to and converted $6,000 to her Roth IRA for 2022 (in 2023). I’ve come to the conclusion that I’ll just have pay the pro-rata tax on that next year. In my infinite wisdom, I started this same process for 2023. I made the $6500 contribution into her existing TIRA.  Because I was just made aware of the pro-rata rule, I did not convert it.  This contribution is just sitting in a money market fund in her TIRA. This is now the only non-deductible money in this IRA.  What are my options here and which one would you recommend? Do I just keep track of the basis in this account in perpetuity? Can I roll it into her simple IRA since that’s not maxed out and then deduct it somehow? I should’ve prefaced all of this with the fact that our combined income level is over the max to have deductible contributions to an IRA. Thank you for taking my question. 

Submitted by Alan - IRA critic on Mon, 2023-03-20 15:54

  • If you do the second conversion, both conversions will be taxed using 12,500 of basis as a fraction of the total year end balance of both her IRAs plus the 12,500 converted. If you do not do the second conversion, leaving the 6500 ND contribution in place will result in the first conversion’s non taxable portion roughly doubling.
  • You might assess the chances of your wife leaving the SIMPLE employer for an employer with a 401k that accepts IRA rollovers. She could then roll the SIMPLE (after two years has passed from her first SIMPLE contribution) and the rollover IRA into the 401k plan, being careful to leave the 12,500 of IRA behind. If this occurs before year end, conversions of 12,500 will be tax free. If this happens in a later year, any basis still in the IRA could be converted tax free in that year. 
  • Of if none of the above is acceptable she could just request a return of the 2023 contribution adjusted for gain or loss, and invest the amount returned in a taxable account. I assume that your joint income is too high for either a deductible contribution or a regular Roth contribution. If for some reason it won’t be this year, she could have the 6500 TIRA contribution recharacterized as a Roth conversion. 
  • If some of the above developments are not clear this early in the year, you could wait until later in the year and then consider what options would work best.

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