Coordination of Simple IRA and Backdoor Roth

Submitted by IRAQuestion5 on Wed, 2018-10-17 22:08

Client and client’s spouse have Simple IRAs. First initial contribution was 11/13/17. They have subsequently left their employer where they were contributing to the Simple IRAs.

For student loan purposes they are filing as Married Filing Separately and due to income cannot make deductible contribution to IRAs or Roth IRA contributions. My understanding is they can still do nondeductible contributions.

Can they subsequently convert those nondeductible contributions to a Roth IRA even though they currently have Simple IRAs that are still within the 2yr window? I know that it is prorata across Simple IRA and IRA (pretax and after tax) but am wondering if it can be done at all since the Simple IRA is still within the 2 years.

If it can be done, in two years when they convert the Simple will they only pay tax on a partial balance? For example, assume the Simple IRA has $5,000 and they make a nondeductible contribution to an IRA of $5,000 and then convert to a Roth. They would owe tax on $2,500 of income today because 50% of IRAs are pretax. When they convert the Simple IRA after the two year period, will they only owe $2,500 on the conversion? Assuming no investment increase or decrease.



Submitted by Alan - IRA critic on Thu, 2018-10-18 00:18

  • The SIMPLE IRA 2 year waiting period does not affect the value that must be shown on line 6 of Form 8606. This waiting period only means that SIMPLE IRA distributions cannot be rolled over and will incur a 25% early withdrawal penalty instead of 10%. This is true even if they are no longer employees of the firm sponsoring the SIMPLE IRA.  If such an early distribution was taken, the taxable amount would be figured on Form 8606 in the same manner as the back door Roth conversion. Once the 2 years is completed nothing will change except that the SIMPLE will be portable to another type plan and will only incur a 10% penalty instead of 25% if there was a distribution. 
  • Therefore, the back door Roth conversions will be taxed the same before or after the SIMPLE 2 year waiting period.  The conversions will be mostly taxable, and the only way to avoid that taxable income would be to wait until the 2 year period is met, and if they have a new employer with a non IRA Retirement plan (eg 401k) that accepts IRA rollovers, they could roll the SIMPLE balance into that plan. This would eliminate pre tax TIRA amounts and make the back door Roth conversions tax free.

Submitted by IRAQuestion5 on Thu, 2018-11-08 17:02

So just to confirm I am understanding correctly. Doing the Backdoor Roth while within the 2yr window of the Simple IRA, does not incur the Simple IRA distribution penalty since we are just changing the tax makeup of the account and not actually moving any money from the account by doing the Backdoor Roth.

Submitted by Alan - IRA critic on Thu, 2018-11-08 18:18

  • That is correct.  On 11/14/2019, the 2 year waiting period for the SIMPLE IRA will be over, and the SIMPLE balance can be tranferred to a non IRA employer plan if a spouse is then participating in an employer plan that will accept the IRA rollover. Meanwhile, each spouse can make a 2018 ND contribution and a 2019 ND contribution come 2019. Then the two ND contributions can be converted with the only taxable amount being the earnings on the ND contributions by the conversion date.
  • Or if the above is not workable, then come 11/14/2019 the ND contributions along with the SIMPLE IRA balances can be converted. The taxable amount will be the SIMPLE IRA balances plus any gains on the prior ND contributions.  Roughly, 1/3 of the converted total would be taxed.

Submitted by IRAQuestion5 on Tue, 2018-11-13 01:44

They do not have to wait until 2019 to do the conversion of the ND contribution correct? They can make a 2018 contribution and then conversion in 2018 (part of which is taxable due to the SIMPLE). And in 2019 do another ND contribution and conversion. Then after 11/14/19 convert the SIMPLE to the Roth (part of which won’t be taxable due to prior Backdoor Roth).Thank you for your help! This discussion forum is very very helpful!

Submitted by Alan - IRA critic on Tue, 2018-11-13 01:59

You are correct about the 2018 conversion since the entire balance of the SIMPLE will evidently be converted as well in very late 2019.  However, if the rollover of the SIMPLE (plus any gains on the IRA contributions) to the spouse’s non IRA plan was on the table in very late 2019, then conversions of ND contributions done in 2019 will be tax free. And if that were the case, the 2018 taxable conversion could be made tax free if it also was postponed until at least January, 2019. 

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