IRA Rollover to Roth and Backdoor Roth Conversion in Same Year?
Thank you to all who participate and contribute to this forum! I have found it both helpful and informative.
Our dilemma: My spouse and I both rolled over employer 401(k) accounts into our traditional IRAs (TIRA) in 2020. In retrospect, we should have left the funds where they were, as we prefer to continue to contribute $7,000 “backdoor” to our Roth IRA (RIRA) accounts as long as it remains permissible (and advantageous).
We then learned having a TIRA balance affects the tax advantaged nature of a backdoor Roth conversion. As a remedy, we decided to bite the bullet and roll all of our TIRA funds into our RIRA accounts in 2021 and pay the taxes on the “ordinary income” to, in essence, clean up the books. So far, so good.
In addition, we also both made $7,000 after-tax contributions to our TIRAs in 2021 and converted them same day to our RIRA accounts – the typical backdoor transaction.
It’s not clear if this is permissible by tax code to do BOTH a backdoor Roth conversion AND a TIRA-to-RIRA rollover IN THE SAME YEAR. Our tax software (TurboTax) indicated at one iteration an excess Roth contribution for both of us of $7,000. In contrast, a financial adviser indicated there is no need to reverse the excess contribution!
We can’t be the only ones who have made similar “smart” moves with their money, so we are reaching out to this forum for a lifeline and helpful advice.
We realize we will be paying taxes on this year’s $7,000 RIRA contributions because of the adjusted basis. FYI – my spouse’s IRA rollover was ~$4,500 and mine was ~$18,000.
Thank you very much. I hope this is clear!
Permalink Submitted by Alan - IRA critic on Thu, 2022-04-21 02:25
You will be reporting a total conversion of 25,000, of which 18,000 is taxable. Spouse will be reporting a total conversion of 11,500 of which 4.500 was taxable. You must have not have entered data correctly into the tax program, because you never made a Roth contribution, you made non deductible TIRA Contributions and then converted them. There is no excess contribution as long as you have the earned income to make a contribution from. Again, if the program is flagging an excess contribution, you entered your contribution incorrectly as a Roth contribution, so you should back it out and start over.
Again, instead of having done a tax free conversion of 7000 and a taxable conversion of 18,000, your tax program combines them on Form 8606 as a single conversion of 25,000, of which 18,000 is taxable.
You could have just made the TIRA contribution of 7000 and converted it, in which case you would be spreading the taxable income over several years. Form 8606 would have calculated that your 7000 conversion was 72% taxable, 28% non taxable (7/25), so you accelerated your taxes all into 2021 instead of spreading it out over several years.
This is less dramatic with your spouse since taxation of 4,500 is much smaller. However, there was proposed legislation that may never advance that would have made it impossible to convert non deductible contributions, but your conversions moved your 7000 of non deductible contributions into your Roth and even though you may not be able to do this in the future if this legislation passes, having converted your entire TIRA balances gets your 7000 each into your Roth before Congress can shut this down, even though it creates a larger tax bill for 2021 due to converting the entire balance. At the end of the day, at least you did not convert a couple hundred thousand of pre tax TIRA money that could have seriously spiked your marginal tax rate for 2021.
Permalink Submitted by Steven Ehmann on Thu, 2022-04-21 17:44
Thank you so much, Alan, for your considerate and lengthy response! I plan to work on this over the next few weeks (my filing extension request has been approved) and may have to come back for additional advice and clarifications.Thanks again! Great forum. Let me know how I might pay it back or pay it forward!