Withdrawing from non-deductible IRA

Submitted by Travis Tsukayama on Tue, 2022-09-27 02:52

Working with a client who made a non-deductible contribution in 2016 to a traditional IRA. Their intention was to execute a backdoor Roth conversion, but after making the contribution they ultimately decided to not go through with it due to the pro-rata rule. As of today, the client has most of their assets in Simple IRA and Rollover IRAs, but still has a relatively small balance in the non-deductible IRA.

My question is regarding the mechanics of withdrawing the balance from the traditional IRA, which has been left in cash since 2016. If we simply take a withdrawal of the IRA balance, I understand we will run into the pro-rata rule and take a tax hit on the majority of the withdrawal. The client is under age 59 1/2, so I believe an early withdrawal penalty also applies to the taxable portion of the withdrawal. Is this correct?

Another option is to go through with the backdoor conversion, paying income taxes on the majority of the conversion amount. No early withdrawal penalties apply in this case?

Client is self-employed and has the Simple IRA set up for their business. I’ve thought about establishing a 401k to accept IRA rollovers into the plan, but probably will not be the first option in this case.

Given the above assumptions are true, it seems to make more sense to go ahead with the backdoor conversion to avoid the early withdrawal penalty, rather than a withdrawal of funds. Possibly converting a portion of the traditional IRA each year over a few years. Any insight would be much appreciated.



Submitted by Alan - IRA critic on Tue, 2022-09-27 14:40

  • The 10% penalty only applies to the taxable portion of a distribution, but not to any portion converted to Roth.
  • Given the situation, if client does not wish to establish a 401k to replace the SIMPLE IRA as of Jan 1 of a future year, there is no rush to take distributions from existing plans due to the pro rata rule. because all such distributions will include just a small portion of IRA basis. At the end of any year, client would end up with just a slightly smaller amount of IRA basis. Of course, if client’s marginal tax rate in some year was lower than client expected it to be in retirement, a conversion including pre tax amounts would be warranted. Otherwise, it would not make sense to pay taxes on conversions at a higher rate than expected in retirement just to move a few dollars of IRA basis into the Roth tax free. 
  • Establishing a 401k plan is the only way to efficiently remove the basis by rolling the pre tax balance of all IRAs into the 401k and then converting the remaining basis tax free.

Add new comment

Log in or register to post comments