Timing issues for back door ROTH conversion
It may be easiest to provide the fact pattern:
3/14/22: taxpayer opens and makes prior year non-deductible IRA contribution $5,500 (this is his only traditional IRA holding).
3/14/22: taxpayer converts the $5,500 to a ROTH IRA.
3/21/22: taxpayer rolls over his 401K of $30,000 into this IRA.
4/13/22: taxpayer makes an additional prior year non-deductible IRA contribution of $500.
4/13/22: taxpayer converts the $500 to a ROTH IRA.
Question:
Is the $5,500 ROTH Conversion 100% tax-free because the basis at the time of conversion was $5,500, or does the $5,500 get tainted because of the 401k rollover in the same year? I am struggling with the FMV in the IRA at the end of the year being $30,000, but that FMV amount was not a part of the account at the time of the $5,500 conversion.
I understand that the $500 conversion will have to be pro rated by the 401K funds that were rolled over.
Permalink Submitted by Alan - IRA critic on Fri, 2023-11-17 19:20
Both the conversions are treated the same. If the 2022 year end balance of all owned non Roth IRAs was 30,000, the conversion math done on Form 8606 will result in 30/36 (.833) of the conversion total being taxable and 6/36 being non taxable. Only 1,000 of the IRA basis is therefore applied to the conversions, leaving 5000 of IRA basis remaining in the IRA. This pattern will repeat each year with the taxable portion gradually diminishing until the entire IRA has been converted. The taxpayer could have avoided this situation by leaving the funds in the 401k as long as back door Roth conversions were being done. Or to prevent future pro rating, the pre tax balance of the IRA (currently the total value less 5000 of basis) might be rolled into any current employer plan that accepts IRA rollovers.