Can a partial Backdoor ROTH IRA be completely tax free?
Need Help! Long term T-IRA owner of an after-tax non-deductible T-IRA (IRS form 8606) since ‘97. Over the years, contributed the max just missing a few years. Account has grown substantially more than tripling. Q: Can I perform a Backdoor Roth IRA conversion of just my initial after-tax investment say $100K and leaving the remaining $200K of performance gains in the T-IRA? I have no other IRAs but looking for a smart strategy to convert T-IRA to ROTH without getting killed in taxes since tax cuts could be expiring in 2025.
Permalink Submitted by PaulC on Fri, 2024-03-15 16:22
It’s not possible to do a selective Roth conversion of only the amount of your after-tax TIRA contributions. The “pro-rata rule” comes into play to spoil such a strategy. Doing a Roth conversion of any amount will subject the conversion amount to the pro-rata rule, whereby each conversion amount will consist partially of non-taxable contribution “basis”, as has been tracked over the years on the form 8606, and also a taxable portion consisting of the gains and pre-tax contributions. The form 8606 for the year of conversion would show those calculations to determine the portion that’s taxable income and also continue to track the adjusted basis going forward.
Such a transaction wouldn’t be labelled as a backdoor Roth, since it’s not a conversion of a current contribution. It’s just a regular Roth conversion that’s only partially taxable, but that doesn’t change the application of the rules.
It’s also not possible to split one IRA into two IRAs where one has the after-tax contributions and the other account holds the gains. The pro-rata rule looks at all TIRA balances (other than inherited IRAs), not the just the balance of the account that the conversion is being made from.
If an TIRA owner has access to an employer plan, such as a 401(k), there could be the possibility of rolling the pre-tax balance (contributions and earnings) into the 401(k) while leaving the contribution basis in the TIRA. That transaction is NOT subject to the pro-rata rule. Following such a rollover, the IRA would consist exclusively of contribution basis and then could be converted tax-free into a Roth IRA. Executing that strategy requires the availability of a plan that accepts such rollovers. Plans are not required to have that provision, even though it’s permissible under the law.
Your best available strategy may be to do discretionary Roth conversions spread over several years while maintaining a certain level of tax impact while keeping in mind the future tax impact of required distributions (RMDs) you’ll have once you reach that age. Of course, future tax rates are never a certainty, so any such planning is based on assumptions that may deviate from the reality.