Rolling-in Trad IRA to workplace 401K/ Converting Trad IRA to ROTH to clean up 8606 reporting and Back Door ROTH contributions

Submitted by Mary Price on Tue, 2024-11-19 10:04

Hello,

I am new here and grateful for any guidance. Our accountant suggested we post our question here.

We currently have to keep track of the nondeductible/deductible/pro-rata basis each year because of co-mingled funds from a recharacterization 10 years ago. We would like to clean it up so we can do Back Door ROTH conversions and avoid the future pro-rata bookkeeping.

We already have ROTH IRA and Trad IRA accounts set up for Back Door ROTH Conversions to keep the transactions clean and trackable (away from our other retirement accts). These Trad IRA accounts are zeroed out each year once the funds are converted to the ROTH accounts.

Husband has Trad IRA he’d like to roll-in to a workplace 401K (Plan allows). Our accountant thinks this will do away with the 8606 and 5498 reporting requirement going forward so long as this Trad IRA balance is $0 at the end of the year. Is this correct?

I also have a Trad IRA (no employer plan to roll into) that I would like to convert to a ROTH. I understand there would be taxes owed at the time of conversion. We think this would also clear away my 8606 and 5498 reporting requirement going forward. Is this also correct?  Can I avoid the 10% early withdrawal penalty if I do this as an “in-institution” conversion and never get a check in hand?

We understand that we would (likely) be giving up the tax benefit of the non-deductible portions of our Trad IRAs, but are willing to do so to eliminate the 8606 and 5498 paperwork.

Are there any “gotchas” we are missing in doing this?

 

Thank you again for any insight the community can provide!

 



Submitted by Alan - IRA critic on Tue, 2024-11-19 14:52

Your accountant is correct that if husband’s entire pre tax IRA balance (all TIRAs if he has more than one) is rolled into his 401k, the remaining after tax balance (aka IRA basis) in the TIRA can be converted to his Roth IRA tax free. However, this will not end the annual filing of Form 8606, since the 8606 is used to both report new non deductible TIRA contributions in Part I plus the conversion in Parts I and II. Therefore, the 8606 will remain due to the back door process, but the pro rating of the pre tax balance will end, making those conversions non taxable. Therefore, the rollover to the 401k is a great strategy to enable the back door Roth strategy with no current taxes as long as the 401k does not have high fees that cancel out the annual tax savings.

A word of caution. Your husband should be very careful not to roll any ND contribution balance in his TIRA to the 401k since this is not allowed and is almost impossible to fix if it happens. And he would not want to do this anyway because he can convert the ND balance left in the TIRA tax free. Therefore, he needs to be very sure that his latest 8606 shows the correct amount of ND contributions on line 14, and that he adds recent ND contributions to that amount and does not include that amount in the 401k rollover.

Forms 5498 are issued by IRA custodians annually to report contributions (whether deductible or not). They are not filed with your tax returns but should be checked when received every May for accuracy and retained for several years. As such there will be a 5498 issued each May to report both new TIRA contributions to the TIRA and conversion contributions to the Roth IRA.

For your own IRA situation, you are correct that a total conversion will include your entire pre tax and IRA basis amounts and end future pro rating, but if your pre tax amount is large enough, it could increase taxable conversion income into the next higher bracket. So it depends on the size of your pre tax IRA balance. There is never a 10% penalty on converted amounts, just ordinary tax on the pre tax portion. If your pre tax IRA dollars are substantial, you could spread your conversions over 2 or more years after determining how long you should take to fully convert the pre tax amounts without spiking your annual taxes. You also will be continuing to make annual non deductible TIRA contributions which would be spousal contributions if you are not working, and these annual contributions will reduce the taxable % of any conversions you do. On the other hand, if you wanted to eliminate YOUR 8606 (not his), you could just discontinue all contributions and YOUR 8606 would be eliminated until you took distributions, but husbands would continue as he would still be making ND contributions and converting.

Finally, note that tax free conversions are a no brainer, but taxable conversions should generally not be done if the rate you will pay is expected to be higher than your estimated tax rate in retirement.

Nothing in this process results in giving up any benefit from non deductible contributions. In husband’s case, once he clears out his pre tax IRA balance to his 401k, he is in a position to make annual ND contributions and convert them tax free. If he was not going to continue after tax contributions to do back door Roths, there is no reason to roll the pre tax balance to the 401k. The sooner that ND contributions can be converted to a Roth IRA and generate gains in the Roth IRA rather than in the TIRA, the better. On the other hand, if Form 8606 were to be avoided at all costs, you would just not make new ND contributions or conversions. Form 8606 is not filed if there are no distributions or contributions, but that simplicity comes at the cost of tax benefits for the future.

 

 

 

Submitted by Mary Price on Wed, 2024-11-20 06:55

Thank you, Alan, for your very detailed response. I followed most of it, but would you please clarify the following:

I am confused about your comment: Your husband should be very careful not to roll any ND contribution              balance in his TIRA to the 401k since this is not allowed and is almost impossible to fix if it happens. This is the first time we’ve come across anyone saying we need to split up the proceeds from the account. If I understand correctly, for example:

2023 8606 shows:

$6K ND Contribution (from Back Door Roth Conversion)

Line 14 shows $9000K (the total TIRA basis for 2023 and earlier)

No additional contributions/conversions since then.

If total in the TIRA is $20K, then only $11K can be rolled-in to his 401K and the balance of $9K would be a direct ROTH conversion?

For my TIRA, your comment: You also will be continuing to make annual non deductible TIRA contributions which would be spousal contributions if you are not working, and these annual contributions will reduce the taxable % of any conversions you do. 

Could you please elaborate? I am not working outside the home. How do spousal contributions reduce the taxable % of conversions?

The reason we are looking to do this is to “reset” the basis and not have to keep track of it going forward. While I now understand that doing the Back Door ROTHs will still trigger the 8606s, this would (hopefully) make these  much cleaner transactions.

Thank you again for all of your help!

 

Submitted by Mary Price on Wed, 2024-11-20 07:33

One more question, please. If we do the roll-in and ROTH conversions this year, does this preclude us from doing a Back Door Roth contribution for 2024? We would wait until after Jan 1 to do this so that the TIRAs are zero on Dec 31st.

Submitted by Alan - IRA critic on Wed, 2024-11-20 20:09

With respect to the IRA to 401k rollover for your spouse, your example is generally correct. The 9000 of IRA basis cannot be rolled to the 401k and if a 2024 ND contribution of 7000 is made this year, that brings the total to 16000. The amount eligible to be rolled in is the total IRA value less that 16,000 or 9000 if no 2024 contribution is made. Since this rollover isolates the IRA basis and the pre tax amount is gone, the 16000 should be converted to a Roth IRA tax free. That’s the benefit of moving the pre tax amount out of the IRA to the 401k. Of course, he could also just take a tax free distribution of the 16000 if money was needed, but the vast majority convert it right after the 401k has accepted the pre tax rollover. Converting the basis prior to the rollover being completed is risky, because if the 401k does not accept the rollover for any reason, then the conversion will be partly taxable.

For your TIRA, a spousal contribution can be made using husband’s income, but because I am assuming your joint AGI is too high to deduct the contribution, your contribution would be non deductible and would increase the IRA basis in your IRA. But you have no employer plan to roll the pre tax amount to, so you might not make the contribution. If you planned to seek work with an employer in the future with a 401k/403b or 457 plan that would accept the pre tax portion of your IRA as a rollover, then you could convert tax free, and you could still make the current contribution to have IRA basis to be converted in the future. Meanwhile your IRA will be generating gains that are pre tax, but adding a new ND contribution each year will increase the portion that is IRA basis. Your latest 8606 would show what your most recent basis is – line 14.

With respect to the filing work, each spouse files an 8606 that relates only to their own IRA and you will note that an 8606 only has room for one SSN.

Your last question – Husband could make a 2024 ND contribution now or up to 4/15/2025, but the conversion should only be done after his plan accepts the rollover or pre tax dollars. It does not matter if his IRA holds a new 2024 contribution which is non deductible as long as there is no pre tax dollars in his IRA. Or he could wait until early next year (prior to 4/15) and make ND contributions for both 2024 and 2025 at the same time and convert them together, as long as the pre tax dollars are now in the 401k. If there is a small amount of gains in the IRA after the pre tax rollover to the 401k, he would convert the entire TIRA balance and the small amount of those gains would be taxable. His IRA would then be 0, but most custodians will not close the account for about a year due to a 0 balance.

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