Backdoor Roth IRAs and Missed RMDs: Today’s Slott Report Mailbag

By Andy Ives, CFP®, AIF®
IRA Analyst
Follow Us on Twitter: @theslottreport

Question:

I read of a way to move money from an IRA to a Roth without incurring any taxes. You set up an IRA account and make a non-deductible contribution of $6,000, then you convert it into a Roth.   Is this legal and possible?

Thanks!

Answer:

This strategy is called a “Backdoor Roth IRA.” Roth IRA accounts have income limits. Not everyone can contribute. However, when a person makes too much money to contribute directly to a Roth IRA, he can use the “backdoor.” Yes, a non-deductible (after-tax) contribution can be made to a traditional IRA, and then those dollars can be immediately converted to a Roth. Since these are after-tax dollars that are converted, there is no tax due on the conversion (assuming no earnings on the after-tax dollars). But be careful! You cannot “cherry pick” the after-tax dollars in your IRA and only convert those. If you have any pre-tax (deductible) dollars in any IRA, SEP or SIMPLE plan, those dollars must be considered under the pro-rata rule. Pro-rata dictates that any conversion will include a proportionate share of pre- and after-tax dollars. The only way a Roth conversion can be 100% tax-free is if you have no pre-tax dollars in any of your IRAs, SEP or SIMPLE plans.

Question:

Hi there. I am a CPA and have been a fan of yours for many years. Our firm has a client who missed multiple years of required minimum distributions (RMDs) and will file a Form 5329 for each year and request a penalty waiver. For purposes of each subsequent years’ calculated RMD, is it possible to reduce the IRA account balance for the prior year’s missed RMD or not?  I have looked extensively and cannot find that is permissible, and a literal reading of the instructions seems to say ‘no’ because the RMD would be based on the actual 12/31 balance. We have not faced this situation before and only ask because it seems like this results in a compounding of the 50% penalty from year to year on the same dollars.

Thanks for any insight you may have.

David

Answer:

David,

While the RMD was missed, it was still part of the account and must still be included in the 12/31 balance for the next years’ RMD. You cannot go back and retroactively reduce the year-end balance by the missed RMD amount. The fact that the untaken RMD remained in the account and must be included in the subsequent year’s 12/31 balance will result in higher subsequent RMDs. The larger the RMD, the larger the penalty for not taking it. You are correct that multiple years of missed RMDs will compound the problem. At least you are on the right track by filing Form 5329 and requesting a penalty waiver.