Higher Education and Backdoor Roth Conversions: Today’s Slott Report Mailbag

Thursday, March 14, 2024

By Sarah Brenner, JD
Director of Retirement Education
Follow Us on X: @theslottreport


Question:

I have a client who is under age 59 ½ with a small traditional IRA. She wants to cash it in and use the funds for college education for her daughter. If I remember correctly, they can use this without a 10% penalty. Is there a limit on the amount she can take penalty-free to use for college?


Answer:

There is no limit to the amount of funds that can be taken penalty-free to pay for higher education costs. The funds can be used for tuition, room and board and other expenses that are required by the school. Keep in mind that although the 10% penalty would not apply to any pretax funds coming out of the IRA, these distributions would still be taxable.


Question:

I am interested in doing the backdoor Roth strategy. I do not have an IRA, but I do have an old SIMPLE IRA from a previous employer. Does the pro-rata rule apply here?

Thanks,

Marcel


Answer:


Hi Marcel,

Whenever the backdoor Roth IRA conversion strategy is being considered, it is good to think about the possible impact of the pro-rata formula. This formula requires you to consider all of your other traditional IRAs when determining the taxation of the conversion.

For this purpose, SIMPLE IRAs are also included (as are SEP IRAs), so when you apply this formula you must also include your old SIMPLE IRA along with any traditional IRAs you might have. This means that, even if you use the backdoor Roth IRA conversion strategy by making a nondeductible traditional IRA contribution and then converting it — a portion of the conversion will still be taxable. That does not mean that doing a backdoor Roth IRA conversion is a bad strategy, but it does mean that you should expect a tax bill.

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