Backdoor conversion mistake

[NoClueMD]

I've been hearing about the backdoor Roth IRA conversion strategy for years and finally decided to do it this year, but I think I've made a mistake and was wondering if anyone might have an idea about how to fix it.  I went into my traditional IRA account today to request a distribution that I could deposit the entirety into my 401k account so I could make a new contribution to the IRA and then convert it to Roth.  However, I saw that I had already made a $5500 deposit into the traditional IRA and then subsequent conversion of that amount into my Roth earlier this year, before I understood the pro-rata rule.  So now I still have $14k in my account.  Am I screwed for this year in terms of having to pay taxes on some of that distribution?

Should I just distribute that $14k into my 401k now, so that I can contribute $5500 next year and roll it over at that point?

Thanks for helping!

 

[spiritrider]

The proper way to have done a backdoor Roth would have been to move all pre-tax (traditional, SEP and SIMPLE) IRA assets to your 401k (assuming it accepts them) by direct rollover. If you just took a distribution from your IRA, you have 60-days to rollover the distribution to your 401k and not have it treated as a distribution subject to ordinary income taxes and a 10% penalty.

From your description, I have the following assumption. You made a $5,500 traditional IRA contribution for the 2017 tax year and converted $5,500 to a Roth IRA during this tax year. You "distributed" $5,500 in pre-tax assets from the traditional IRA to rollover to the 401k. You have $14K in additional pre-tax assets remaining in the traditional IRA. Is this all precisely true? If not correct.

If this is true, you are still in a position to correct this. You will want to move the $14K to the 401k. It is generally easier to do this by direct rollover. Note: When I am saying $14K, I am referring to 100% of the remaining pre-tax balance.

If you do this correctly. You will have no pre-tax IRA balances on 12/31/2017, there will be nothing to prorate and only the Roth conversion will be taxable. If you do not rollover any remaining pre-tax balances, you will have to prorate the conversion.

P.S. I edited this response, because initially was thinking about the one rollover per one year period rule. However, "D'oh", this rule only applies to IRA => IRA indirect rollovers, never when a qualified plan is on one end.

[The White Coat Investor]

NoClueMD wrote:

I’ve been hearing about the backdoor Roth IRA conversion strategy for years and finally decided to do it this year, but I think I’ve made a mistake and was wondering if anyone might have an idea about how to fix it.  I went into my traditional IRA account today to request a distribution that I could deposit the entirety into my 401k account so I could make a new contribution to the IRA and then convert it to Roth.  However, I saw that I had already made a $5500 deposit into the traditional IRA and then subsequent conversion of that amount into my Roth earlier this year, before I understood the pro-rata rule.  So now I still have $14k in my account.  Am I screwed for this year in terms of having to pay taxes on some of that distribution?

Should I just distribute that $14k into my 401k now, so that I can contribute $5500 next year and roll it over at that point?

Thanks for helping!

 

Click to expand...

I keep running into people that want to do a Backdoor Roth IRA and then do something (like what you did or something similar but also a mistake) and THEN read up on it. Give me some tips here. What could I have told you a year ago that would have kept you from doing this?

At any rate, the easiest fix at this point is just convert the whole $14K IRA to a Roth IRA. It'll cost you some taxes but it'll be much cleaner. The issue right now is that a pro-rated part of what you converted to Roth was previously after-tax and now a pro-rated part of what you didn't convert to Roth is after-tax and probably can't go into your 401(k). You might be able to just roll in the pre-tax portion to the 401(k) and isolate the basis to then convert to a Roth, but not sure it's worth it for a total IRA of just $14K. I might worry more about it for a $140K IRA. But I'd just convert the whole thing, pay the taxes, and move on.

[The White Coat Investor]

spiritrider wrote:

The proper way to have done a backdoor Roth would have been to move all pre-tax (traditional, SEP and SIMPLE) IRA assets to your 401k (assuming it accepts them) by direct rollover. If you just took a distribution from your IRA, you have 60-days to rollover the distribution to your 401k and not have it treated as a distribution subject to ordinary income taxes and a 10% penalty.

From your description, I have the following assumption. You made a $5,500 traditional IRA contribution for the 2017 tax year and converted $5,500 to a Roth IRA during this tax year. You “distributed” $5,500 in pre-tax assets from the traditional IRA to rollover to the 401k. You have $14K in additional pre-tax assets remaining in the traditional IRA. Is this all precisely true? If not correct.

If this is true, you are still in a position to correct this. You will want to move the $14K to the 401k. It is generally easier to do this by direct rollover. Note: When I am saying $14K, I am referring to 100% of the remaining pre-tax balance.

If you do this correctly. You will have no pre-tax IRA balances on 12/31/2017, there will be nothing to prorate and only the Roth conversion will be taxable. If you do not rollover any remaining pre-tax balances, you will have to prorate the conversion.

P.S. I edited this response, because initially was thinking about the one rollover per one year period rule. However, “D’oh”, this rule only applies to IRA => IRA indirect rollovers, never when a qualified plan is on one end.

Click to expand...

I don't think you're giving good advice here. I think he's saying he had a pre-tax IRA of $8500. Then he added $5,500 of after-tax money. Then he took $5,500 of the pro-rated IRA and put it in a Roth IRA. It's like cream in the coffee. Once you put it in you can't get just the cream back out.

[NoClueMD]

Here is the sequence of events.  I had some money from previous years in a traditional IRA.  I must not have done my research, because I did not empty it into a 401k before I contributed $5500 additional to it in March 2017.  In April 2017, I converted $5500 to a Roth IRA, leaving a balance of $14k in the traditional IRA.  I have not taken any of it out to put into a 401k yet, but have requested the form.

So, I realize this was not the right way to do it.  I hadn't joined the forum at the time.  You're right, it's relatively small change, so tax impacts won't be huge, but what would be the best way to deal with the situation at this point?

 

 

[The White Coat Investor]

The original IRA was tax-deferred? I'd convert it all. You'll pay taxes on (14000/19500)*14000 of it. So maybe $4K in taxes to put the whole thing in a Roth IRA.

[NoClueMD]

The original IRA was traditional, so that means tax-deferred, right?  So I should just bite the bullet and go ahead and roll that over into a Roth and pay the taxes this year?

I also have a 401k account that has both pre-tax and Roth contributions.  Sorry I'm not more well-versed in this stuff.

 

 

[The White Coat Investor]

Yes, that's what I'd do.

Roth is different from post-tax, by the way. Post-tax contributions to traditional IRAs have taxable earnings. Roth contributions do not.

[spiritrider]

I am going to have to disagree WCI.

The best option is for the OP to roll over the $14k pre-tax traditional IRA balance to his 401k.

When the 8606 is completed, there will be $5,500 non-deductable IRA contribution and a $5,500 Roth conversion with no tax liability.

There will be no pre-tax balance on 12/31, the only day that matters for form 8606.

[Fender1960]

I guess I'll piggyback on this mistake.  I had no IRA accounts prior to this year and I had planned on doing the bdRoth this year so I opened the Vanguard account in June and put $100.00 in there- the money market.  It now has $100.36 (dividend/reinvested).  Today without thinking ahead I put the $5,400, so the account will soon have $5,500.36 (was thinking $5,500).  When I convert to the Roth, will it let me do all of it or will the 0.36 be stuck, or does this 0.36 cause me any issue anywhere?  Thanks (all this due to 0.36)

[spiritrider]

You will have $5,500 in non-deductible traditional IRA contributions.

You will do a Roth conversion of whatever the balance is on the day of conversion. Assuming it is $5,500.36, the $0.36 will be taxable. Probably will be lost to rounding and cost you nothing.

[The White Coat Investor]

spiritrider wrote:

I am going to have to disagree WCI.

The best option is for the OP to roll over the $14k pre-tax traditional IRA balance to his 401k.

When the 8606 is completed, there will be $5,500 non-deductable IRA contribution and a $5,500 Roth conversion with no tax liability.

There will be no pre-tax balance on 12/31, the only day that matters for form 8606.

Click to expand...

You may be right, at least as far as the IRS will ever know because the only documentation of this is 8606 and it treats every conversion and contribution done during the calendar year as basically being done at the same time. You certainly could not do that if you had done the conversion the year before. I think it violates the spirit of the law, but perhaps not the letter. i.e. as far as the IRS knows (and perhaps cares) the cream isn't mixed into the coffee until Dec 31st each year no matter when it is put in.

Not that converting the whole thing is a bad thing to do anyway. It's lower hassle, very clear on the 8606, and gives you a larger tax-free account for a pretty low tax cost.