backdoor roth - 10% IRS penalty?

[floridanurse]

on phone with fidelity advisor with the intention of converting the $5000 we put into a tIRA into a ROTH. The so called backdoor ROTH.

fidelity advisor was hesitant and explained I'd receive a penalty of 10% from IRS and then another (i forget) tax implication.

I haven't read anything on the forums about people paying this penalty. What gives? Did I do something wrong when I signed up for the traditional IRA?

thank you everyone.

EDITED TO ADD:

The initial representative that I spoke with (the one who said there was a penalty) transferred me to an advisor to 'discuss the tax implications' of IRAs. The advisor told me it was a mistake. I'm not sure how to delete the post so I'm just editing to ammend.

 

[frayne]

From FIDO's FAQ page on conversions; https://www.fidelity.com/retirement-ira/ira/roth-ira-faq

You'll owe taxes on the previously untaxed amount of your IRA that's converted. But, unlike Traditional IRA withdrawals before age 59½, there's no penalty involved.


There are a number of factors to consider to help you decide how much to convert. Consider these questions:

• Do you have the money set aside in a nonretirement account to pay the tax?
• How much can you convert without moving into a higher tax bracket?

It’s generally considered a good idea to use cash from a nonretirement savings or brokerage account to pay the taxes, instead of using the proceeds from the conversion.

• Using funds from the retirement account you are converting will reduce the amount of money you will have in your Roth IRA. Doing so could generate even more tax liability and reduce the additional advantage of potential tax-free growth on the full amount of the conversion.
• If you are under 59½, using funds from the retirement account you are converting may result in an additional 10% tax penalty that may significantly reduce the potential benefit from the conversion.

 

[Alan]

I think the post and thread is worth leaving in place as it shows that the first rep one speaks to is not always fully up with tax situations.

 

[PatrickA5]

I had the exact same thing happen to me back in 2010 when I did my first backdoor Roth conversion. All of my TIRA contributions up to that point were non-deductible, so I had a basis in the IRAs of slightly less than the full value. The Fidelity guy kept telling me I'd have to pay tax on the entire conversion. I finally had to tell him to transfer me to someone that knew something about taxes. He insisted that he'd handled thousands of these situations and I would be told the same thing by the next representative. I told him to humor me and send me to someone else. The second person knew the correct rules. If you have a doubt about an answer you're getting, get a second opinion.

 

[floridanurse]

Did the conversions in 30 seconds via the Fido website. Painless.

I'm curious though if after first of year, is it better to just insert another $5k into each tIRA and convert or make smaller monthly contributions to traditional acct until we hit the 5k mark and then convert. Does it matter? What do others do?


Also, it was funny, while I was talking to the second rep, he asked me all these financial questions, then was really trying I push me to talk to one of the annuity specialists. He was telling me how great their programs were. I politely declined.

But it brought up an interesting question that I will start in a separate thread.

 

[bUU]

What I have read pushes me into believing that fully-funding the tIRA early in the year and doing the conversion immediately is better, if you've got the money. That way, you have far less taxable gain to pay tax on when you do the conversion, and you have that many more months of gain that are tax-free on distribution.

 

[PatrickA5]

I make the full TIRA contribution on Jan 2nd and convert it a couple days later. We get to contribute an extra $500 this year!

 

[Animorph]

I've been keeping enough cash that I did the non-deductible tIRA contribution with cash, left it there for a few months, and then converted to Roth. I had a few pennies of interest I'll have to pay for.

 

[KM]

Ditto - I put our TIRA contribution "all-in" on Jan 2 (non-deductible) and then convert within a day or two later. I put it in the money market fund....that way I dont have to bother with a gain or loss.

Did not know we get another $500/person this year. Excuse me now while I go look for another $1K to move

 

[floridanurse]

Ty for replies, so in 2013 we can put $5500 each in?

 

[Animorph]

Yep, $5500 is the new contribution limit for 2013:

Retirement Topics - IRA Contribution Limits

(Look a few lines down from the 2012 info.)