Backdoor Roth and Roth conversions - no current Roth or IRA

[cathy63]

Can someone point me to the tax code. Trying to prove to my friend that this is how it works.

Do you want the actual tax code reference, or will an official IRS Publication suffice? Here's IRS Pub 590-B: https://www.irs.gov/pub/irs-pdf/p590b.pdf

See page 31. "What Are Qualified Distributions?"

 

[Dash man]

Can someone point me to the tax code. Trying to prove to my friend that this is how it works.

https://www.irs.gov/publications/p590b#en_US_2021_publink100089553

 

[G-Man]

Do you want the actual tax code reference, or will an official IRS Publication suffice? Here's IRS Pub 590-B: https://www.irs.gov/pub/irs-pdf/p590b.pdf

See page 31. "What Are Qualified Distributions?"

Thank you.

 

[G-Man]

https://www.irs.gov/publications/p590b#en_US_2021_publink100089553

Thank you

 

[SevenUp]

I just opened a ROTH IRA yesterday and will do the back door roth conversion in a day or two. Those funds will not be available for me to withdrawn tax-free until age 61 (5 years from now).

Actually those funds will be available for you to withdraw tax-free immediately. Not that you will likely want to do that, but you could.

See the distribution rules in table form: the amount put into Roth via the backdoor process is "Conversions, nontaxable portion".

If your contribution earns a couple of dollars in the traditional account so, for example, you contribute $6000 but end up converting $6002, the $2 would be taxable for the conversion year. Should you then take a withdrawal from the Roth, that $2 would be "Conversions, taxable portion" and subject to a 10% penalty. You would thus be liable to pay $2 * 10% = $0.20, but that rounds down to $0.

 

[G-Man]

Actually those funds will be available for you to withdraw tax-free immediately. Not that you will likely want to do that, but you could.

See the distribution rules in table form: the amount put into Roth via the backdoor process is "Conversions, nontaxable portion".

If your contribution earns a couple of dollars in the traditional account so, for example, you contribute $6000 but end up converting $6002, the $2 would be taxable for the conversion year. Should you then take a withdrawal from the Roth, that $2 would be "Conversions, taxable portion" and subject to a 10% penalty. You would thus be liable to pay $2 * 10% = $0.20, but that rounds down to $0.

Now you have me curious. I'm not 59 1/2 years old yet. Are you telling me I can withdrawn the Roth conversion dollars from my Roth 401k tax-free right now without satisfying the 5 year period?

So it's the earnings/growth that does not have the same treatment.

For example, I back door Roth $7K and it grows to $7.5K. I can withdrawn the $7K tax free this year without satisfying the 5 year period?

Please help me understand this.

 

[SevenUp]

Now you have me curious. I'm not 59 1/2 years old yet. Are you telling me I can withdrawn the Roth conversion dollars from my Roth 401k tax-free right now without satisfying the 5 year period?

So it's the earnings/growth that does not have the same treatment.

For example, I back door Roth $7K and it grows to $7.5K. I can withdrawn the $7K tax free this year without satisfying the 5 year period?

Please help me understand this.

Yes, that's correct.

That table is organized top to bottom the way the law treats Roth IRA distributions: contributions are deemed to be withdrawn first and earnings last.

If there have been no direct Roth contributions, then the taxable portion of any conversion comes first. In the backdoor Roth process, if the amount you convert is exactly the same as the non-deductible contribution, then there is no taxable portion of that conversion. If the contribution earned $2 in interest before you converted, there would be a $2 taxable portion of that conversion.

Clearer, or still murky?

 

[G-Man]

Yes, that's correct.

That table is organized top to bottom the way the law treats Roth IRA distributions: contributions are deemed to be withdrawn first and earnings last.

If there have been no direct Roth contributions, then the taxable portion of any conversion comes first. In the backdoor Roth process, if the amount you convert is exactly the same as the non-deductible contribution, then there is no taxable portion of that conversion. If the contribution earned $2 in interest before you converted, there would be a $2 taxable portion of that conversion.

Clearer, or still murky?

Murky..

Well this video is not totally correct. In the video, the 5 year seasonings only applies to the Roth growth and not the Roth conversion amount. Based on the table in the previous post, those dollars are tax-free immediately. Please confirm.

 

[SevenUp]

Murky..

Well this video is not totally correct. In the video, the 5 year seasonings only applies to the Roth growth and not the Roth conversion amount. Based on the table in the previous post, those dollars are tax-free immediately. Please confirm.

The difference is between
a) a "normal" Roth conversion in which one takes pre-tax money from a traditional IRA and converts it to Roth, vs.
b) the "backdoor Roth process" in which one makes a non-deductible (aka "after-tax") contribution to a traditional IRA and then converts that to Roth.

In a) all that money is "Conversions, taxable portion" (using the colored chart language) and in b) all (or the vast majority) is "Conversions, nontaxable portion".

 

[Gumby]

My understanding is that the 5 year rule applies to the whole converted amount. See https://www.irs.gov/publications/p590b

But, you have a basis in the account on which you have already paid tax. The only taxable income will be gains on that conversion amount while it has been in the Roth. In other words, if you withdraw before the 5 years are up, the IRS treats your Roth like a regular taxable account. You pay tax on money that has not been previously taxed.

If you take a distribution after you are 59-1/2, you are not subject to the 10% early distribution penalty.

 

[MarieIG]

I would suggest you consider opening up a non-deductible IRA for you and your wife. Put it in a cash/brokerage account, and then convert it to a Roth. File your 8606 to establish your cost basis. Hence, you have opened up a Roth IRA.

You can do a small inservice conversion to your Roth 401k - but your income will probably will be more this year, and your taxes at a higher level; or you can put some or all of your 401k for the rest of the year directly into the Roth 401k (you would not get a deduction on these contributions.) When you retire (or before if your plan allows) you can roll your Roth 401k into your Roth IRA.

 

[SevenUp]

My understanding is that the 5 year rule applies to the whole converted amount. See https://www.irs.gov/publications/p590b

But, you have a basis in the account on which you have already paid tax. The only taxable income will be gains on that conversion amount while it has been in the Roth. In other words, if you withdraw before the 5 years are up, the IRS treats your Roth like a regular taxable account. You pay tax on money that has not been previously taxed.

That's close.

If you had no direct Roth contributions (so the "Contributions" rows in the colored table don't apply) and withdraw before 5 years and you are under 59.5, you pay a 10% penalty on the amount that was taxable when you made a conversion.

If the conversion (in the past) was a "normal" conversion of pre-tax traditional funds, all of that was taxable when the conversion was made and in this example (a current Roth withdrawal) would all be subject to the 10% penalty (but not to any tax rate).

If the conversion (in the past) was part of a backdoor Roth process and no gains had occurred while in the traditional IRA, none of that was taxable when the conversion was made and in this example (a current Roth withdrawal) there would be neither penalty nor tax.

 

[G-Man]

I would suggest you consider opening up a non-deductible IRA for you and your wife. Put it in a cash/brokerage account, and then convert it to a Roth. File your 8606 to establish your cost basis. Hence, you have opened up a Roth IRA.

You can do a small inservice conversion to your Roth 401k - but your income will probably will be more this year, and your taxes at a higher level; or you can put some or all of your 401k for the rest of the year directly into the Roth 401k (you would not get a deduction on these contributions.) When you retire (or before if your plan allows) you can roll your Roth 401k into your Roth IRA.

Help me understand the approach below...

"I would suggest you consider opening up a non-deductible IRA for you and your wife. Put it in a cash/brokerage account, and then convert it to a Roth."

Here is what I have done so far. Is this not the correct approach?
1. Created a TIRA and a Roth IRA with Fidelity.
2. Added post-tax dollars to the TIRA.
3. Once the funds settle in the TIRA, immediately transfer those dollars to the Roth IRA; thus creating a back door Roth conversion.

Here is the article on the Fidelity site that I followed as well.
https://www.fidelity.com/insights/retirement/back-door-roth-ira

Is there a different approach?

 

[Gumby]

...

If the conversion (in the past) was a "normal" conversion of pre-tax traditional funds, all of that was taxable when the conversion was made and in this example (a current Roth withdrawal) would all be subject to the 10% penalty (but not to any tax rate).

If the conversion (in the past) was part of a backdoor Roth process and no gains had occurred while in the traditional IRA, none of that was taxable when the conversion was made and in this example (a current Roth withdrawal) there would be neither penalty nor tax.

If I may pick a nit - if you have gains in the Roth (either following a regular tIRA conversion or a back door conversion) you must pay taxes on those gains if you have not met the 5 year period. That's how I read the regulations.

 

[MarieIG]

Help me understand the approach below...

"I would suggest you consider opening up a non-deductible IRA for you and your wife. Put it in a cash/brokerage account, and then convert it to a Roth."

Here is what I have done so far. Is this not the correct approach?
1. Created a TIRA and a Roth IRA with Fidelity.
2. Added post-tax dollars to the TIRA.
3. Once the funds settle in the TIRA, immediately transfer those dollars to the Roth IRA; thus creating a back door Roth conversion.

Here is the article on the Fidelity site that I followed as well.
https://www.fidelity.com/insights/retirement/back-door-roth-ira

Is there a different approach?

That is basically what I was talking about. When I said brokerage, I meant inside the non-deductible IRA as it is easily convertible. So, it looks like you have started your Roth.

 

[SevenUp]

If I may pick a nit - if you have gains in the Roth (either following a regular tIRA conversion or a back door conversion) you must pay taxes on those gains if you have not met the 5 year period. That's how read the regulations.

Yes, if and only if you withdraw more than the total of your Contributions, "Conversions, taxable portion", and "Conversions, non taxable portion".

Unlike annuities, in which gains are deemed to be withdrawn before contributions, distributions from Roth IRAs are deemed to come from "gains in the Roth" last of all.

 

[SecondCor521]

I'm so glad this stuff is easy.

 

[G-Man]

I have been calling Fidelity for the last couple days because the dollars transferred from my checking account to the TIRA is not available to withdraw/transfer to the Roth IRA yet. The dollars has settled into the TIRA account but is not available for withdrawal yet. So, there may be some interest/growth in the TIRA before I'm able to transfer all of it to the Roth IRA. Maybe less than $5 dollars.

How would I report this on my income taxes if there is some growth that has occurred in the TIRA?

PS. Would a 1099-R be triggered if the TIRA growth amount is less than $10?

https://turbotax.intuit.com/tax-tip...m-pensions-annuities-retirement-etc/L0g2CrvvL

https://ttlc.intuit.com/community/r...-are-only-sent-a-1099-r-form-if-you/00/431878

 

[Dash man]

I have been calling Fidelity for the last couple days because the dollars transferred from my checking account to the TIRA is not available to withdraw/transfer to the Roth IRA yet. The dollars has settled into the TIRA account but is not available for withdrawal yet. So, there may be some interest/growth in the TIRA before I'm able to transfer all of it to the Roth IRA. Maybe less than $5 dollars.



How would I report this on my income taxes if there is some growth that has occurred in the TIRA?

You’ll get a 1099R for the conversion. You’ll have to record the tIRA contribution on Form 8606 and not take a deduction for the contribution. The difference will be included as taxable income.

 

[G-Man]

You’ll get a 1099R for the conversion. You’ll have to record the tIRA contribution on Form 8606 and not take a deduction for the contribution. The difference will be included as taxable income.

I did not contribute the entire $7K yet on this first contribution. I'm only doing partial contributions until I reach $7K by the end of the year.

So, if there are a few dollars of interest in the TIRA before I transfer to the Roth IRA, do I transfer the initial contribution + growth or just the initial contribution to the Roth IRA. Or does it matter? Meaning I still need to report the growth amount on my taxes.

For the next contribution, I will transfer the money from my Fidelity brokerage account to the TIRA and then to the Roth IRA. I was told that the transfer is immediate if I take that approach.

 

[Dash man]

I did not contribute the entire $7K yet on this first contribution. I'm only doing partial contributions until I reach $7K by the end of the year.

So, if there are a few dollars of interest in the TIRA before I transfer to the Roth IRA, do I transfer the initial contribution + growth or just the initial contribution to the Roth IRA. Or does it matter? Meaning I still need to report the growth amount on my taxes.

For the next contribution, I will transfer the money from my Fidelity brokerage account to the TIRA and then to the Roth IRA. I was told that the transfer is immediate if I take that approach.

Just transfer the whole balance if you want. The interest will be minimal.
I think you’re overthinking this.

 

[TheWizard]

I'm so glad this stuff is easy.

It CAN be rather easy if you connive your situation to one where you definitely don't plan to withdraw any funds from your Roth for many years, certainly until over 59-1/2.

The backdoor Roth contribution process can be a bit non-easy initially but a good writeup on it helps.

I did a backdoor Roth contribution just once several years ago:
1) I rolled my modest tIRA into my 403(b) first.
2) I accumulated $6000 of after-tax money into my now empty tIRA over a period of months, from part-time employment.
3) I did a conversion of the entire amount in my tIRA, about $6050, into my Roth IRA.
4) Later on, I paid income tax on that $50 gain that occurred during time in the tIRA.

I've done my own income taxes for decades, so this whole process was rather simple, for me...

 

[cathy63]

...So, if there are a few dollars of interest in the TIRA before I transfer to the Roth IRA, do I transfer the initial contribution + growth or just the initial contribution to the Roth IRA. Or does it matter? Meaning I still need to report the growth amount on my taxes...

Convert the entire amount this year. You want your tIRA to have a $0 balance on 12/31/2022. You will pay income tax on any earnings that are included in the conversion.

If you leave any money in the tIRA, then your conversion will be pro-rated between pre- and post-tax money, which means anything left in the tIRA will also be a mix of pre- and post-tax money. It's not the end of the world, but it's annoying to have to keep track of your 8606 form and carry this basis forward into future years. The cleanest thing from a tax perspective is to convert the entire amount and just pay the tiny amount of tax on the earnings.

I did not go back and read the entire thread, but in case nobody has pointed it out, the backdoor Roth strategy disappears as soon as you roll over an employer 401K (or 403b, 457, etc) into a tIRA. Once you have a significant amount of untaxed money in a tIRA, you can still do Roth conversions of course, but since every conversion is pro-rated, you need to think about it differently. If 95% of the money in your tIRA has never been taxed, then 95% of every conversion is taxable income.

 

[G-Man]

Just transfer the whole balance if you want. The interest will be minimal.
I think you’re overthinking this.

Overthinking comes from being in IT for over 30 years. Sorry for all the questions.

 

[TheWizard]

...I did not go back and read the entire thread, but in case nobody has pointed it out, the backdoor Roth strategy disappears as soon as you roll over an employer 401K (or 403b, 457, etc) into a tIRA. Once you have a significant amount of untaxed money in a tIRA, you can still do Roth conversions of course, but since every conversion is pro-rated, you need to think about it differently. If 95% of the money in your tIRA has never been taxed, then 95% of every conversion is taxable income.

This is why I did a reverse rollover from tIRA to 403(b) a few years back before doing a backdoor Roth contribution.
I happen to have some excellent Vanguard institutional index funds in my 403(b) so I'm leaving the money there rather than returning it to a tIRA...