Backdoor ROTH IRA strategy may not last

[Luvtoride]

Interesting article in today's WSJ. I hope the "free" link below works. Get your Roth conversions in soon (before 1/1/22).

My company never allowed excess 401k contributions to use for ROTH IRAs (but they did have a very generous match- 116% of my contributions.

https://www.wsj.com/articles/retire...zrbha5dmwto&reflink=desktopwebshare_permalink

Brian

 

[Montecfo]

There was a pretty long thread on this recently. But regular Roth conversions from traditional IRAs are not affected at all unless you are above $400k/$450k (single/married) in income and then only from 2032 forward, according to the article.

So for most people there is no rush, even if this legislation passes.

(Link worked but I'm a subscriber).

 

[MichaelB]

A previous discussion on this same topic that unfortunately took a bad turn, here https://www.early-retirement.org/fo...sed-ira-and-roth-for-high-earners-110903.html

Let’s hope this thread stays on track.

 

[qwerty3656]

There was a pretty long thread on this recently. But regular Roth conversions from traditional IRAs are not affected at all unless you are above $400k/$450k (single/married) in income and then only from 2032 forward, according to the article.

So for most people there is no rush, even if this legislation passes.

(Link worked but I'm a subscriber).

Are regular Roth conversions OK? Isn't this article saying they aren't?

https://www.marketwatch.com/story/c...retirement-tax-move-11632861718?siteid=yhoof2

 

[gauss]

^
As long as you define regular Roth conversions to exclude any after-tax money contributions that may exist in your traditional IRA/401k.

The linked Marketplace article specifically references after-tax money.

-gauss

 

[Luvtoride]

Are regular Roth conversions OK? Isn't this article saying they aren't?

https://www.marketwatch.com/story/c...retirement-tax-move-11632861718?siteid=yhoof2

Qwerty, I just read and was going to add the same article you just posted! Yes, this says that ALL ROTH conversions would be eliminated after 12/31/21 regardless of income level!
Talk about changing the rules in the "late innings" of the game!?

 

[NgineER]

Qwerty, I just read and was going to add the same article you just posted! Yes, this says that ALL ROTH conversions would be eliminated after 12/31/21 regardless of income level!
Talk about changing the rules in the "late innings" of the game!?

I think they are just eliminating the after-tax 401k contributions and the nondeductible IRA contributions, not regular conversions.

I currently do the after-tax 401k contribution which allows me to save 9% of my salary in a Roth IRA even though I earn too much.

 

[ncbill]

Assuming this takes effect, what happens to those after-tax contributions "stuck" in a traditional IRA?

Don't they still get pulled out tax-free with just some additional paperwork?

 

[Sunset]

Assuming this takes effect, what happens to those after-tax contributions "stuck" in a traditional IRA?

Don't they still get pulled out tax-free with just some additional paperwork?

Somewhat related, how does a person do a roth conversion on ONLY the pre-tax contributions.

If I recall correctly, ours has been a small mix of pre and post tax $$ getting converted.

I suppose, they could change the paperwork form, so the post-tax money is not counted and left in the IRA.

This has the potential to become something I've always wanted, Let me withdraw ALL the post-tax money from the IRA at one time, so I don't have to carry over numbers for decades.

 

[gauss]

Assuming this takes effect, what happens to those after-tax contributions "stuck" in a traditional IRA?

Don't they still get pulled out tax-free with just some additional paperwork?

Basically yes.

When you take distributions from your traditional IRA that contains some "after-tax" contributions, then you need to file IRS form 8606 part I with your tax return. This form calculates the taxable vs non-taxable amount of your distribution and is based on the pro-rata share of after-tax contributions to total account value.

Note that the after-tax contributions will come out tax free on a pro-rata basis as described above, but any growth based on these contributions will be taxable. The "growth" is taxable in a similar manner to the tax-deferred contributions


-gauss

 

[oldphd]

I'm one who will be following this due to my situation. As with anything, I think there will be unexpected situations since it's hard to make a rule that covers everything in a fair and consistent manner.

My situation...

I made traditional IRA contributions for several years that were non-deductible since we filed MFS (married filing separately). It saved money for us on our state taxes. When leaving jobs at different times, I consistently rolled over my 401k/403b/457 $$$ into an IRA. As I do Roth conversions/IRA withdrawals now, I file 8606, where I currently have just over 2% of the balance in non deductible contributions so the tax has already been paid. The way I interpret this proposal is I would be unable to continue with conversions.

Never did what they are describing with the $50K+ contributions in a 401k, but it sounds like I'll get caught in the web, even if they didn't intend. I'm hoping there will be some provision that will allow me to continue with the Roth conversion without doing the 8606 and declaring it all as income, or just withdraw the remaining money in the IRA that has already been taxed. When I made the contributions I didn't understand all the rules downstream, and might have avoided it just so I didn't have to do the 8606.

 

[SecondCor521]

Assuming this takes effect, what happens to those after-tax contributions "stuck" in a traditional IRA?

Don't they still get pulled out tax-free with just some additional paperwork?

From my read of the summary of the bill, you would be prohibited from converting them to a Roth. Since there is currently no mechanism I know of for only converting the pre-tax portions, you'd effectively be prohibited from any Roth conversions after the end of this year, regardless of income.

I think you'd still be able to make withdrawals from the traditional IRA, and the pro-rata portion of after-tax contributions would still come out tax free. This would presumably still be reported on Form 8606.

 

[camfused]

^^^ Ok, but what is to prevent financial institutions (like Fidelity or Vanguard) from rolling out software that CAN figure out the pre-tax portions, and therefore allow you to convert next year? Or, am I missing something?

 

[SecondCor521]

^^^ Ok, but what is to prevent financial institutions (like Fidelity or Vanguard) from rolling out software that CAN figure out the pre-tax portions, and therefore allow you to convert next year? Or, am I missing something?

By law (somewhere in the IRS code, which is Title 26, United States Code), Roth conversions from traditional IRAs which have after-tax contributions have to be made on a pro rata basis. So if 10% of your traditional IRA is after-tax, and you convert $100, then $90 of it is pre-tax and $10 of it is after-tax. You, me, the IRS, Fidelity, Vanguard and everyone else has to follow the pro rata rule (or break the law). Specifically this means you can't just tell Fidelity or Vanguard to only convert the $10 of after-tax money and leave the $90 in the traditional IRA. This is true even if you have all of your pre-tax money in one traditional IRA and all of your after-tax money in another traditional IRA.

If this law passes, then that $10 of after-tax money cannot be converted to a Roth. You, me, the IRS, Fidelity, Vanguard, and everyone else has to follow the "after-tax money cannot be converted to a Roth" rule (or break the law).

It's not a matter of the accounting. Vanguard and Fidelity can definitely write software to keep track of the pre-tax portions. But I seriously doubt Vanguard or Fidelity would break the law with you, me, or anyone else (again, assuming this passes, and assuming we're talking specifically about 2022 Roth conversions where someone has after-tax contributions in their traditional IRA).

 

[gauss]

^ What about the scenario where the pre-tax money is converted, but the after-tax portion is distributed as cash? This would seem to honor both the pro-rata rules as well as the no after-tax Roth conversion rules.

This may still be possible under the new bill, but I would need to confirm to be sure.

-gauss

 

[pb4uski]

Actually, when I retired and moved my 401k most of it was pre-tax money and was rolled over to my tIRA but I had a little bit that was after-tax contributions... there was one year where I contributed a little more than the maximum pre-tax contributions and they characterized the excess as after-tax contributions.

I just got a check and spent the money.... it wasn't until years later that I learned that I could have rolled it over to my Roth IRA, but that never seemed right... sounds like they are now proposing to"fix" it.

 

[SecondCor521]

^ What about the scenario where the pre-tax money is converted, but the after-tax portion is distributed as cash? This would seem to honor both the pro-rata rules as well as the no after-tax Roth conversion rules.

This may still be possible under the new bill, but I would need to confirm to be sure.

-gauss

I don't even think that's possible now. My understanding is that the conversion and the distribution would both be pro-rata. So if you converted $100 and distributed $100, you'd end up with $90 / $10 converted and $90 / $10 distributed. A quick check of Form 8606 makes me think I'm right on this.

If you're talking about 401(k) distributions or conversions, then that's a different story, and what you describe might be possible there; I'm not sure.

 

[Sunset]

Here is my stab at working with the proposed law:

If a person has multiple IRA's , perhaps from rolling over some 401K's and and even some regular IRA's.
That person could figure out if any of them are free of after-tax contributions.
Then roll all the other IRA's into a 401k or self 401k.
Then they would be free to do conversions, after all the conversions, they can roll out the 401K(s) to an IRA

 

[SecondCor521]

Here is my stab at working with the proposed law:

If a person has multiple IRA's , perhaps from rolling over some 401K's and and even some regular IRA's.
That person could figure out if any of them are free of after-tax contributions.
Then roll all the other IRA's into a 401k or self 401k.
Then they would be free to do conversions, after all the conversions, they can roll out the 401K(s) to an IRA

Yeah, that'll work to separate the two and get away from the pro-rata rule, if you have an employer plan that accepts incoming rollovers. I don't know about solo 401(k)'s. Kitces talks about it here:

https://www.kitces.com/blog/roth-ir...sis-rollover-pro-rate-rule-employer-plan-qcd/

Note that there's no need to have multiple IRA's - anything rolled into the employer plan is considered to be pre-tax. Once all pre-tax dollars are rolled in, everything left is after-tax.

However, after doing that you still would not be able to do conversions under the new law, because it prohibits pre-tax conversions to Roth - that's the point.

I suppose one could do the above, then totally distribute the after-tax amounts, then rollover the 401(k) back into a fresh IRA which would only contain pre-tax dollars at that point. Then one could Roth convert.

It'd be nice if they changed the law to be more surgical and just prevent backdoor Roths and leave people with some nondeductible contributions alone.

 

[gauss]

I don't even think that's possible now. My understanding is that the conversion and the distribution would both be pro-rata. So if you converted $100 and distributed $100, you'd end up with $90 / $10 converted and $90 / $10 distributed. A quick check of Form 8606 makes me think I'm right on this.

If you're talking about 401(k) distributions or conversions, then that's a different story, and what you describe might be possible there; I'm not sure.

Agreed that the current IRS form 8606 does indeed read this way.

On the other hand, depending on how the bill/law reads, and interpreted by regulation, maybe the 2022 8606 form will be redesigned to accomplish what I suggested.

I haven't read the actual bill yet. I am spending my time trying to convert my after-tax balances before the year end.


-gauss

 

[SecondCor521]

Agreed that the current IRS form 8606 does indeed read this way.

On the other hand, depending on how the bill/law reads, and interpreted by regulation, maybe the 2022 8606 form will be redesigned to accomplish what I suggested.

I haven't read the actual bill yet. I am spending my time trying to convert my after-tax balances before the year end.

-gauss

Good luck.

Here's the text from the readable summary:

"Furthermore, this section prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021."

-- https://waysandmeans.house.gov/site...ns.house.gov/files/documents/SubtitleISxS.pdf

Here's the text from the actual bill:

"(B) CONVERSIONS.—Subparagraph (C) of section 408A(d)(3) is amended by adding at the end the following new sentence: ‘‘This subparagraph shall not apply if any portion of the plan being converted would be treated as not includible in gross income if distributed at the time of the conversion.’’"

-- HR5376, Section 138311, page 2,272, https://www.congress.gov/bill/117th-congress/house-bill/5376

 

[Deej]

This sucks for some of us. DH plans to retire from megacorp very early next year where we'd be in the 12% tax bracket for only 2.5 years (now 22%). We planned on starting backdoor roth conversions next year by opening an IRA, and contributing for the next 7-8 years before RMDs begin (converting $400K+ during those 7-8 years). He has over 1.3M in his 401K - no roth at all. I've been after him to make the shift years ago and he didn't listen. Once he hits 66.6, he'll collect SS and with pension putting us back into the 22% bracket.

 

[SecondCor521]

This sucks for some of us. DH plans to retire from megacorp very early next year where we'd be in the 12% tax bracket for only 2.5 years (now 22%). We planned on starting backdoor roth conversions next year by opening an IRA, and contributing for the next 7-8 years before RMDs begin (converting $400K+ during those 7-8 years). He has over 1.3M in his 401K - no roth at all. I've been after him to make the shift years ago and he didn't listen. Once he hits 66.6, he'll collect SS and with pension putting us back into the 22% bracket.

Emphasis added.

Remember, IRA contributions (even backdoor Roth contributions) require earned income. Maybe you'd still be working.

 

[pb4uski]

This sucks for some of us. DH plans to retire from megacorp very early next year where we'd be in the 12% tax bracket for only 2.5 years (now 22%). We planned on starting backdoor roth conversions next year by opening an IRA, and contributing for the next 7-8 years before RMDs begin (converting $400K+ during those 7-8 years). He has over 1.3M in his 401K - no roth at all. I've been after him to make the shift years ago and he didn't listen. Once he hits 66.6, he'll collect SS and with pension putting us back into the 22% bracket.

I wouldn't hit the panic button yet... the DC sausage machine is still churning and who knows what might happen.

 

[Ian S]

Just to be clear, I think this only affects conversions that involve plans that include both pre and post tax contributions. All of my plans only include pre-tax contributions so I can still do Roth conversions, correct?