I’m no financial genius, and I’m trying to wrap my head around this. If we could stay on point about this, it would be appreciated. Tangents and what-ifs will only confuse the issue.
I think I’ve got the gist of it, after re-reading various internet websites on the subject. Can someone fact-check my understanding?
After you top a certain income amount, you can’t contribute your $6,500 to a *Roth *IRA anymore.
However, income limits don’t apply to *traditional *IRAs; you can still contribute $6,500 a year to one of those.
Assuming that the $6,500 you contributed to a traditional IRA was after-tax dollars, once those dollars are in the traditional IRA, you can backdoor-convert it to a Roth IRA without incurring any taxes or penalties.
Does that about sum it up, or am I missing something?
If you have another IRA that was funded with pre-tax dollars, then you will probably owe taxes on some of the rolled-over amount. You will also owe taxes on any earnings your after-tax IRA received before you rolled it over. IANATL or CPA, but did a lot of research when I wanted to do this.
Doesn’t matter. If you have other traditional IRAs with before-tax dollars in them, it affects how much tax you pay on the roll over amount (if any). Better for you to talk to whatever broker you are going to use for the rollover.
If you say “I don’t have any traditional IRAs that are funded with pre-tax dollars”, then you will only pay taxes on the earnings of your after-tax dollar IRA that accrued before you rolled it over (if there are any).
As others have implied, this works best if you only have a single IRA with $6500 in it when you convert.
If not, then taxes are due when you convert. For simplicity, let’s image you have an old IRA-1 with $6500 from pre-tax dollars. You contribute $6500 post-tax dollars to a new IRA-2 and convert it. The IRS says you have to pay taxes on $3250 - it assumes that half of the conversion comes from each IRA. (To make it even more complicated, now you have a post-tax basis in your remaining IRA-1).
One solution if you have an existing IRA is to roll it into a current 401k/403b. Then open a new one for the backdoor.
Thanks, that’s helping to make it a little clearer. I do have an existing traditional IRA which contains both pre-tax money (a rollover from a previous employer), and some after-tax money (contributions from me for the past two years).
Backdoor converting some of this to a Roth sounds pretty complicated. I do like your solution of rolling the IRA over into my 401(k) and opening a new IRA to start afresh, but then I’d have to cash out some funds and stocks that I particularly like. My 401(k) just has a list of a couple of dozen very dull funds.
I had a similar situation and I wish I had never mixed pre and post tax money in an IRA. It requires tracking them separately at tax time and a new calculation each time you withdraw from the IRA - forever.
I found a solution - too complex to explain in this post but let me know if you want me to go there.
Once you do have a Roth though you could invest in whatever stocks you want.
If you are self-employed there is also the “individual 401K” option. Which does not limit you to “a list of a couple of dozen very dull funds.”
If that’s you, it *might *provide another way to park your existing IRA money out of the way so you can do the backdoor Roth maneuver with fresh money.
I say might because I have no clue about the specifics of IRA-401K rollovers; doubtless some maneuvers are OK and others are verboten. I just have no idea which are which.
You may only roll over the pre-tax portion of your IRA into a 401(k). (All earnings, whether on pre-tax or after-tax contributions are considered pre-tax.) You may not roll after-tax contributions into a 401(k).
So you can’t start over completely. You still have to separate the pre-tax and after-tax funds. But that’s a good thing because you can convert all after-tax funds, regardless of when you contributed them, to a Roth IRA tax-free.
I converted my post-tax IRA contribution to a Roth, then I rolled the rest of the IRA into a 401k (this action actually happened a couple times to sweep up some minor interest payments). At the end of the tax year, since the IRA balance will be zero, no taxes are due on the Roth rollover. (Basically neither action is considered as an IRA withdrawal that would trigger taxes).
Actually, the zero balance at the end of the year in an IRA is the key to the Backdoor Roth as well.
Yes, the key is the balance of your IRA at the end of the year. If that’s zero and you made a rollover, then the Internal Revenue Code says that the entirety of your basis in your traditional IRA carries over to the Roth, reducing the amount of income you recognize on the rollover. If there is anything left in any IRA you own, then the rollover is deemed to be pro-rata from “pre-tax” funds based on your traditional IRA basis, the size of the rollover, and the size of all your IRAs at the end of the year. This is the entire reason (or at least, a reason, but the only one I’ve found that it actually matters for taxes) that brokerages report to your the fair value of your IRA account at the end of each year - they have no way of knowing whether you rolled over other IRA accounts, and you need to consider the total fair market value of all your IRAs when determining how much of your traditional IRA basis gets rolled over when converted into a Roth.
That’s something I hadn’t thought of. If I hold a traditional IRA that contains some money from a 401(k) rollover and some money which after-tax money contributed by myself, there will be tangled tax issues when it comes to retirement and I start taking distributions? Oy.
If that’s the case, I think I’ll take action now and spare myself the confusion in the future when I’m getting a bit too elderly to enjoy complex tax figuring.
It’s not that bad. Every year your tax filing software produces a Form 8606 which documents the amount of post-tax dollars in your IRA.
Once you start taking distributions the logic is real simple. What fraction of your IRA’s total value is “basis” = post-tax deposits as shown on your current 8606? Let’s say it’s 15% post-tax and 85% pre-tax. Then 85% of however much you withdrew that year is taxable as income. 15% is not. You’re paying now the tax you didn’t pay way back then. And you don’t need to pay tax now on what you already paid tax on then.
It’s no harder than that. It does require that you made an updated 8606 (or equivalent records) for every year you added post-tax money. So you know how much total post-tax money went in when you finally start pulling out.
During your withdrawal years the 8606 is also updated to track the post-tax money you’re pulling out. Again it’s all automatic within TurboTax or whatever.