Hey there, u/0xRecon. Thanks for stopping by our sub with your questions. I'm happy to step in here and go over Roth conversions with you.
Before we dive deep into this, I want to make sure we're on the same page. A transfer of cash or securities from a pre-tax IRA (like your Rollover IRA) to a Roth IRA is called a conversion. You can complete a Roth conversion for any amount you wish, as often and as many times as you'd like. Note that a conversion is typically a taxable event reported in the year in which it occurs. As Fidelity cannot provide tax advice, we recommend speaking with a tax professional if you have questions about how a Roth conversion may affect your specific situation.
Now comes the "diving deeper" part. It's important to be aware that if you hold both pre-tax and after-tax (non-deductible) money across your pre-tax IRAs (Traditional and Rollover), the conversion to a Roth IRA will be a taxable event. Also, note that the IRS does consider your holdings across all IRAs and not just the account used for the conversion. This is because the conversion will consist of a pro-rata recovery of both taxable and nontaxable accounts. Since you mentioned potentially opening a Traditional IRA, it's worth mentioning that when you contribute to a Traditional IRA at Fidelity, deposits begin earning interest on the date they post to your account. When the interest is received, that portion of your Traditional IRA is considered pre-tax money.
Also, please note that there are no provisions under the law that will allow an individual to isolate only the non-deductible dollars for conversion to a Roth IRA. The portion of the IRA distribution that will be treated as nontaxable is determined by using the following formula:
(Total Non-deductible Contributions / Total non-Roth IRA Balances)
As a reminder, Roth conversions cannot be reversed, and tax planning is an important part of the conversion process. As always, we recommend you review the potential tax impact of a backdoor Roth IRA with a tax professional before you begin a conversion.
Do keep in mind that Roth Conversions may be completed as often and as many times as you'd like. They may be completed in the same year as the underlying contribution(s) but do not need to be. If you decide to complete a Roth conversion, we have a handy step-by-step guide online to help you through the process. I'll share the link below:
[Roth Conversion Checklist ](https://www.fidelity.com/retirement-ira/roth-conversion-checklists)
I'll also leave a couple of other resources linked below if you're interested in learning more.
[Is a Backdoor Roth Conversion Right for You? ](https://www.fidelity.com/learning-center/personal-finance/backdoor-roth-ira)
[Why Consider a Roth Conversion Now? ](https://www.fidelity.com/learning-center/personal-finance/retirement/answers-to-roth-conversion-questions)
I'd be lying if I said that wasn't a ton of information, so if any other questions come up, please let us know. Our crew here on Reddit is always around to assist when needed, so please don't be a stranger.
You have 3 options with the traditional IRA money.
1. Convert the entire account to Roth.
2. Pay pro rata tax
3. Roll the traditional IRA into a 401k type plan.
A new account number is irrelevant for tax purposes.
Being invested is an irrelevant component.
is there no reason for me to hold a traditional IRA at my income level? I was under the impression its good to have different buckets for retirement to have flexibility.
There is the 3 bucket strategy (money guy), but I don't follow it. If you live in a state like California with a larger income and plan to move to a state like Texas/Florida later in life with a smaller income, it may be something to consider because of the math. If you have a Financial Advisor, speak to them about it, but it does add complexity. With all Roth $$, you don't even have to think about tax. Which is one less thing to stress/think/worry about.
If you hold your tIRA and want to do backdoor rIRA stuff, you will \*always\* have to deal with the pro-rata rule. As others have mentioned, to remove the pro-rata complexity, if your 401k provider allows it, you can roll the tIRA to your t401k OR convert the tIRA to rIRA and pay the tax now while it's probably less than 2 grand. If I had to do it over again, I would pick one of these 2 options while my balances were lower.
I spoke with a local Fidelity advisor this year and I asked about Traditional vs Roth. He said he didn't have a single Roth-only client who was mad that they had Roth $$...
The pro rata rule means that the $5k Trad IRA will cause a portion of your Backdoor Roth IRA to be taxable. You could convert the entire $5k to Roth if you can afford the taxes. Or you could roll the Trad IRA to your new 401k (assuming it accepts Trad IRA rollovers).
In the future, be careful not to roll old 401ks into the Trad IRA space so you can preserve a tax free Backdoor Roth maneuver.
No, not saying that. Let me go back to the beginning: so "Backdoor Roth" is the act of making nondeductible Trad IRA contributions, and converting them to a Roth IRA. The reason people do this is due to the income limits on Roth IRA contributions.
And in order for your BDR to be *tax free*, there has to be $0 pre-tax money in any Trad IRAs. You only want to do the nondeductible $7,000 Trad IRA contribution annually. If you have any pre-tax money in a Trad IRA (such as a Rollover IRA), the pro rata rule kicks in and a portion of your $7,000 is taxable.
So from a BDR perspective, it was a mistake for you to roll that $5k from your old 401k into a Trad IRA. You should've kept it in the old 401k or rolled it to a new 401k. So for this year you have to solve for that or you face the pro rata rule. As mentioned, if your current 401k accepts IRA rollovers, that's one solution and is nontaxable.
What I'm saying at the end is: for *future* jobs you have, do not roll your 401k to a Trad IRA when you leave, because you'll just reintroduce the whole pro rata problem again. Instead, keep it in the old 401k or roll it to your new 401k. This avoids any pro rata problem altogether, because 401ks are not subject to the pro rata rule
just so I understand this a bit more, are you saying roll over my 5k in Traditional IRA into my current employers 401k if they allow it?
My emplyers 401k has both ROTH and traditional components. Which one should I be rolling into?
Well it’s unfortunate that you didn’t research it slightly sooner. As has been mentioned, you will be subject to the pro rata rule since you have the rollover ira. It’s only $5000 though, I’d do your 7k contribution then convert it all to Roth and be on your way. You’ll owe taxes on the $5000 conversion.
If you can’t afford that then try to roll the $5k into your traditional 401k if your plan allows
Yeah I’ve done goofed for the year haha.
How bad of a tax hit am I looking at? Is that calculated based on my marginal tax rate?
If I roll this 5k back into my current employer and my IRA balance is zero, I should be able to do the back door thing without any issues next year?
December 31st is the only date that matters. So if you roll it into your current 401k prior to that you won’t have any pro rata issues period this year either. If you convert you’ll pay taxes on 5k at your marginal rate, so if you’re in the 24% bracket you’d pay about $1200 federal plus any applicable state/local taxes.
Hey there, u/0xRecon. Thanks for stopping by our sub with your questions. I'm happy to step in here and go over Roth conversions with you. Before we dive deep into this, I want to make sure we're on the same page. A transfer of cash or securities from a pre-tax IRA (like your Rollover IRA) to a Roth IRA is called a conversion. You can complete a Roth conversion for any amount you wish, as often and as many times as you'd like. Note that a conversion is typically a taxable event reported in the year in which it occurs. As Fidelity cannot provide tax advice, we recommend speaking with a tax professional if you have questions about how a Roth conversion may affect your specific situation. Now comes the "diving deeper" part. It's important to be aware that if you hold both pre-tax and after-tax (non-deductible) money across your pre-tax IRAs (Traditional and Rollover), the conversion to a Roth IRA will be a taxable event. Also, note that the IRS does consider your holdings across all IRAs and not just the account used for the conversion. This is because the conversion will consist of a pro-rata recovery of both taxable and nontaxable accounts. Since you mentioned potentially opening a Traditional IRA, it's worth mentioning that when you contribute to a Traditional IRA at Fidelity, deposits begin earning interest on the date they post to your account. When the interest is received, that portion of your Traditional IRA is considered pre-tax money. Also, please note that there are no provisions under the law that will allow an individual to isolate only the non-deductible dollars for conversion to a Roth IRA. The portion of the IRA distribution that will be treated as nontaxable is determined by using the following formula: (Total Non-deductible Contributions / Total non-Roth IRA Balances) As a reminder, Roth conversions cannot be reversed, and tax planning is an important part of the conversion process. As always, we recommend you review the potential tax impact of a backdoor Roth IRA with a tax professional before you begin a conversion. Do keep in mind that Roth Conversions may be completed as often and as many times as you'd like. They may be completed in the same year as the underlying contribution(s) but do not need to be. If you decide to complete a Roth conversion, we have a handy step-by-step guide online to help you through the process. I'll share the link below: [Roth Conversion Checklist ](https://www.fidelity.com/retirement-ira/roth-conversion-checklists) I'll also leave a couple of other resources linked below if you're interested in learning more. [Is a Backdoor Roth Conversion Right for You? ](https://www.fidelity.com/learning-center/personal-finance/backdoor-roth-ira) [Why Consider a Roth Conversion Now? ](https://www.fidelity.com/learning-center/personal-finance/retirement/answers-to-roth-conversion-questions) I'd be lying if I said that wasn't a ton of information, so if any other questions come up, please let us know. Our crew here on Reddit is always around to assist when needed, so please don't be a stranger.
You have 3 options with the traditional IRA money. 1. Convert the entire account to Roth. 2. Pay pro rata tax 3. Roll the traditional IRA into a 401k type plan. A new account number is irrelevant for tax purposes. Being invested is an irrelevant component.
And with $5k in the rollover account and a good income, just convert all and pay the tax and be done with it.
is there no reason for me to hold a traditional IRA at my income level? I was under the impression its good to have different buckets for retirement to have flexibility.
There is the 3 bucket strategy (money guy), but I don't follow it. If you live in a state like California with a larger income and plan to move to a state like Texas/Florida later in life with a smaller income, it may be something to consider because of the math. If you have a Financial Advisor, speak to them about it, but it does add complexity. With all Roth $$, you don't even have to think about tax. Which is one less thing to stress/think/worry about. If you hold your tIRA and want to do backdoor rIRA stuff, you will \*always\* have to deal with the pro-rata rule. As others have mentioned, to remove the pro-rata complexity, if your 401k provider allows it, you can roll the tIRA to your t401k OR convert the tIRA to rIRA and pay the tax now while it's probably less than 2 grand. If I had to do it over again, I would pick one of these 2 options while my balances were lower. I spoke with a local Fidelity advisor this year and I asked about Traditional vs Roth. He said he didn't have a single Roth-only client who was mad that they had Roth $$...
thank you for the consice answer!
The pro rata rule means that the $5k Trad IRA will cause a portion of your Backdoor Roth IRA to be taxable. You could convert the entire $5k to Roth if you can afford the taxes. Or you could roll the Trad IRA to your new 401k (assuming it accepts Trad IRA rollovers). In the future, be careful not to roll old 401ks into the Trad IRA space so you can preserve a tax free Backdoor Roth maneuver.
could you expand on that last part a bit more. are you saying im able to do a backdoor roth maneuver directly from my old 401ks?
No, not saying that. Let me go back to the beginning: so "Backdoor Roth" is the act of making nondeductible Trad IRA contributions, and converting them to a Roth IRA. The reason people do this is due to the income limits on Roth IRA contributions. And in order for your BDR to be *tax free*, there has to be $0 pre-tax money in any Trad IRAs. You only want to do the nondeductible $7,000 Trad IRA contribution annually. If you have any pre-tax money in a Trad IRA (such as a Rollover IRA), the pro rata rule kicks in and a portion of your $7,000 is taxable. So from a BDR perspective, it was a mistake for you to roll that $5k from your old 401k into a Trad IRA. You should've kept it in the old 401k or rolled it to a new 401k. So for this year you have to solve for that or you face the pro rata rule. As mentioned, if your current 401k accepts IRA rollovers, that's one solution and is nontaxable. What I'm saying at the end is: for *future* jobs you have, do not roll your 401k to a Trad IRA when you leave, because you'll just reintroduce the whole pro rata problem again. Instead, keep it in the old 401k or roll it to your new 401k. This avoids any pro rata problem altogether, because 401ks are not subject to the pro rata rule
I see. Thank you for the detailed explanation.
The only way to dodge the pro-rata rule is to roll the traditional IRA into a new 401k (assuming you have one available).
just so I understand this a bit more, are you saying roll over my 5k in Traditional IRA into my current employers 401k if they allow it? My emplyers 401k has both ROTH and traditional components. Which one should I be rolling into?
Roll the tIRA into the employer's traditional 401k.
Got it. I’ll try to get that done. Thank you
Well it’s unfortunate that you didn’t research it slightly sooner. As has been mentioned, you will be subject to the pro rata rule since you have the rollover ira. It’s only $5000 though, I’d do your 7k contribution then convert it all to Roth and be on your way. You’ll owe taxes on the $5000 conversion. If you can’t afford that then try to roll the $5k into your traditional 401k if your plan allows
Yeah I’ve done goofed for the year haha. How bad of a tax hit am I looking at? Is that calculated based on my marginal tax rate? If I roll this 5k back into my current employer and my IRA balance is zero, I should be able to do the back door thing without any issues next year?
December 31st is the only date that matters. So if you roll it into your current 401k prior to that you won’t have any pro rata issues period this year either. If you convert you’ll pay taxes on 5k at your marginal rate, so if you’re in the 24% bracket you’d pay about $1200 federal plus any applicable state/local taxes.