17
Morningstar FundInvestor
December
2013
the low end of the phase-out range for married
couples ($
178
,
000
), and the total range is $
10
,
000
(the difference between $
178
,
000
and $
188
,
000
).
Her allowable Roth contribution amount will therefore
be docked by
20%
(her $
2
,
000
overage divided by
the total phase-out range of $
10
,
000
.) Thus, she can
make a $
4
,
400
contribution ($
5
,
500
reduced by
20%
) to a Roth in
2013
.
A complicated mess? You bet. Thus, if it looks like
you’re at risk for falling into the phase-out range, it
may well make sense to make a nondeductible
IRA
contribution and then convert to a Roth shortly there-
after because contribution limits don’t apply to either
maneuver. That way you’re avoiding the phase-out
range altogether, as well as the possibility of partial
contributions. This maneuver won’t be attractive if
you have other traditional
IRA
assets, however, for
reasons outlined in this article.
You noted in a previous article that if you have pretax
assets in an IRA, you can avoid taxes on your backdoor
Roth IRA by rolling those pretax IRA assets into your
new employer’s 401(k). But if the employer allows IRA
rollovers, does it matter if the rolled IRA is a mix of
deductible contributions and rollovers from a prior
employer’s 401(k)?
Opening a new nondeductible
IRA
and then con-
verting to a Roth
IRA
shortly thereafter (the backdoor
IRA
maneuver) won’t typically result in a tax bill—
unless, that is, you have other traditional
IRA
assets
that have never been taxed. If you have other tradi-
tional
IRA
assets, the portion of the conversion that
is taxable will be based on your ratio of
IRA
assets
that have been taxed (nondeductible contributions) to
those
IRA
assets that have never been taxed (monies
rolled over from traditional
401
(k)s, deductible con-
tributions, and investment earnings). For this reason,
the backdoor
IRA
conversion may not be a good
strategy for people with other traditional
IRA
assets,
such as rollovers from previous employers’
401
(k)s.
However, as you note, a possible workaround is to
roll pretax traditional
IRA
assets into a current
employer’s
401
(k). In so doing, you can effectively get
those monies out of your
IRA
kitty, thereby start-
ing with a clean slate with your new nondeductible
IRA
contribution.
In the past, the Internal Revenue Service made a
distinction between assets that got into an
IRA
because they were rolled over from a previous emp-
loyer’s
401
(k) plan and those that got into the
IRA
because the account owner contributed funds directly
to the
IRA
from the get-go. (The former was called
a
conduit
IRA
and the latter a
contributory
IRA
, and if
these two account types got mashed together, the
account was said to be
commingled
.) The
IRS
has
since relaxed that distinction, however. Now, if you
choose to do a reverse rollover—that is, move money
from your
IRA
to your employer’s
401
(k) because you
intend to do a backdoor
IRA
—you only need to make
sure of three things:
1
)
that your employer’s plan
allows such a transfer;
2)
that you’re contributing only
pretax
IRA
monies to the
401
(k) (you cannot move
aftertax
IRA
assets (that is, nondeductible
IRA
contri-
butions) into a
401
(k)); and
3)
that your
401
(k) plan
is a worthy receptacle for new assets.
I have an account, Account A, with traditional IRA
money. Could I open a new account, Account B,
and make use of the backdoor conversion option for
that account only and leave the Account A money
in the traditional account? Or is the IRS mixing both
accounts and mandating the tax regardless of which
account was converted?
As appealing as your strategy sounds as a means of
doing a tax-free backdoor
IRA
when you already
have other traditional
IRA
assets, the
IRS
“pro rata”
rule pertains to all of your
IRA
assets. Therefore, the
tax treatment of your new
IRA
—Account B—would
be based on the ratio of money that has never been
taxed in all of your
IRA
s relative to any aftertax
monies in all of your
IRA
s. Assuming you put $
5
,
500
of aftertax dollars into Account B but had $
100
,
000
in pretax dollars in Account A, your conversion of
Account B would be more than
95%
taxable, because
more than
95%
of your total
IRA
assets have never
been taxed.
œ
Contact Christine Benz at
