One way to avoid the pro-rata rule. The pro-rata rule is an important, though commonly misunderstood, rule that affects the taxation of IRA money. the balance on your traditional IRA on Dec 31. I currently have 22K in a SEP-IRA at American funds, I want to start doing the backdoor Roth next year, but avoid paying any unnecessary taxes via the pro rate rule. Click the Accounts tab at the top of the page. How to Avoid the Pro-Rata Basis Rule . So if I had a 401k with 10% Roth and 90% Traditional. Now for the bad news: you will be subject to the “pro-rata” rule if you have a balance in a pre-tax IRA as of 12/31 of the year that you make a backdoor Roth conversion. In this case, you would be subject to the Pro Rata rule since there was already money in the traditional IRA. Given that the pre- and post-tax funds were at no time co-mingled in the same account, and that the pre-tax funds were deposited after a conversion had already taken place and the account zeroed out, would there be any basis for pro rata solely given the fact that the event happened to have occurred in the same calendar year? Distributions sent to multiple destinations at the same time are treated as a single distribution for allocating pretax and after-tax amounts (Notice 2014-54). Avoiding the Pro-rata rule on a SEP while doing a backdoor roth 10-17-2018, 09:12 PM. So my questions relate to allowed workarounds to avoid the pro-rata rule. If you do, the government will treat it as if you converted over $5k of the non-deductible assets and $5k of the deductible assets. It only comes into play when your traditional IRA consists of both pre-tax and after-tax monies. The important thing is that the amount you converted to Roth is no less than your total basis in nondeductible traditional IRA contributions, otherwise rolling the balance of your traditional IRAs over to the 401(k) will impermissibly include some of your basis. The IRS requires rollovers from traditional IRAs to Roth IRAs to be done pro rata. A reminder that when it comes to taxes, you can’t rely on what you think might be the case – details and specific wording matter. You don't need to pay anything for the Pro Rata Rule because the $5k contributed to Roth is seen as 100% post-tax. You may request: • A direct rollover of $80,000 in pretax amounts to a tra… This is the rule that says you need to empty out your traditional IRA by December 31st of the year you do the conversion. Step 3 Beware of the Pro-Rata Rule Get rid of any SEP-IRA , SIMPLE IRA , traditional IRA , or rollover IRA money. Don't know on this ... let us see if @dmertz  can                    weigh in on this matter. We want to hear from you and encourage a lively discussion among our users. To avoid the pro rata rule, you have three options, all of which involve getting rid of the IRA. If you find discrepancies with your credit score or information from your credit report, please contact TransUnion® directly. However, the pro rata rule can prevent you from simply converting just the $6,500. Later in 2020 - Your traditional IRA increases from investments by $1k. There is only one real risk with this approach, the pro-rata rule. The pro-rata basis rule does not apply if you have all your other retirement money in a 401(k) plan.   You could then, each year, make a nondeductible IRA contribution, and assuming you immediately convert it to a Roth, the full amount of the conversion will be considered the basis. Possible workaround actions:: 1) My workplace 401K does allow for a reverse roll over of my Rollover IRA and Roth IRA. previous article on Backdoor Roth IRA Conversions, The Best Online Brokers for Stock Trading, Power Trader? See the Best Online Trading Platforms, New Investor? In order to avoid Pro Rata Rule complications, though, this option (to roll the funds rolled-in to an employer-sponsored retirement plan back out at any time) cannot be exercised until the calendar year after the left-behind-after-tax-IRA funds are converted to a Roth IRA. Most retirement accounts require withdrawals in retirement to be taxed as ordinary income. When you converted all of your Traditional assets you left the account empty. The $5,000 that appears on line 14 of the 2019 Form 8606 transfers to line 2 of the 2020 Form 8606. However, this calculation is done on a pro-rata basis and is subject to the aggregation rule. All conversions done in a year are considered. By way of an example: post-tax contributions subject to IRS limitations were deposited into a traditional IRA account in May of a calendar year; after which, the entirety of the balance was converted and moved to a separate Roth account, reducing  the traditional IRA account balance to $0. If you do, then the portion that you convert to the Roth has to be prorated over the total amount you have in all your traditional IRAs, SEP IRAs, and Simple IRAs. The question is: what tactics can we use to roll over her IRA to a 401k to "wipe the slate clean" and avoid the pro rata rule when making backdoor Roth contributions? So, you have a balance of $12,000, and a non-deducted basis of $2,500. Avoiding The IRA Aggregation Rule Via 401(k) And Other Employer Retirement Plans. Now for the bad news: you will be subject to the “pro-rata” rule if you have a balance in a pre-tax IRA as of 12/31 of the year that you make a backdoor Roth conversion. Use a reverse rollover to avoid the pro rata rule. 2. The easiest way to avoid dealing with this rule is to have a zero balance in all traditional IRAs, SEP IRAs, and SIMPLE IRAs . The short answer is no, you cannot do this. This means you can roll over all your pretax amounts to a traditional IRA or retirement plan and all your after-tax amounts to a different destination, such as a Roth IRA. I am trying to figure out how could I using excel calculate pro-rata split. Let's use the amounts $15k originally in traditional (pre-tax) and added $5k (post-tax). The pro-rata calcu­lation is not based on the balances in the IRAs on the date of the conversion. There is only one real risk with this approach, the pro-rata rule. Instead, the pro-rata calculation is … To avoid paying taxes for the Backdoor Roth conversion we did for 2015 and in the future, do you guys suggest that we "roll-in" the Rollover IRA to my current 403b therefore effectively removing those assets from consideration for the pro-rata rule? If you already have a traditional IRA to which you made tax-deductible contributions, make sure to follow the pro-rata rule. And the way to ensure that is to roll the pre-tax funds out of your IRA, and into the employer-sponsored plan, if it accepts rollovers into the plan. I had assumed that this would trigger the pro rata rule. This information may be different than what you see when you visit a financial institution, service provider or specific product’s site. The pro-rata rule. Example: You withdraw $100,000 from your plan, $80,000 in pretax amounts and $20,000 in after-tax amounts. The barrier to the backdoor Roth—in many folks’ minds—is the pro rata rule. So if I had a 401k with 10% Roth and 90% Traditional. Try sneaking in the backdoor, A Step-by-Step Guide to the Backdoor Roth IRA for High Income Earners. The 2020 Form 8606 will also show $0 on line 6 and $5,000 on line 8, resulting in all $5,000 of basis being applied to the $5,000 conversion. Timing Roth IRA Conversions: Avoid pro-rata rule by later opening separate account? 2. Please help us keep our site clean and safe by following our, Prevent identity theft, protect your credit, The difference between term and whole life insurance, How medical conditions affect your life insurance rate. If you move $5k into the Roth IRA, that means $3.75k (75%) was pre-tax and $1.25k (25%) was post-tax, meaning you would need to pay taxes on the $3.75k. Investing the Traditional IRA in Long-Term Assets and Letting It Sit. However, this does not influence our evaluations. I also want to switch everything over to vanguard. All financial products, shopping products and services are presented without warranty. A few months later - $5k is contributed to the traditional IRA through a 2019 (prior year) nondeductible contribution. (Not sure if it matters that the contribution was for 2019 vs 2020 tax year). Have a question about investing or retirement? The pro-rata rule. Unfortunately, the IRS pro-rata rule applies to all money across ALL accounts, so you can’t get around it by opening a new separate account at a different company. The Internal Revenue Code’s (IRC) pro-rata rule prevents you from being able to simply distribute or convert only the after-tax amount (basis) or before-tax amount. Joanna D. Pratt, CFA is an experienced institutional investor. The Pro Rata rule requires that IRA withdrawals contain a proportionate amount of both the pre-tax and the after-tax amounts in the account. To avoid the pro-rata rule, you can either: 1. Say you have money in a traditional IRA and attempted to do the Backdoor Roth conversion (put post-tax money into that Traditional IRA, then convert it to a Roth IRA). Like Like 2. And one should consider that the conversion step of the backdoor Roth is no longer reversible. The pro rata rule requires that a taxpayer include all IRA assets when determining the taxes due on a Roth conversion. The remaining money in your traditional IRA is $15k (11.25k pre-tax, 3.75k post-tax). Log in to your account on a web browser. If you already have a traditional IRA to which you made tax-deductible contributions, make sure to follow the pro-rata rule. Since you already moved $5k into the Roth IRA, i. roll the pre-tax funds into an employer                    401k to bring the traditional IRA balance down to $0? Later that year in November, funds from a qualified account (e.g., a 401k rollover ) were deposited into that same Traditional IRA such that the entirety of the balance was now sourced solely from pre-tax funds because the Roth conversion had already taken place earlier that year. NerdWallet strives to keep its information accurate and up to date. But assuming that you can, yes, you can later split the rollover with the pre-tax money going to a traditional IRA and the post-tax money going to a Roth IRA. So, the task - there are certain number of units to be sold to various customers. Calculate the total balance of all after-tax dollars in all of your … For tax purposes, the distributions from the traditional IRA are treated as if they occurred simultaneously on December 31. Disclaimer: NerdWallet strives to keep its information accurate and up to date. This will save you from having to undo things in the case that the rollovers are not accepted. 2. The barrier to the backdoor Roth—in many folks’ minds—is the pro rata rule. Growth is treated as deducted for this calculation. The only way to circumvent the IRA aggregation & pro-rata rules is to ensure that 100% of your IRA contributions are non-deductible ones. Property and Casualty insurance services offered through NerdWallet Insurance Services, Inc.: Licenses, NerdWallet Compare, Inc. NMLS ID# 1617539, NMLS Consumer AccessLicenses and Disclosures, California: California Finance Lender loans arranged pursuant to Department of Financial Protection and Innovation Finance Lenders License #60DBO-74812. To avoid the pro-rata rule, you can either: 1. However with the pro-rata rule, my taxable income on the conversion amount would be much higher; if I didn’t have the Fidelity Rollover Account. Would I have to open a new account or can I put the new money in the same empty Traditional IRA that I rolled over earlier in the year?   You could then, each year, make a nondeductible IRA contribution, and assuming you immediately convert it to a Roth, the full amount of the conversion will be considered the basis. Would you just be taxed on the 15k the same as if it was all done in one transaction, and do any gains affect this? If that money is always there, then I'll always be subject to the pro-rata rule, no? But this question is less about the math and more about language. The IRS requires rollovers from traditional IRAs to Roth IRAs to be done pro rata. So if you have $5k in a non-deductible Traditional IRA at Fidelity and $5k in a non-deductible Traditional IRA at Vanguard and $10k in a deductible IRA at Schwab, the government only views this as $10k non-deductible and $10k deductible in a Traditional IRA. Total up all after-tax dollars in IRAs. The rule says that you have to aggregate all your IRAs to determine how … If you are trying to avoid pro-rata taxation, you should wait until the pre-tax TIRA balances have completed their moves into employer 401k accounts. Sure, she could get a "corporate job" with a traditional 401k and roll over into that. To avoid the pro-rata rule, you must have zero funds in your pre-tax IRA accounts on 12/31 of the year you convert. For example, if you have an IRA and 50% of it is after-tax money, half of your distribution would be subject to taxes. Example: You withdraw $100,000 from your plan, $80,000 in pretax amounts and $20,000 in after-tax amounts. Auto-suggest helps you quickly narrow down your search results by suggesting possible matches as you type. Dec 31, 2020 - There is $0 in all of your traditional IRAs. All you need to do is complete that rollover before year end and that balance will not be counted for pro rate calculation. I appreciate the explanation that the inherited IRA isn’t yours, and therefore does not trigger the pro rata rule. Thanks so much for taking the time to weigh in @Critter-3 and @dmertz! Premier investment & rental property taxes. The good news is that there may be a way to avoid this. Let's use the amounts $15k originally in traditional (pre-tax) and added $5k (post-tax). However, later on in the same year, you want to avoid / minimize the taxes from the Pro Rata rule, since the rule is based on the balance on your traditional IRA on Dec 31. Click on Settings in the menu on the left-hand side of the page. It may be easier to calculate taxes owed if you never co-mingle non-deductible and deductible assets, but it’s not technically necessary to have separate accounts. When the pro rata rule … But we are not interested in doing that now (she is a SAHM for our three young kids). What confuses people, however, is the pro-rata rule. No retroactive consequences. For those less familiar with Backdoor Roth IRAs, the pro rata rule states that if you convert any Traditional IRA assets (Traditional IRA, Simple IRA, SEP IRA) to a Roth IRA, that you cannot select to rollover only the non-deductible assets and leave the deductible assets in the Traditional IRA. Reverse Rollover. the pro-rata rule but are not included in the pro-rata calculation for your own Traditional IRAs. If there are, roll over existing pre-tax IRAs to a 401(k) (if available) to avoid the IRA aggregation rule Contribute to non-deductible IRA (if eligible) Invest funds in the non-deductible IRA The after-tax amounts are called 'basis.' Given that $5k was already "rolled over" into a Roth IRA earlier in the year: Since you already moved $5k into the Roth IRA, i. roll the pre-tax funds into an employer 401k to bring the traditional IRA balance down to $0? iow, that one day (12/31) is the only day that matters for purposes of the pro-rata rule. Great question. Ask An Advisor here. These after-tax dollars can come from non-deductible IRA contributions or rollovers of after-tax funds from employer plans. NerdWallet’s recommended IRA account providers, Income Too High for a Roth IRA? This information may be different than what you see when you visit a financial institution, service provider or specific product’s site. Many or all of the products featured here are from our partners who compensate us. However with the pro-rata rule, my taxable income on the conversion amount would be much higher; if I didn’t have the Fidelity Rollover Account. Convert your current pre-tax IRA into a Roth IRA, 2. I also want to switch everything over to vanguard. Thank you to Russell Herdman for his contributions to this article. However, if your 403b plan does not accept IRA rollovers you could recharacterize the conversion and eliminate the tax bill under the pro rate rules. When they say you must convert “all” or a portion of “all” of your Traditional IRA assets, does that mean all at the time you did the conversion or all at any point during the tax year? For 2020 Tax year - For tax purposes when filling out Form 8606, you need to pay $0 for the $5k that gets put into the Roth IRA. You will need to fill out this form when contributing to or rolling over nondeductible IRA assets. In the case of a 401K with mixed pre and post tax money, whether it is because of a Roth 401K or after tax contributions for an in-service rollover, withdrawing funds has to be done in proportion to the funds in the accounts. Dec 31, 2020 - The Roth IRA now has $5010 after interest (I don't think this is relevant). No retroactive consequences. Pre-qualified offers are not binding. The answer is the latter. The Pro Rata rule requires that IRA withdrawals contain a proportionate amount of both the pre-tax and the after-tax amounts in the account. I currently have 22K in a SEP-IRA at American funds, I want to start doing the backdoor Roth next year, but avoid paying any unnecessary taxes via the pro rate rule. Because all of your IRAs are treated as one account, you generally cannot segregate the after-tax … The pro-rata rule is an important, though commonly misunderstood, rule that affects the taxation of IRA money. In the case of a 401K with mixed pre and post tax money, whether it is because of a Roth 401K or after tax contributions for an in-service rollover, withdrawing funds has to be done in proportion to the funds in the accounts. If you already have a traditional IRA to which you made tax-deductible contributions, make sure to follow the pro-rata rule. The short answer is no, you cannot do this. It doesn't matter that the conversion was don in two separate parts.