backdoor roth pro-rata question

[CptCool]

Hi,

Due to some not-so-smart decisions (followed by a lot of procrastination) I realized my vanguard roth contributions for 2017 I made early in the year are over the acceptable limit.

I was hoping to do a backdoor roth instead, but have never been in this situation before. My vanguard account currently contains traditional IRA that is non-taxed.

If I were to open an IRA and roth IRA at Schwab (or any other non-vanguard brokerage), contribute 5500 to the IRA, then transfer the 5500 to the roth, would that be ok? Or does the pro-rata rule count all IRA holdings at all brokerage firms?

[jlcnuke]

I'm confused, are you thinking that doing a backdoor Roth will eliminate your over-contributions to your IRA? The contribution limit doesn't go up by doing a backdoor Roth.. or are you saying you weren't eligible for it? If it is just an eligibility problem, recharacterize it to a traditional contribution then backdoor Roth it. (Note, the ability to recharacterize roth back to traditional is going away, so be wary in the future. I'm "pretty sure" it's still allowed for 2017 tax year though, you might want to check though.

The pro-rata rule though does apply to all IRAs in your name, not just the specific one you're doing the backdoor Roth from.

You may want to look at this though for your over-contribution amounts https://investor.vanguard.com/ira/excess-contribution

[CptCool]

I'm confused, are you thinking that doing a backdoor Roth will eliminate your over-contributions to your IRA? The contribution limit doesn't go up by doing a backdoor Roth.. or are you saying you weren't eligible for it? If it is just an eligibility problem, recharacterize it to a traditional contribution then backdoor Roth it. (Note, the ability to recharacterize roth back to traditional is going away, so be wary in the future. I'm "pretty sure" it's still allowed for 2017 tax year though, you might want to check though.

The pro-rata rule though does apply to all IRAs in your name, not just the specific one you're doing the backdoor Roth from.

You may want to look at this though for your over-contribution amounts https://investor.vanguard.com/ira/excess-contribution

Sorry, I forgot to mention that I will be removing my over-contribution at vanguard. Looks like it'll just have to go into taxable investments instead

Based on the bold above you did answer my question, thank you!

[terran]

If I were to open an IRA and roth IRA at Schwab (or any other non-vanguard brokerage), contribute 5500 to the IRA, then transfer the 5500 to the roth, would that be ok? Or does the pro-rata rule count all IRA holdings at all brokerage firms?

All IRAs are considered one, so it doesn't matter if you open at a different brokerage, you'll still need to consider all of your IRAs, so any traditional to Roth conversion will be considered to have come from after tax and pre tax in proportion to the balance of each. I believe it's form 8606 where you would see the effect of this in terms of how much of your conversion would be taxable.

Note, the ability to recharacterize roth back to traditional is going away, so be wary in the future. I'm "pretty sure" it's still allowed for 2017 tax year though, you might want to check though.

This isn't quite right. Recharacterizations of Roth contributions (as is the case for the OP) will continue to be allowed. What will no longer be allowed is recharacterization of Roth conversions. The biggest strategy this will invalidate is the "Roth conversion horse race" where one converts several different asset classes, sees which does best after the conversion, then recharacterizes the others. It will also mean that those making taxable conversions (such as those in retirement creating a roth conversion ladder) will need to be more careful not to over-convert before they have a good idea of what their income from other sources will be.

You're right that conversions made in 2017 can still be recharacterized until the tax filing deadline.

[jlcnuke]

If I were to open an IRA and roth IRA at Schwab (or any other non-vanguard brokerage), contribute 5500 to the IRA, then transfer the 5500 to the roth, would that be ok? Or does the pro-rata rule count all IRA holdings at all brokerage firms?

All IRAs are considered one, so it doesn't matter if you open at a different brokerage, you'll still need to consider all of your IRAs, so any traditional to Roth conversion will be considered to have come from after tax and pre tax in proportion to the balance of each. I believe it's form 8606 where you would see the effect of this in terms of how much of your conversion would be taxable.

Note, the ability to recharacterize roth back to traditional is going away, so be wary in the future. I'm "pretty sure" it's still allowed for 2017 tax year though, you might want to check though.

This isn't quite right. Recharacterizations of Roth contributions (as is the case for the OP) will continue to be allowed. What will no longer be allowed is recharacterization of Roth conversions. The biggest strategy this will invalidate is the "Roth conversion horse race" where one converts several different asset classes, sees which does best after the conversion, then recharacterizes the others. It will also mean that those making taxable conversions (such as those in retirement creating a roth conversion ladder) will need to be more careful not to over-convert before they have a good idea of what their income from other sources will be.

You're right that conversions made in 2017 can still be recharacterized until the tax filing deadline.

Good catch, thanks for the clarification :)

[MDM]

Looks like it'll just have to go into taxable investments instead.

Using taxable may well be the best option.

But it does depend on the amount of pre-tax money sitting in tIRAs now, relative to the amount of backdoor Roth contributions you would like to make in years to come.

And that's if you have no option to roll the pre-tax IRA money into a 401k or 403b.

[CptCool]

As a follow-up to this, I have another question. I contacted Vanguard over the phone and told them I over-contributed to my Roth for tax year 2017 and wanted to remove my entire contribution and any related gains. They sent me a form, I filled it out & waited as it couldn't be processed until Monday (yesterday).

I took a look this morning and noticed that Vanguard is reporting it as the full $5,500 contribution in 2017 and $5,500 + nominal gains as a distribution in 2018. Is this correct? Shouldn't this be a return of contribution instead? As is, I will have to amend my tax return because I wasn't expecting the reporting to be done this way.

[MDM]

As is, I will have to amend my tax return because I wasn't expecting the reporting to be done this way.

What did you expect for the reporting?  Based on what IRS publication guidance?

This is a tricky area....

[CptCool]

As is, I will have to amend my tax return because I wasn't expecting the reporting to be done this way.

What did you expect for the reporting?  Based on what IRS publication guidance?

This is a tricky area....

Well I haven't received a 1099-r for it since it was just done yesterday, but I assumed that they would fill out box 7 of the https://www.irs.gov/pub/irs-pdf/f1099r.pdf with code 8 which is defined as "Excess contributions plus earnings/excess deferrals (and/or earnings) taxable in 2017". The contribution was made in Feb 2018 and withdrawn in April 2018 before filing taxes. I included the ~$100 or so of earnings I had as taxable income this year & reported $0 in IRA contributions for 2017.

However, since the vanguard website is showing it as a distribution in 2018 with a full $5,500 contribution in 2017, I'm guessing they'll code it as something different, such as code 7 "Normal distribution". I have no idea how that is supposed to be reported for tax purposes, but I bet it's different from the way I did it

[MDM]

As is, I will have to amend my tax return because I wasn't expecting the reporting to be done this way.

What did you expect for the reporting?  Based on what IRS publication guidance?

This is a tricky area....

Well I haven't received a 1099-r for it since it was just done yesterday, but I assumed that they would fill out box 7 of the https://www.irs.gov/pub/irs-pdf/f1099r.pdf with code 8 which is defined as "Excess contributions plus earnings/excess deferrals (and/or earnings) taxable in 2017". The contribution was made in Feb 2018 and withdrawn in April 2018 before filing taxes. I included the ~$100 or so of earnings I had as taxable income this year & reported $0 in IRA contributions for 2017.

However, since the vanguard website is showing it as a distribution in 2018 with a full $5,500 contribution in 2017, I'm guessing they'll code it as something different, such as code 7 "Normal distribution". I have no idea how that is supposed to be reported for tax purposes, but I bet it's different from the way I did it

The $100 probably should not have been included as 2017 income, but rather as 2018 income.  E.g., see IRA Reporting: Excess Contributions and Recharacterizations.  You might call Vanguard between now and October to learn how they plan to report it, and perhaps decide if you want to file an amended return.  Depends on the value of your time vs. the tax paid on that $100, that you may also have to pay for the 2018 tax year when the 1099-R comes in.