Backdoor Roth IRA: Now Officially Supported by Congressional Intent?

rothheartIn 2010, the tax laws were changed to eliminate the income limits on conversions from Traditional IRAs to Roth IRAs. Since Roth IRAs still have income limits on direct contributions, this opened up a “backdoor” where high-income individuals could first contribute to a non-deductible Traditional IRA and then immediately convert to a Roth IRA. If there were no capital gains upon conversion, there would be no taxes due. Thus, the term “Backdoor Roth IRA”.

Some financial experts fretted about the legality of this move due to something called the step transaction doctrine. Some financial advisors instructed people to take special steps to help ensure the legitimacy of their Roth IRA conversions. You also have to be careful if you have other Traditional IRA accounts that you are not rolling over (“IRA aggregation rule”).

Even with all this discussion, there was never any official acknowledgement of this tax move. In past years, there were explicit budget proposals that would have curbed this option. Some argued that this talk itself was implicit acknowledgement that it was legal. Confused yet?

Apparently, the official acknowledgment finally came with the new tax law when they stopped allowing Roth IRA recharacterizations (undos). According to this Forbes article Congress Blesses Roth IRAs For Everyone, Even The Well Paid, a conference committee report by Congress included the following footnotes. Thanks to reader Abel for the tip.

268 Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA, as discussed below.

269 Although an individual with AGI exceeding certain limits is not permitted to make a contribution directly to a Roth IRA, the individual can make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA.

276 The provision does not preclude an individual from making a contribution to a traditional IRA and converting the traditional IRA to a Roth IRA. Rather, the provision would preclude the individual from later unwinding the conversion through a recharacterization.

277 In addition, an individual may still make a contribution to a traditional IRA and convert the traditional IRA to a Roth IRA, but the provision precludes the individual from later unwinding the conversion through a recharacterization.

Do these footnotes end all speculation? Ed Slott seems to think that this indicates “intent” by Congress, and he is a respected tax source. The same conclusion is also drawn by Natalie Choate in this Morningstar article.

Both my wife and I have made non-deductible Traditional IRA contributions every year since 2010. I think if it was really an “unintended loophole”, they would have closed it by now (as with Social Security benefits). I am not a tax professional, I’m just a guy who wishes we didn’t need experts to interpret every little thing. If there were any people who needed additional convincing, perhaps this will give them the confidence to proceed.

Comments

  1. hope we stop calling it “backdoor” ROTH IRA now. I prefer calling it as “2-step ROTH IRA” instead.

  2. Nice find! I just did my non deductible IRA contributions for 2017 and 2018, and the Roth conversion a week later. Good to know I’ve now got documented congressional intent to back it up!

  3. Great find. Thanks you.

    Could you provide simple instructions on how to do this with new contributions? We also have past Traditional IRAs and an old 401K we rolled over to a Traditional IRA that seem complicated in regards to ID’ing the basis and then converting to a Roth. But we would like to do this for new contributions. Thanks.

    • If you made pre-tax deductible contributions to a 401k or IRA, then I believe your basis is zero since you haven’t paid tax on anything yet. So if you put in $10,000 into a pre-tax deductible IRA or 401k and it grew to $15,000, then if you wanted to roll over to Roth IRA you’d have to pay taxes on all $15,000 as taxable income for that year. Does that make sense? That converted money then becomes Roth money and will no longer be tax upon qualified withdrawal.

      You’d have to decide if you wanted to pay those taxes now if you wanted to go through this 2-Step Roth IRA route for new money. (One alternative that some people do is roll over their pre-tax IRAs into a 401k plan that allows incoming transfers. That excludes the money from the IRA aggregation rule.)

      If you made a non-deductible traditional IRA contribution, you would have tracked the basis using Form 8606, as you would have already paid tax on the contribution.

  4. This is a great strategy for those who cannot otherwise make deductible traditional IRA contributions or ROTH contributions. But if you already have other traditional IRA accounts, watch out for the aggregation rule to avoid potential tax consequences.

  5. Jonathan, me and my wife file jointly and recently our MAGI exceeded the direct contribution to Roth IRA and also deductible IRA. So looked into Backdoor Roth. However, I have changed jobs in the past and have rolled my 401K to trad IRA, so contributing to Non-Deductible IRA and then converting to Roth (backdoor) is also blocked given that both my wife and I, have some traditional IRA’s. Not very inclined to move our Trad IRA into 401K just for this backdoor option. Wondering if there exist any other options? Do you or any of your reader know any option? Have been contributing to IRA for the past 20 years and feel being missed out when not contributing.

    Also, I see above you said you been doing non-deductible IRA contribution. I assume you do so and convert to Roth (backdoor). Or is it just plain non-deductible IRA? If so, do you see value in non-deductible IRA as opposed to a taxable account? I don’t see any advantage.

    Thanks
    Richard

    • I am in the same situation as Richard. Very interested to learn what options, if any, exist.

      Richard – Regarding your last question, the only benefit I see in making non-deductible IRA contributions over using a taxable account is the ability to delay paying income taxes on capital gains until you begin taking IRA distributions. Of course, with a taxable account Uncle Sam will take his share in the calendar years those gains are realized.
      However, non-deductible IRA contributions complicate things in that you have to track deductible vs non-deductible contributions in order to avoid “double-taxation” on your distributions (since you would have already paid taxes on a portion of your IRA contributions).
      For me, I’d rather keep it simple and utilize a taxable account. Plus, I can take advantage of tax harvesting during downturns.

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