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Let's say you have $5,000 in a deductible traditional IRA. You want to contribute $5,000 to a backdoor Roth IRA so you open a non-deductible traditional IRA and fund it with $5,000 to convert to a Roth IRA.

According to the pro-rata rule, you have a total IRA balance of $10,000 with a 50/50 split between pre-tax and post-tax money. As such, you must pay taxes on 50% of the converted amount i.e. $2,500 in this example.

What isn't clear to me is what happens to the post-tax and pre-tax balances after this conversion takes place. On the one hand, you have now paid taxes on $2,500 of the pre-tax money, so it seems to me that that portion of the distribution is coming from the pre-tax IRA in order to maintain the existing proportion of post-tax vs. pre-tax funds. On the other hand, you are doing a conversion of the post-tax IRA, so it seems to me that the full amount is coming from the post-tax IRA.

Would the post-conversion balances look like 'A' or 'B'?

A. Funds are distributed only from the post-tax balance being converted:

  • Deductible IRA: $5000
  • Non-Deductible IRA: $0
  • Roth IRA: $5000

B. Funds are distributed such that pre-tax/post-tax balances remain proportional:

  • Deductible IRA: $2500
  • Non-Deductible IRA: $2500
  • Roth IRA: $5000

Case 'A' seems like it would result in double taxation -- you are paying taxes on $2,500 of the already post-tax funds for the conversion and still owe taxes on the $2,500 from the pre-tax IRA that applied to the pro-rata calculation.

5

The post-conversion balances would look like A:

  • Deductible IRA: $5000
  • Non-Deductible IRA: $0
  • Roth IRA: $5000

The brokerage has no idea how much of your IRAs are deductible, and are just going to do what you ask (i.e. convert $5000 from account X to account Y). Plus you could have IRAs at other brokerages that they aren't even aware of.

However, this won't result in double taxation, because regardless of your IRA balances, you still have a non-deductible basis of $2500 (see Form 8606). So if you were to immediately do another $5000 conversion, you would only owe income tax on $2500 of that, even though you are technically converting entirely from what you are considering as a "deductible" IRA.

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  • I think what you're describing is actually B. – user102008 Nov 30 '19 at 19:47
  • @user102008 I guess it depends on if you mean the nominal balances or the "virtual" balances. If you log in to your brokerage, you're certainly going to see A. But B would be a more realistic representation of where you stand, tax-wise. – Craig W Nov 30 '19 at 19:51
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    @CraigW: But brokerage accounts do not say "deductible" or "non-deductible", because whether it is deducted is determined by what you do when you file taxes, which the brokerage does not know about. So that interpretation would only make sense if they meant "account 1 whose money I know came from a deductible contribution" and "account 2 whose money I know came from a non-deductible contribution". – user102008 Nov 30 '19 at 22:28
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    @user102008 Well in that case neither A or B is technically correct. But I think it's reasonable to use OP's account names. – Craig W Nov 30 '19 at 22:35
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    My intent was that "Deductible IRA", etc. under the cases would represent the individual brokerage accounts, so 'A' would be correct. The point I was missing is that the tax implications of contributions and deductions are decoupled from the actual brokerage account so my wording in the question is a bit ambiguous because of this. – David Anderson Dec 1 '19 at 16:10
2

B is correct. Your converted portion consists 50/50 of pre-tax and after-tax funds, so you converted $2500 of pre-tax funds and $2500 of after-tax funds, and what remains in your Traditional IRA therefore consists of $5000-$2500=$2500 pre-tax funds and $5000-$2500=$2500 after-tax funds.

All of the money in Traditional IRAs are considered together for the pre-tax/after-tax purposes, no matter how you divide them into accounts. This is the IRA aggregation rule. So it doesn't matter if you make the after-tax contribution into a different "account" than your existing pre-tax funds; they will be mixed. The pre-tax/after-tax character is not applied to money in a particular account -- but money in your Traditional IRAs overall. So there is no such thing as a "post-tax IRA account" or "pre-tax IRA account". You just have 2 Traditional IRA accounts, converted the money from one of them, and the money in the other account remains, but that remaining money is split 50/50 into pre-tax and after-tax parts. It would make no difference which of the two accounts you used the money from to make the conversion -- the two accounts are treated the same -- they are both part of your Traditional IRA.

When you fill out Form 8606, you will see that the basis in Traditional IRA (the after-tax amount) at the end is $2500.

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