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A few years ago I began doing backdoor Roth contributions. Up until that point I had done traditional Roth contributions only. I contacted my IRA account holder Vanguard and asked some questions about the process. I was told that the existing (traditional) IRA account would have to get completely converted to a Roth. They said I could not make a $6000 contribution to it and then roll only that amount over.

I stated I didn't want to pay the tax hit on the whole thing. I only wanted to do current and future year contributions this way. Vanguard's solution was to roll my existing traditional IRA out of their system entirely and into my traditional 401k account. Which I did. Then my traditional IRA account had a balance of $0.00. Finally, I made a traditional contribution of the $6,000 and rolled the entire account over to a Roth account. I've done this a few years in a row now.

Oddly in my conversations with Vanguard they stated that I couldn't roll my IRA to another provider. They said I literally could not own ANY traditional IRA with any balance and do a Roth conversion. This made no sense to me but I didn't have any other IRAs so I didn't worry about it.

Fast forward three years and I've discovered my credit union has a savings account tagged as an IRA in my name. It has only $40 in it and I didn't even remember it was there. I got a "fair market value" letter for tax purposes this year. There's nothing to file as it made no interest and had no distributions. The account has been there 10+ years.

Was what Vanguard told me correct? If so was I not allowed to do a Roth conversion? What should I do with this account? It's literally only $40 so I don't care if the account goes away or if I lose what is there. Just don't want to be in violation on all the conversions I have done.

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I was told that the existing (traditional) IRA account would have to get completely converted to a ROTH. They said I could not make a $6000 contribution to it and then roll only that amount over.

They probably didn't say "have to", because that wouldn't be true. But "should" definitely is. Having a balance in traditional IRA (especially if it was from a deductible contribution) affects the calculations of non-taxable conversion (and makes it somewhat taxable).

They said I literally could not own ANY traditional IRA with any balance and do a ROTH conversion.

That is (kindof) correct. It doesn't matter how many IRA accounts you have with how many custodians, from the IRS perspective they're all bundled together into one. So you can do Roth conversion, you'd just need to take the balance of all your traditional IRAs into account and report the total on your form 8606.

If so was I not allowed to do a ROTH conversion?

You were allowed, but you should have included that balance in your calculations and prorated the total 6040. But in this case the amount is relatively negligible. I suggest to immediately roll that $40 in to your Roth IRA, report it as taxable conversion, and hope the IRS wouldn't audit you for the past years. Just the calculations and the reporting would cost you (and the IRS) more than the extra tax liability.

But if the IRS does notice and comes for you - you'll have to amend the last 3 years and pay the extra tax (which would really be immaterial, but there's no such concept in the IRC).

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  • I guess that makes sense. And I've only messed up taxes on this small balance. Since it is a separate institution and will require some forms and effort to transfer/rollover, would it make sense to just withdraw this $40 and pay whatever taxes arise from that? If a rollover is indeed better should I transfer it to my traditional IRA with Vanguard, contribute another $5940 to that traditional account, and then backdoor the whole thing to the ROTH?
    – Paul
    Commented Feb 6, 2022 at 23:00
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    @Paul you can withdraw it, and then contribute $40 to vanguard traditional IRA. As long as you make it within 60 days from the withdrawal it is considered an indirect rollover and there are no taxes and penalties. You can do an indirect rollover once per year. Why waste perfectly good $40 retirement contribution?
    – littleadv
    Commented Feb 6, 2022 at 23:07
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Yes, you can, but it won't help you.

In a nutshell, for the IRS, all your IRAs (at any company) are one big pot. If you pay 6000 in any IRA, it always goes in the pot, and gets mixed completely immediately.

As a result, when you convert 6000 to Roth even a millisecond later, it will be a (proportional) mixture of the older pre-tax money and the newer post-tax money, and the pre-tax money will be taxable when converted. You will owe taxes on some of the conversion - and you will have some post-tax money left in your IRA (which converts tax-free to Roth in the future). But you will need to keep track of it with form 8606.

It will always be a proportional mixture, until all your IRAs are empty at the end of a year.

Overall, you don't lose any taxes, but it's a pain to track every year with the 8606, and if you ever forget it, you pay double tax on that amount.

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