Timing on Back Door Roth IRA Contributions & Conversions
If you're looking to do a backdoor Roth IRA conversion, timing is crucial, especially if you're concerned about the IRS Form 8606, which reports nondeductible contributions to traditional IRAs.
Why You Can't Do a Backdoor Roth IRA Conversion the Year After Filing Form 8606
The issue arises because the backdoor Roth IRA conversion process requires you to meet specific timing and tax rules. Here’s a breakdown of the key points:
Pro-Rata Rule: When you convert funds from a traditional IRA to a Roth IRA, the IRS uses the "pro-rata rule" to determine the amount of taxes owed on the conversion. The rule requires you to consider all traditional IRA balances (including SEP and SIMPLE IRAs) as of December 31 of the year you convert. If you delay the conversion until the next year, it might affect your tax calculations because all of your traditional IRA balances will be considered for that year.
Contribution Year vs. Conversion Year: If you made a nondeductible contribution to a traditional IRA in one tax year but don’t convert it to a Roth IRA until the following year, the conversion technically occurs in a different tax year. This could lead to complications in reporting on Form 8606, as that form reports the contribution and conversion in the same tax year.
Taxable Income Impact: Delaying the conversion to the following year may inadvertently increase your taxable income if you have other IRA balances subject to the pro-rata rule. This can increase your tax burden on the conversion.
Timely Reporting: When you file Form 8606 for a specific tax year, the IRS expects you to accurately report nondeductible contributions and any conversions that occurred during that same year. A mismatch between the contribution and conversion year can cause confusion, errors, or potential tax penalties.
To avoid these issues, it's generally best to make your nondeductible contribution and complete the Roth conversion within the same calendar year. This keeps things simple for tax reporting purposes and minimizes the impact of the pro-rata rule.