Hi everyone and happy new year!
In 2023, I chose to pursue the Backdoor Roth IRA strategy because my income exceeded the Roth IRA income limit. My IRA is in Fidelity and I have never had an IRA before 2023.
On October 5, 2023, I contributed $6,500 to a traditional IRA. I converted the $6,500 as soon as the funds settled and I transferred the full amount to a Roth IRA which occurred on October 13, 2023. I went and looked at my accounts later, and on October 29, 2023, I had received a $10 dividend in my traditional IRA account because of the money market fund Fidelity automatically invests your money into.
My question is this: if I choose to pursue the Backdoor Roth IRA strategy again in 2024, how do I avoid the tax implications that come from the pro-rata rule given my traditional IRA already has a balance of $10 and will likely continue to grow. If I invest $7,000 of after-tax dollars in October 2024, and convert that to my Roth IRA, will I owe any taxes?
If that is the case, should I just withdraw this $10 I’ve earned now and take the 10% early withdrawal penalty? Would I owe any taxes if I do this given the money I contributed was after-tax dollars?
I apologize if something was not clear or did not make sense, this is all confusing but I appreciate any guidance anyone can offer.
Thanks!
Ah, the Backdoor Roth IRA maneuver – a classic move for high earners who want to slip into the Roth party after hours. Let's swing through the tax vines together on this one:
Pro-Rata Rule Jungle: The pro-rata rule is like a sneaky snake in the grass when it comes to Backdoor Roth IRAs. It slithers in when you have both pre-tax and after-tax dollars in any of your IRAs. The IRS will look at all your IRAs to determine how much of your conversion is taxable based on the proportion of pre-tax and after-tax dollars. But since you've only got a tiny $10 dividend, the tax impact should be minimal – it's like a mosquito bite, not a gorilla punch.
Avoiding Tax Vines: To dodge these tax implications in 2024, you'll want to convert any balance (like that $10) to your Roth IRA before you make your 2024 contribution. This way, you keep your traditional IRA balance at a clean $0 before the next contribution, avoiding the pro-rata rule's bite.
The $10 Dilemma: If you withdraw that $10 now, you're looking at a 10% penalty plus taxes on the earnings – not just the contribution. Since it's a dividend, it's considered earnings. But remember, we're talking about a banana peel here, not a whole bunch. The tax on a $10 dividend will be peanuts, and the penalty – a single dollar bill.
The 2024 Backdoor Swing: When you contribute your $7,000 in 2024, if you've cleared out any earnings from your traditional IRA, you should be able to convert it to your Roth IRA without owing taxes, since you've already paid taxes on the contributions.
In the grand jungle of retirement planning, always keep an eye out for the little critters (like dividends and earnings) that can affect your Backdoor Roth strategy. And remember, it's always a good idea to consult with a tax professional or financial advisor who can help you navigate these vines with precision. They're like the safari guides of the financial wilderness!
Sources: How much do you contribute to your 401k?, I cant save money, Retirement Planning for IB Analysts, The TAX CUT - How you plan to spent it
A $10 conversion seems strange but I do not see any reason you could not do it. Why don't you move the balance into the ROTH and pay the taxes.
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