Your ability to contribute to a Roth IRA or receive a deduction for traditional IRA contributions is restricted as your income goes beyond a certain threshold. However regardless of your income level, you are still allowed to make a nondeductible contribution to your traditional IRA.

Making a nondeductible contribution to your traditional IRA and then converting it to a Roth IRA is known as a “backdoor Roth” because if you do it correctly 100% of your Roth conversion will be after-tax and thus not taxable.

However, if you already have a pre-tax traditional IRA balance, each distribution or conversion is taxed pro-rata after-tax and pre-tax based on the size of your IRAs and the size of your nondeductible basis. This complicates the backdoor Roth strategy, although its benefits still remain for many.

The analogy is: Like you can’t take a sip of your coffee without getting part coffee and part cream so too you can’t withdraw from your IRA assets without getting part traditional and part nondeductible.

Along these lines, I received the following question at the end of last year:

On November 14, I initiated a lump sum rollover of my pension with the plan of depositing into my IRA in a qualified rollover. Unfortunately, after submitting the paperwork, I remembered that I had done a backdoor Roth this year. Is there anything I can do to avoid messing up my backdoor Roth contribution?

Depending on how you initiated the lump sum rollover, you may be in luck. A rollover from your pension plan (or other non-IRA qualified retirement plan) initiated in 2024 through a 60-day rollover contribution (a check made out to your name and not your IRA) could be deposited in the new year and not interfere with your backdoor Roth. Any other circumstance gets caught as counting towards your December 31 reconstituted IRA balances and would interfere.

The reasoning, for those interested, is as follows:

While Form 8606 Line 6 uses “value of all your traditional, SEP, and SIMPLE IRAs as of December 31, plus any outstanding rollovers” (emphasis added), the definition of “outstanding rollovers” does create an opening for your pension rollover. In the Form 8606 instructions , it says, “For purposes of line 6, a rollover is a tax-free distribution from one traditional, SEP, or SIMPLE IRA that is contributed to another traditional, SEP, or SIMPLE IRA.”

This means that only an IRA to IRA tax-free distribution counts as an outstanding rollover. A rollover from a non-IRA employer retirement plan (like a 401k or pension plan) to an IRA does not count as an outstanding rollover for the purposes of the nondeductible basis calculation on Form 8606.

However, if you deposit those funds into an IRA before year end, then those assets would be a part of the “value of all your traditional, SEP, and SIMPLE IRAs as of December 31.”

This would imply that so long as you can deposit those funds into your IRA after the turn of the new year, you’ll be okay.

Luckily for the questioner, Monday, November 14, 2024 is only 48 days before January 1, 2025, and 48 days is less than 60 days.

The differences between a direct rollover and a 60-day rollover contribution matter.

Qualified pensions are employer-sponsored retirement plans that normally have the option of either being annuitized into a monthly benefit or rolled over in a lump sum to a different qualified retirement plan, such as a traditional IRA.

When the lump sum benefit is chosen, either the pension plan uses a direct rollover to issue you a check made payable to your IRA or they use a 60-day rollover contribution to issue you a check made payable to you personally. Either way, you can deposit the check into the IRA in order to complete the rollover.

However, these two strategies are viewed very differently by the IRS.

A check made payable to your IRA is considered a direct rollover and imagined to be receive by your IRA on the date that the check was issued regardless of when you actually deposit the check. In this case, the distributing pension plan will report on your 1099-R that $0 of the rollover is taxable, and it is consistent that the receiving IRA will report having received those funds in the tax year of the date on the check.

However, a check made payable to you personally may never make it to your IRA. The distributing pension reports 100% of the distribution as taxable on the 1099-R, and it is up to the tax preparer to tell the IRS how much of the distribution was a nontaxable qualified rollover. It is only when the funds are contributed to an IRA that the 60-day rollover contribution is completed and the funds are received in the IRA.

Similarly, if a 60-day rollover is chosen, the pension plan likely deducted mandatory withholding from your lump sum prior to issuing the check. As the IRS says, “A retirement plan distribution paid to you is subject to mandatory withholding of 20%, even if you intend to roll it over later. … A distribution sent to you in the form of a check payable to the receiving plan or IRA is not subject to withholding.”

In the event that the pension plan used withholding, you would be able to contribute funds from another source into your IRA to make up for the amount withheld and complete a full rollover.

Regardless though, it is in this case that the IRA rollover could be completed in the new year alongside the deposit of funds and leave your backdoor Roth strategy alone.

Photo by Vickey Gu on Unsplash. Image has been cropped.