Financial Health/Portfolio checkup

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Financial Health/Portfolio checkup

Postby failwhaler » Fri Jul 19, 2013 7:55 am

Greetings all,

My wife and I are federal DINKs. Due to our employer (a government agency), our incomes are highly variable depending on where we are stationed in the world. That being said, we save at a pretty high rate because we have very few expenses. Information about our goals, finances, & some questions below, if you have the time. Thanks in advance.

Emergency funds: Taken care of.
Debt: Monthly credit card debts of $1k-2k, paid off in full every month. No other debt (no mortgage, car payments, etc)
Tax Filing Status: Married filing jointly.
Tax Rate: 28%* Federal, 4.9%** State
State of Residence: Kansas
Age: Both 27
Desired Asset allocation: 85% stocks / 15% bonds
Desired International allocation: 20% of stocks

*Not quite sure which tax bracket we'll be in this year. Depends on overtime. Currently we're probably going to be in the 28% bracket. We might get kicked up to the 33% bracket.
**Kansas recently changed their income tax rate, but I am confused if it takes affect this year. Anyone know for sure?

Goals
  1. Comfortable retirement. While we have the sense that we're doing pretty well for our age, we're always looking to do more when practical.
  2. We'd like to purchase a house at some point - not so soon that we're unwilling to expose our money to market risk, but in the future it'll happen. Since we're highly mobile it's impossible to say when, so we've decided to treat our portfolio as if that part was not relevant.
  3. When we do have children we'd like to get them off to a good start with college savings.

Total portfolio size: Roughly $300k

Cash for investing: Roughly $7k/month after expenses.

Current assets:

We have a taxable brokerage account with Vanguard containing:
  • Vanguard Balanced Index Fund Admiral Shares (VBIAX) ER = 0.10% / $13k (4.4%)
  • Vanguard Intermediate-Term Bond Index Admiral Shares (VBILX) ER = 0.10% / $11k (3.7%)
  • Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) ER = 0.05% / $53k (18.4%)
  • Vanguard Total International Stock Market Index Fund Admiral Shares (VTIAX) ER = 0.16% / $11k (3.7%)
  • Vanguard Energy Fund Investor Shares (VGENX) ER = 0.31% / $4k (1.5%)
  • Vanguard Health Care Fund Investor Shares (VGHCX) ER = 0.35% / $6k (2%)
My TSP:
  • G fund - $3k (1.1%)
  • F fund - $2k (.5%)
  • C fund - $32k (11.4%)
  • S fund - $25k (9%)
  • I fund - $12k (4.3%)
My Roth IRA, Vanguard
  • Vanguard Wellington Fund Investor Shares (VWELX) ER = 0.25% / $16k (5.5%)
Wife TSP (5% match)
  • G fund - $2k (0.7%)
  • F fund - $1k (0.5%)
  • C fund - $37k (13.1%)
  • S fund - $26k (9.1%)
  • I fund - $16k (5.6%)
Wife Roth IRA, Vanguard
  • Vanguard Wellington Fund Investor Shares (VWELX) ER = 0.25% / $16k (5.5%)
Contributions

Annual Contributions
  • $17.5k to my TSP
  • $17.5k to wife's TSP
  • $5.5k to my IRA/Roth IRA
  • $5.5 to wife's IRA/Roth IRA
  • $?? taxable**
*Again, contributions to our taxable brokerage accounts are highly variable.

Questions:
1. I want to get out of the sector funds (VGENX and VGHCX), and doing so will incur a long-term capital gain. Since we're right on the edge of the tax brackets, does it make sense to wait to do this as to not put us over into the 33% bracket? Do long-term capital gains count in that context or are they separate because they are taxed at a different rate?

2. I'm not sure if I should keep money in the Wellington fund - it's a 60/40 stock/bond split. Are there better options for having in a Roth IRA in terms of tax efficiency?

3. By my calculations we're currently at 88% stocks and 12% bonds/fixed income, not including our emergency fund. I'd like to reallocate this occasionally to get to a more stable allocation of around 50% bonds and 50% stocks by the time we can retire in 20 years or so. Any suggestions on a schedule? Move 5% from stocks to bonds every 2-3 years? Should I be rebalance within the tax advantaged accounts constantly (monthly/quarterly/whatever)?

4. Even if we are in the 28% tax bracket this year we will almost certainly be above the Roth IRA limit. I was planning on doing the backdoor Roth IRA. Am I correct thinking this is a good idea, since I believe if you are over the contribution limit you do not get a tax break for a traditional IRA?

5. We will both have a federal pension (in theory) when we retire - in your opinion do you think it's safe to rely on this when taking our retirement plans into consideration? I don't think we would change our TSP contributions, but we could probably afford to cut our Roth IRA contributions and fund a 529 plan or plans for our future kids.

6. Are there any major holes in our portfolio given our (admittedly general) goals?

Thanks!
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Re: Financial Health/Portfolio checkup

Postby failwhaler » Fri Jul 19, 2013 10:51 pm

Anyone?
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Re: Financial Health/Portfolio checkup

Postby Duckie » Sat Jul 20, 2013 3:22 am

failwhaler, you want an AA of 85% stocks, 15% bonds (a little low for your ages), with 20% of stocks in international. That breaks down to 68% US stocks, 17% international stocks, and 15% bonds. Here is a possible retirement portfolio:

Taxable at Vanguard -- $98K -- 34%
17% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.05%)
17% (VTIAX) Vanguard Total International Stock Index Fund Admiral Shares (0.16%)

His Thrift Savings Plan -- $74K -- 26%
16% C Fund (0.027%)

10% G Fund (0.027%)

Her Thrift Savings Plan -- $82K -- 29%
16% C Fund (0.027%)
8% S Fund (0.027%) <-- Roughly 80% large caps (C Fund) plus 20% mid/small caps (S Fund) makes up the total US stock market.
5% F Fund (0.027%)

His Roth IRA at Vanguard -- $16K -- 5.5%
5.5% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.05%)

Her Roth IRA at Vanguard -- $16K -- 5.5%
5.5% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.05%)

My comments:
  • This ignores the cost of selling in taxable.
  • This puts TISM in taxable to take advantage of the 
Foreign tax credit and at Vanguard because the I Fund is the only weak link in the TSP. It's missing emerging markets, small caps, and Canada.
  • This removes the funds with bonds from your taxable account.

Your questions:
1. I want to get out of the sector funds (VGENX and VGHCX), and doing so will incur a long-term capital gain. Since we're right on the edge of the tax brackets, does it make sense to wait to do this as to not put us over into the 33% bracket? Do long-term capital gains count in that context or are they separate because they are taxed at a different rate?
-- You will pay 15% long-term gains whether you are in the 28% or 33% bracket.

2. I'm not sure if I should keep money in the Wellington fund - it's a 60/40 stock/bond split. Are there better options for having in a Roth IRA in terms of tax efficiency?
-- Owning a balanced fund when also owning separate funds makes figuring complicated. Any fund in a Roth IRA is tax-efficient.

3. By my calculations we're currently at 88% stocks and 12% bonds/fixed income, not including our emergency fund. I'd like to reallocate this occasionally to get to a more stable allocation of around 50% bonds and 50% stocks by the time we can retire in 20 years or so. Any suggestions on a schedule? Move 5% from stocks to bonds every 2-3 years? Should I be rebalance within the tax advantaged accounts constantly (monthly/quarterly/whatever)?
-- If you want to move from your desired AA of 15% bonds to 50% bonds over the next 20 years then yes, add 5% every two to three years. For regular rebalancing, once or twice a year is fine.

4. Even if we are in the 28% tax bracket this year we will almost certainly be above the Roth IRA limit. I was planning on doing the backdoor Roth IRA. Am I correct thinking this is a good idea, since I believe if you are over the contribution limit you do not get a tax break for a traditional IRA?
-- You don't get a tax break because you have employer plans (TSPs). The Backdoor Roth IRA is a good idea for you because you have no non-Roth IRAs so won't be affected by the pro-rata rule.

5. We will both have a federal pension (in theory) when we retire - in your opinion do you think it's safe to rely on this when taking our retirement plans into consideration? I don't think we would change our TSP contributions, but we could probably afford to cut our Roth IRA contributions and fund a 529 plan or plans for our future kids.
-- With $7K a month after expenses you have plenty of room to max both TSPs, both Roth IRAs, set aside money for a house down-payment or any other short-term need, and fund 529 plans when necessary.

6. Are there any major holes in our portfolio given our (admittedly general) goals?
-- You have bonds (Balanced Index and Intermediate-Term) in your taxable account. Holding taxable bonds in a taxable account is not a good idea. And you have plenty of room for bonds (and good choices) in your tax-sheltered accounts.

Something to think about.
Last edited by Duckie on Sat Jul 20, 2013 7:24 pm, edited 1 time in total.
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Re: Financial Health/Portfolio checkup

Postby failwhaler » Sat Jul 20, 2013 6:05 am

Thank you very much for your detailed reply! I really appreciate it. Some follow-up comments/questions:
15% bonds (a little low for your ages)

I know the "rule of thumb" is to have [your age] in bonds, but also that your bond allocation depends on your appetite for risk. Since we both have stable jobs, I was thinking we could afford to take on more risk while we're still relatively young with no kids. I imagine this is a fairly gray area, though.
1. I want to get out of the sector funds (VGENX and VGHCX), and doing so will incur a long-term capital gain. Since we're right on the edge of the tax brackets, does it make sense to wait to do this as to not put us over into the 33% bracket? Do long-term capital gains count in that context or are they separate because they are taxed at a different rate?
-- You will pay 15% long-term gains whether you are in the 28% or 33% bracket.

Just to be double-sure, any long-term capital gains incurred are only taxed at 15%, and do not count towards the income that gets taxed at the marginal rate?
2. I'm not sure if I should keep money in the Wellington fund - it's a 60/40 stock/bond split. Are there better options for having in a Roth IRA in terms of tax efficiency?
-- Owning a balanced fund when also owning separate funds makes figuring complicated. Any fund in a Roth IRA is tax-efficient.

Roger.
3. By my calculations we're currently at 88% stocks and 12% bonds/fixed income, not including our emergency fund. I'd like to reallocate this occasionally to get to a more stable allocation of around 50% bonds and 50% stocks by the time we can retire in 20 years or so. Any suggestions on a schedule? Move 5% from stocks to bonds every 2-3 years? Should I be rebalance within the tax advantaged accounts constantly (monthly/quarterly/whatever)?
-- If you want to move from your desired AA of 15% bonds to 50% bonds over the next 20 years then yes, add 5% every two to three years. For regular rebalancing, once or twice a year is fine.

Got it. Thank you.
4. Even if we are in the 28% tax bracket this year we will almost certainly be above the Roth IRA limit. I was planning on doing the backdoor Roth IRA. Am I correct thinking this is a good idea, since I believe if you are over the contribution limit you do not get a tax break for a traditional IRA?
-- You don't get a tax break because you have employer plans (TSPs). The Backdoor Roth IRA is a good idea for you because you have no non-Roth IRAs so won't be affected by the pro-rata rule.

Ah ok, that makes sense. What is the pro-rata rule (sorry, somewhat of a newb here)? Is this going to affect us in future years (I anticipate being above the contribution limit for the next several years)?
5. We will both have a federal pension (in theory) when we retire - in your opinion do you think it's safe to rely on this when taking our retirement plans into consideration? I don't think we would change our TSP contributions, but we could probably afford to cut our Roth IRA contributions and fund a 529 plan or plans for our future kids.
-- With $7K a month after expenses you have plenty of room to max both TSPs, both Roth IRAs, set aside money for a house down-payment or any other short-term need, and fund 529 plans when necessary.

Thanks, that's what I was thinking. The pension is just a nice to have... part of me is skeptical we'll ever see it.
6. Are there any major holes in our portfolio given our (admittedly general) goals?
-- You have bonds (Balanced Index and Intermediate-Term) in your taxable account. Holding taxable bonds in a taxable account is not a good idea. And you have plenty of room for bonds (and good choices) in your tax-sheltered accounts.

I'll get moving on that soon.
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Re: Financial Health/Portfolio checkup

Postby pkcrafter » Sat Jul 20, 2013 10:46 am

Ah ok, that makes sense. What is the pro-rata rule


Link to Wiki on back door Roth/pro-rata rule.

http://www.bogleheads.org/wiki/Back_door_Roth_IRA
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Re: Financial Health/Portfolio checkup

Postby failwhaler » Sat Jul 20, 2013 11:36 am

It looks like the pro-rata rule is only an issue if I have multiple non-Roth IRAs. Since we'll each only have one it seems like it won't be a problem.
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Re: Financial Health/Portfolio checkup

Postby Default User BR » Sat Jul 20, 2013 12:56 pm

failwhaler wrote:It looks like the pro-rata rule is only an issue if I have multiple non-Roth IRAs. Since we'll each only have one it seems like it won't be a problem.

No, that has nothing to do with it. In the eyes of the IRS you only have one traditional IRA (which for this purpose includes SEP, SIMPLE and rollover IRAs).

If you have a mix of taxable and non-taxable contributions to the IRAs then any distribution, including conversion for backdoor Roth, will be subject to pro-rata calculation. You don't have any taxable contributions, so no concerns.


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Re: Financial Health/Portfolio checkup

Postby Duckie » Sat Jul 20, 2013 7:52 pm

failwhaler wrote:Just to be double-sure, any long-term capital gains incurred are only taxed at 15%, and do not count towards the income that gets taxed at the marginal rate?

The capital gains can shift you from 28% to 33% for regular income, but the gains themselves are only 15% (plus possibly the Medicare surtax). See here. Create a dummy return at TaxACT to see what I mean.

It looks like the pro-rata rule is only an issue if I have multiple non-Roth IRAs. Since we'll each only have one it seems like it won't be a problem.

It's not the number of IRAs so much as their balance at the end of the year. The balance needs to be zero.

When using the backdoor Roth method you open a Traditional IRA, fund it, then convert it (moving the money out). As long as the TIRA is empty by the end of the year (and you have no other non-Roth IRAs) there is no pro-rata problem. Since both you and your wife have no other non-Roth IRAs, you're safe.

The issue is that lots of other people have other non-Roth IRAs (Traditional IRAs, SEP IRAs, SIMPLE IRAs, Rollover IRAs). These all count as one big fat IRA and are affected by the pro-rata rule, which negates most of the advantage of the backdoor Roth. See Pro-Rata Rule.
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Re: Financial Health/Portfolio checkup

Postby MitchC » Sat Jul 20, 2013 8:07 pm

re: backdoor Roth IRA's... so the following year, one would go through the same process ? Fund the TIRA, convert to Roth (the existing one ?)
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Re: Financial Health/Portfolio checkup

Postby Duckie » Sat Jul 20, 2013 9:51 pm

MitchC wrote:[S]o the following year, one would go through the same process ? Fund the TIRA, convert to Roth (the existing one ?)

Yes.
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Re: Financial Health/Portfolio checkup

Postby failwhaler » Sun Jul 21, 2013 10:49 am

If I put $5500 into a Traditional IRA now and it gains value, how does that work with rolling it into the Roth? Can I roll all of it?
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Re: Financial Health/Portfolio checkup

Postby tyler_cracker » Sun Jul 21, 2013 1:55 pm

failwhaler wrote:If I put $5500 into a Traditional IRA now and it gains value, how does that work with rolling it into the Roth? Can I roll all of it?


you pay tax on the gains when you do the conversion.

you can convert the whole thing.
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Re: Financial Health/Portfolio checkup

Postby pkcrafter » Sun Jul 21, 2013 4:34 pm

failwhaler wrote:If I put $5500 into a Traditional IRA now and it gains value, how does that work with rolling it into the Roth? Can I roll all of it?

You can, but the cleanest way to do a backdoor Roth is to fund the TIRA and immediately convert to a Roth before there are gains to worry about.

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Re: Financial Health/Portfolio checkup

Postby failwhaler » Mon Jul 22, 2013 11:16 am

pkcrafter wrote:
failwhaler wrote:If I put $5500 into a Traditional IRA now and it gains value, how does that work with rolling it into the Roth? Can I roll all of it?

You can, but the cleanest way to do a backdoor Roth is to fund the TIRA and immediately convert to a Roth before there are gains to worry about.

Paul


I've read that it's a good idea to open the traditional IRA account well before you fund it and do the conversion - is there any truth to that? Just thinking about it I guess it would seem a little fishy if you opened an account and funded it in week #1, then the next week transferred all of it to the Roth IRA. Is there any merit to that line of reasoning?
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Re: Financial Health/Portfolio checkup

Postby Default User BR » Mon Jul 22, 2013 2:36 pm

failwhaler wrote:I've read that it's a good idea to open the traditional IRA account well before you fund it and do the conversion - is there any truth to that? Just thinking about it I guess it would seem a little fishy if you opened an account and funded it in week #1, then the next week transferred all of it to the Roth IRA. Is there any merit to that line of reasoning?

I can't see what benefit an empty account would be. Some have speculated that the IRS might try to apply step-transaction logic to backdoor Roths. To my knowledge they never have done so or even hinted that they might. If they did, it would likely be the time from the contribution to conversion that mattered.

I wouldn't worry about it. It's been going on long enough that it would be quite the morass at this point to start trying to apply it. There are no guidelines in the pubs, so how would any reasonable taxpayer know what period would be required, especially ex-post-facto?


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Re: Financial Health/Portfolio checkup

Postby failwhaler » Tue Jul 23, 2013 12:13 am

That was my logic too, but wanted to do due diligence and ask the question. Thanks.
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Re: Financial Health/Portfolio checkup

Postby M_to_the_G » Tue Jul 23, 2013 9:24 am

2 reactions from a fellow fed:

1. I wouldn't worry at all about the pension not being there when you retire, and I would definitely include it in your retirement-income-needs calculations. It would take a lot to eliminate federal pensions. I do, however, believe that FERS will be changed significantly at some point for new hires, much like CSRS was changed to FERS in the early 80's. It won't affect those who are already in the FERS system.
2. Give this a read (http://www.myfederalretirement.com/public/1181.cfm). Very enlightening article.

I am at 85/15 (per the below AA) and intend not/not to change my AA as I get closer to retirement. My thinking on this could change in the future, though. My personal situation includes a small ROTH I inherited from my mother (4.5% of my total portfolio) which can be ignored for these purposes.

Taxable at Vanguard -- 30.4%
11.4% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.05%)
19% (VTIAX) Vanguard Total International Stock Index Fund Admiral Shares (0.16%)

Thrift Savings Plan -- 53%
25% C Fund (0.025%)
13.8% S Fund (0.024%)
9.5% F Fund (0.024%)
4.8% G Fund (0.025%)

Roth IRA at Vanguard -- 11.9%
7.1% (VFIAX) Vanguard 500 Index Fund Admiral Shares (0.05%)
4.8
% (VGSLX) Vanguard REIT Index Fund Admiral Shares (0.10%)

Non-Spouse Inherited ROTH IRA at Vanguard -- 4.5%
4.5% (VASGX) Vanguard LifeStrategy Growth Fund (0.17%)

Total AA -- 100%
42% U.S. Large Cap Stock
18% U.S. Small & Mid Cap Stock
20% International Stock
10% U.S. Bond
5% TSP G Fund
5% REIT
0.2% International Bond
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Re: Financial Health/Portfolio checkup

Postby failwhaler » Tue Jul 23, 2013 11:00 am

M_to_the_G wrote:1. I wouldn't worry at all about the pension not being there when you retire, and I would definitely include it in your retirement-income-needs calculations. It would take a lot to eliminate federal pensions. I do, however, believe that FERS will be changed significantly at some point for new hires, much like CSRS was changed to FERS in the early 80's. It won't affect those who are already in the FERS system.
2. Give this a read (http://www.myfederalretirement.com/public/1181.cfm). Very enlightening article.


Hi, thanks for the article... I did find it worth the read and interesting. The problem I had with it is that it takes federal pensions and social security as a given for federal retirees. I am probably being too cautious about the pension, but honestly I will be very surprised if I get social security at the rate things are going.
Last edited by failwhaler on Tue Jul 23, 2013 12:32 pm, edited 1 time in total.
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Re: Financial Health/Portfolio checkup

Postby M_to_the_G » Tue Jul 23, 2013 11:55 am

failwhaler wrote:
M_to_the_G wrote:1. I wouldn't worry at all about the pension not being there when you retire, and I would definitely include it in your retirement-income-needs calculations. It would take a lot to eliminate federal pensions. I do, however, believe that FERS will be changed significantly at some point for new hires, much like CSRS was changed to FERS in the early 80's. It won't affect those who are already in the FERS system.
2. Give this a read (http://www.myfederalretirement.com/public/1181.cfm). Very enlightening article.


Hi, thanks for the article... I did find it worth the read and interesting. The problem I had with it is that it takes federal pensions and social security as a given for federal retirees. I am probably being too cautious about the pension, but honestly I will be very surprised if I ever see a cent from social security at the rate things are going.



Yes, the debate about Social Security rages on, some saying it's folly to think it will still exist in a few decades and some saying it's folly to think it won't. Either way, Social Security is a minor component of my retirement plan and not what I am banking my financial security on, but I do include it in my calculations. If it goes, I'll be okay... provided society doesn't descend into Mad Max territory. A lot of Americans depend entirely on Social Security; I can't imagine what would happen if the program ended.

Back to your post, have you all decided what you want to do with your AA? When do you want to pull the trigger?
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Re: Financial Health/Portfolio checkup

Postby failwhaler » Tue Jul 23, 2013 12:35 pm

M_to_the_G wrote:Back to your post, have you all decided what you want to do with your AA? When do you want to pull the trigger?


I think Duckie's suggestion is a good one, and I'll probably go through with that. I need to think about the tax implications of buying & selling in the taxable account. Like I said, my pay is highly variable and I'd really like to avoid getting pushed into the 33% bracket. In the next few months I should have a better idea of where we'll be and I will plan accordingly.
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Re: Financial Health/Portfolio checkup

Postby failwhaler » Sat Jul 27, 2013 12:28 pm

Sorry to bump, but had another question on the timing of the backdoor Roth. I can do this any time before April 15, 2014, correct? Also if I do the Traditional IRA and then convert it, the IRS only "sees" the contribution to the Traditional IRA?
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Re: Financial Health/Portfolio checkup

Postby Duckie » Sat Jul 27, 2013 9:18 pm

failwhaler wrote:Sorry to bump, but had another question on the timing of the backdoor Roth. I can do this any time before April 15, 2014, correct?

You are allowed to do it up to that point, but it's a lot less complicated if you make the contribution for the same year you convert it. In other words, if the contribution is for 2013 it would be better if it was made and converted in 2013. Check out IRS Form 8606 which you'll each have to fill out every year you make the non-deductible contribution and/or the conversion. It's not required but it's easier if you do them both in the same tax year.
Also if I do the Traditional IRA and then convert it, the IRS only "sees" the contribution to the Traditional IRA?

When you file Form 8606 with the rest of your taxes the IRS sees both the contribution and the conversion.
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Re: Financial Health/Portfolio checkup

Postby Default User BR » Sun Jul 28, 2013 1:44 pm

failwhaler wrote:Sorry to bump, but had another question on the timing of the backdoor Roth. I can do this any time before April 15, 2014, correct? Also if I do the Traditional IRA and then convert it, the IRS only "sees" the contribution to the Traditional IRA?

Again, there's no such thing as "backdoor Roth" as far as the IRS is concerned. There are no special rules regarding contributions. It's the same as for a Roth or Traditional IRA (in fact it IS a TIRA). So the yearly IRA contributions have to be completed by "tax day" of the next year. That is indeed 4/15/2014 for 2013 contributions. When you do the conversion is up to you. The only thing is that the conversion is for the year in which it is performed. As Duckie mentioned, it can be simpler to do it all on one 8606, but you don't have to.


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Re: Financial Health/Portfolio checkup

Postby failwhaler » Sun Jul 28, 2013 1:58 pm

Default User BR wrote:Again, there's no such thing as "backdoor Roth" as far as the IRS is concerned. There are no special rules regarding contributions. It's the same as for a Roth or Traditional IRA (in fact it IS a TIRA). So the yearly IRA contributions have to be completed by "tax day" of the next year. That is indeed 4/15/2014 for 2013 contributions. When you do the conversion is up to you. The only thing is that the conversion is for the year in which it is performed. As Duckie mentioned, it can be simpler to do it all on one 8606, but you don't have to.


Ok, I think I am tracking now. I guess I shouldn't worry about the IRS penalizing a traditional IRA into a Roth, otherwise the "back door" wouldn't really be a back door...
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