Real world mechanics of a "backdoor" Roth

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Topic Author
mrfinesse84
Posts: 16
Joined: Tue Aug 12, 2014 10:57 pm

Real world mechanics of a "backdoor" Roth

Post by mrfinesse84 »

Hi everyone,

I have a question pertaining to a "backdoor" Roth IRA. I currently have a modest Roth IRA account at Scottrade. Since opening that brokerage, I have been fortunate enough to begin a high-paying job, which has prevented me from contributing to my Roth IRA. However, I have a 401(k) at work which I fund to the maximum limit ($17,500). I do not have any other retire account -- just the Roth IRA account at Scottrade and a 401(k) at work. I would like to contribute to my Roth IRA and have been reading about the backdoor method. I would like to know how I can go about making a non-deductible IRA contribution and then convert that contribution into my Roth. Here are my questions:

1. When I first went to Scottrade to make a non-deductible IRA contribution, I was told they only have traditional or Roth contribution option -- not a non-deductible option. Am I supposed to make a traditional IRA contribution for purposes of beginning the backdoor method?

2. Assuming the answer to No. 1 is yes, when tax time comes around what am I supposed to ask for or fill out (i.e., requisite tax forms) to show that my contribution at Scottrade was a non-deductible contribution?

3. Can I still take advantage of the backdoor method and stay away from violating the "pro rata" rule, even though I have an existing 401(k) at work and a pre-existing Roth IRA?

Any advice and guidance would be appreciated.

Thanks!
mhalley
Posts: 10432
Joined: Tue Nov 20, 2007 5:02 am

Re: Real world mechanics of a "backdoor" Roth

Post by mhalley »

1.
Nondeductable is just an irs term. Just open the Traditional IRA, then transfer the funds over to the roth. When you do that, you will get a warning that it is a taxable event.

2.
The brokerage firm will send you a form about the distribution. I think you have to fill out an irs form 8606.

http://www.irs.gov/uac/Form-8606,-Nondeductible-IRAs

3.
The pro rata rule has to do with iras, 401ks do not count.

Mike
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Real world mechanics of a "backdoor" Roth

Post by sscritic »

As mhalley says, you make a contribution to a traditional IRA. Whether that contribution is deductible is another matter.

IRA deductions go on line 32 of your 1040
32 IRA deduction
The 1040 Instructions for line 32 start with
If you made contributions to a traditional IRA for 2013, you may be able to take an IRA deduction.
May be able. Some are, some aren't. You can't from what you say.

Nondeductible contributions are reported on Form 8606, Nondeductible IRAs. Form 8606 is also used to report your conversion, but you can make a non-deductible contribution without converting it. You want to convert, but you don't have to.
Topic Author
mrfinesse84
Posts: 16
Joined: Tue Aug 12, 2014 10:57 pm

Re: Real world mechanics of a "backdoor" Roth

Post by mrfinesse84 »

Thanks to you both.

My first follow-up question goes back to something mhalley (Mike) wrote. For point number 3, Mike stated:
[t]he pro rate rule as to do with [IRAs], 401ks do not count.

For purposes of clarification, the pro rate rule applies for traditional IRAs, not pre-existing Roth IRAs -- is that correct? Again, I have a pre-existing Roth IRA, so I do no want to touch upon the pro rata rule if I can avoid it.

My second follow-up question goes to something sscritic discussed about Form 8606. Please pardon my lack of understanding how IRS paperwork submissions go, but is Form 8606 a form that Scottrade will provide to me that is already completed for me or is it something that I must independently fill out when tax time comes around?

Thanks again for the great insights.
DSInvestor
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Joined: Sat Oct 04, 2008 11:42 am

Re: Real world mechanics of a "backdoor" Roth

Post by DSInvestor »

mrfinesse84 wrote:
For purposes of clarification, the pro rate rule applies for traditional IRAs, not pre-existing Roth IRAs -- is that correct? Again, I have a pre-existing Roth IRA, so I do no want to touch upon the pro rata rule if I can avoid it.
The prorata rule does not look at assets in Roth IRA. It looks at assets in Traditional IRA, Rollover IRA, SEP-IRA, SIMPLE-IRA.
mrfinesse84 wrote:
My second follow-up question goes to something sscritic discussed about Form 8606. Please pardon my lack of understanding how IRS paperwork submissions go, but is Form 8606 a form that Scottrade will provide to me that is already completed for me or is it something that I must independently fill out when tax time comes around?
When you tell your tax software that you made Traditonal IRA contributions, your tax software will determine whether those contributions are deductible or non-deductible based on your tax situation (coverage by employer plan, income). If non-deductible,the tax software will fill out and include form 8606.
Wiki
JW-Retired
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Joined: Sun Dec 16, 2007 11:25 am

Re: Real world mechanics of a "backdoor" Roth

Post by JW-Retired »

Suggest you Google "Form 8606", download the form, and look at it. It's a bit confusing so keep asking if you have questions.
JW
Retired at Last
Topic Author
mrfinesse84
Posts: 16
Joined: Tue Aug 12, 2014 10:57 pm

Re: Real world mechanics of a "backdoor" Roth

Post by mrfinesse84 »

Thanks, JW and DSInvestor.

I previously looked at the hard copy Form 8606, and it confused the hell out of me. I used TurboTax to file taxes last year, so I'm taking a little comfort that, as DSInvestor noted, the software can complete the Form for me. I'll try to compute the numbers on the Form myself nonetheless, just so I understand everything will be right when I enter the information into my tax software.
pshonore
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Re: Real world mechanics of a "backdoor" Roth

Post by pshonore »

mrfinesse84 wrote:Thanks, JW and DSInvestor.

I previously looked at the hard copy Form 8606, and it confused the hell out of me. I used TurboTax to file taxes last year, so I'm taking a little comfort that, as DSInvestor noted, the software can complete the Form for me. I'll try to compute the numbers on the Form myself nonetheless, just so I understand everything will be right when I enter the information into my tax software.
The software will get it right, IF you answer the questions right and input the proper forms and codes. It can still be very confusing. Someone (I think it was Oblivious Investor aka Mike Piper) had a step by step scenario on their website. There's usually lots of help around here at tax time.
fortyofforty
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Joined: Wed Mar 31, 2010 12:33 pm

Re: Real world mechanics of a "backdoor" Roth

Post by fortyofforty »

The key points to remember:

Your investment company (in my case, Vanguard (of course)) doesn't know or care whether or not your initial investment into the Traditional IRA is deductible. That is determined by your own tax situation, and between you and the IRS.

Your investment into the Traditional IRA must be separate from any other investments. In fact, I believe you cannot invest into a Traditional IRA that has assets in it already or a large can of worms is opened. I found it much easier to make sure we had no investments in any Traditional IRAs by moving that money to work retirement plans. A clean slate made for a much simpler tax situation.

Finally, make sure the conversion occurs quickly, since you will owe taxes on any gains made by your investment between the Traditional IRA contribution and the conversion to the Roth. I used a Money Market, and converted as soon as possible (for Vanguard, it was the following day). Some investment companies allow a "mid-air" conversion, instantaneous. But that was not the case with Vanguard. The investment literally gained a few cents overnight, so it was a non-issue, tax-wise.

Hope this helps a little. It does generate some tax paperwork, but I think it's worth it.
seahawkraptor
Posts: 7
Joined: Sun Aug 10, 2014 2:21 am

Re: Real world mechanics of a "backdoor" Roth

Post by seahawkraptor »

I can say from experience that Scottrade is a pain to deal with if you want to do a backdoor roth. Each time you convert you have to fill out a bunch of paperwork and mail it in, and it can take more than two weeks just to move the money from your ira to the roth ira.

I moved everything to Vanguard last year and when I did my backdoor this year everything was online and the money was moved in 2 days.
Topic Author
mrfinesse84
Posts: 16
Joined: Tue Aug 12, 2014 10:57 pm

Re: Real world mechanics of a "backdoor" Roth

Post by mrfinesse84 »

PShonore, thanks for the advice. I'm not a tax professional, but I will be careful when entering my data into TurboTax. I will also try adn Google Oblivious Piper's step-by-step guide -- thanks for that heads-up! I'm also comforted by the support on this blog and the speedy responses.

FortyofForty, thanks for your advise as well. I do not think I will run into the "can of worms" situation you cautioned me about in your post. I have a 401(k) at work and a Roth IRA (which was previously a 401(k) account that turned to an IRA, the proceeds of which I took in 2008 to open an Roth IRA account at Scottrade -- I converted the IRA proceeds to fund the Roth at Scottrade and paid my taxes on it back in 2008). Therefore I only have 2 retirement accounts now, and none of them are traditional IRAs. I think I'm alright, but please let me know if I'm not. I also have a taxable brokerage account with Vanguard (only to trade ETFs), which should not be impacted with the backdoor conversion that I'm considering.

Moreover, I will ensure the conversion occurs quickly. When I opened by account at Scottrade, they initially opened a traditional IRA account first to receive the rollover funds that I brought in from my prior 401(k) account, which was turned into an IRA account after I quit my job. Then, Scottrade opened a Roth IRA account which it funded with the converted proceeds from the traditional account. So, that's a long way of saying I have a traditional IRA account at Scottrade that's still open but has zero money in it. I can put in my non-deductible funds onto that traditional IRA and not invest it in anything, so that I don't make any real taxable gains prior to the backdoor conversion taking place (I believe Scottrade has a nominal interest rate it allows its accounts to accrue -- so that'll be the only "gains" I should be taxed on).
fortyofforty
Posts: 2083
Joined: Wed Mar 31, 2010 12:33 pm

Re: Real world mechanics of a "backdoor" Roth

Post by fortyofforty »

It sounds like you'll be good in terms of the assets going into and out of an existing Traditional IRA. If I recall, the danger was if you put new funds into the existing Traditional IRA, then try to convert a part of it to a Roth, the entire amount gets "tainted" and probably taxed. That's oversimplifying, but you should get the idea.

As for Turbo Tax, you essentially have to just play the "game" of answering the questions. Yes you contributed to a Traditional IRA. Yes, you know you cannot deduct the amount. Yes, you know it's a non-deductible IRA contribution. Yes, you know you owe taxes. Then, yes you converted the amount to a Roth IRA. It's somewhat convoluted, but it's just that step by step process you must follow, and I believe Turbo Tax gets it right. At least, that's as I remember it. You'll also get forms from the custodian indicating you will owe taxes on the amount contributed to the Traditional, then Roth IRA. Bottom line is that you'll get your money into that Roth, where it can grow and grow and never (we hope) get taxed again. :sharebeer
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