Backdoor Roth wi pretax dollars

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
mybogledhead
Posts: 46
Joined: Wed Feb 04, 2015 9:25 pm

Backdoor Roth wi pretax dollars

Post by mybogledhead »

Hello bogleheads,

I'm working on moving all my wife and I's assets to Vanguard, but am trying to do it in the most tax-efficient way from the get-go. Every time I think I have a plan I read something that makes me hesitate.

I have about $10K ($1K in long-term capital gains) in a traditional IRA. I did this when I left my most recent job and my mother-in-law recommended a guy from Edward Jones. At this time that money is being transferred from active funds with Edward Jones to a money market fund in a traditional IRA with Vanguard. Once it gets there I had planned to do a Backdoor Roth conversion with the entire amount, buy a target retirement fund, and just eat the tax bill for one year. I thought I would only be taxed on the $1K of capital gains, but now I'm wondering if I'll be taxed on the entire $10K since it was originally from a 401(K). I don't currently have a 401(K) with my current job, so I can't move the money there. My wife and I are currently in the 33% tax bracket, but will likely move up to the highest bracket next Fall.

Questions
1) If I do the conversion, will I be taxed on $1K or $10K?
2) If I'll be taxed on $10K, should I wait until I get a new job with a 401(K), likely to happen in August or September, then transfer the money to that account? Then do the Backdoor conversion in the normal way with new after-tax contributions?
3) My wife has about $25K in a 401(K) with a previous employer. I originally planned to transfer that to Vanguard, then convert it all to a Roth as well, again eating the tax bill. Now I'm thinking it might be better to just transfer that to her current employer's 401(K) plan, avoid the taxes, and use our after tax retirement contribution to open an IRA at Vanguard and convert to Roth.

Thanks in advance for the help!
JW-Retired
Posts: 7189
Joined: Sun Dec 16, 2007 11:25 am

Re: Backdoor Roth wi pretax dollars

Post by JW-Retired »

What you are describing isn't a backdoor Roth conversion, it's just a conversion. You will pay tax on $10k.

The backdoor Roth is three steps.
(1) make a non-deductible contribution to a tIRA.
(2) convert the tIRA to a Roth.
(3) pay the tax owed, if any, per your form 8606 accounting of your IRA basis. If you have no other money in any IRA accounts (tIRA, SEP, SIMPLE, or rollover) besides the non-deductible contribution amount, then the tax would be zero.
JW
ps: I wouldn't do conversions of your existing pre-tax IRA funds at your 33% bracket. Move both IRA's funds into the 401k's and then you will be able to do backdoor Roth's in the future without any tax impact.
Retired at Last
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Backdoor Roth wi pretax dollars

Post by DSInvestor »

I agree with JW's suggestion not to convert when you're in such a high tax bracket.

Your wife should check with her 401(k) to see if they a) accept inbound rollover from IRA and b) have low cost investment options. If that checks out, she could contribute 5.5K for tax year 2014 and another 5.5K for 2015. This gives her 11K of IRA basis. Once those contributions are in, she can convert an amount exactly equal to her IRA basis (11K) and then rollover all remaining assets in her Traditional IRA and Rollover IRAs into her 401k before Dec 31. The key is to get a zero balance in her non-Roth IRA accounts on Dec 31 as that is what form 8606 looks at when prorating IRA basis.

You won't know what kind of 401k plan you'll have until later in the year. However the deadline for 2014 IRA contributions is April 15. You could contribute 5.5K for 2014, 5.5K or 2015 to give you 11K basis. You won't know if you can isolate your basis until you see your next 401k plan. If you do a full conversion of 21K, 11K basis will be fully consumed resulting in 11K non-taxable and 10K taxable if you're willing to pay the tax. Or you could convert 11K and hope that the 401k will accept rollovers before Dec 31 to allow to isolate the basis. If the 401k does not accept rollovers, you can either prorate the basis or convert the remainder to Roth to zero out the TIRA before Dec 31.
Wiki
Topic Author
mybogledhead
Posts: 46
Joined: Wed Feb 04, 2015 9:25 pm

Re: Backdoor Roth wi pretax dollars

Post by mybogledhead »

Hmmm, not what I was hoping to hear, but I guess it's manageable. Here's my new plan.

For myself, I'll keep the money in the current tIRA until I can (hopefully) move it to my new 401(K) this Fall. Then I'll start making nondeductible contributions to the IRA and doing the Backdoor Roth conversion.

For my wife, it looks like they (MassMutual) accept transfers from previous employers into their 401(K). The fund selection isn't great, and currently her money is going into a T. Rowe Price Target Retirement 2045 fund with an expense ratio of 0.76%. In my mind I'm thinking the tax benefits of being able to do the Backdoor Roth would outweigh the higher expense ratio, but I'm open to comments/suggestions.

Thanks again for the advice. Please let me know if I missed something.
Alan S.
Posts: 12629
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Backdoor Roth wi pretax dollars

Post by Alan S. »

You are correct because you are only rolling a modest amount. Conversely, if you rolled 500k into a .76 ER plan the cost of the fees would offset the value of a back door Roth contribution.
Post Reply