Decided on a new thread title after wading through a steaming pool of journalism on another, better advertised billion dollar giveaway.
I’m interested in how many states’ tax codes permit a deductible back door Roth, by which I mean dodging the state tax by making a deductible TIRA contribution and immediately converting to a Roth IRA without incurring state tax (so you get the best of both). A couple could save $300 - $1,000/year doing this on $4,000-$12,000 of IRA contributions, an immediate 5-9% return, depending on your state.
Illinois is the only state I know that allows this without an age or dollar limitation [edit: looks like Kentucky exempts conversions up to $41,000, which isn't much of a limit; edit2: Oklahoma looks good, too], but a cursory (read sloppy) review of state income tax instructions indicates that a number of other states allow this for $2,000 or $3,000 (each, so $4,000 or $6,000 for a couple) regardless of age, and some other states allow this if you’re over 55 or 60 or some similar pre-retirement age.
I want to emphasize that I am not a taxpayer in 49 of these states nor DC, and I obviously have not spent more than five minutes on each state’s tax form instructions, so I may very well be dead wrong in many instances. I will gratefully take corrections and additions and edit this first post accordingly in an effort to minimize the dissemination of bogus information. I haven’t finished looking at all states, but I thought I’d go ahead and start the thread and list all 50 states below so you can be a cog in the Mechanical Turk and check me on your state or help me out where I have a blank.
I’m ignoring here that many states provide big breaks for folks over 65. I know that some people continue to work past 65 and therefore may be able to do Backdoor Both. I want to focus on opportunities for the younger crowd.
The tax rate given in parentheses is a representative number for rough comparison only. I picked MFJ with state taxable income of $100,000 as the illustrative rate example, because a state taxable income of $100,000 may* roughly correspond to a federal AGI which puts the couple roughly in the middle of the deductible TIRA phaseout range ($92,000 - $112,000 for 2012), viz., eligible to contribute $4,000 or $6,000 deductible, combined. Higher income couples (up to about $200,000 gross) can still make deductible contributions to a spousal TIRA if one spouse is not covered by an employer plan, or (without income limit) to two TIRAs if neither is covered. However, these latter types will also be in high federal tax brackets, so leaving the deductible TIRA as such may make more sense. $100,000 state taxable income may* also roughly correspond to the top of the federal 15% bracket for a family with 2.3 kids and a mortgage.
*Most states allow pretty small deductions and exemptions, so state taxable income is often not far off federal AGI, especially if you’re adding back in things like municipal bond interest. I know this does vary widely. In any case, most state income taxes are flat or nearly flat (for example, the rate I cite for $100,000, or a rate less than 1% lower, kicks in at $50,000 or less – the only exceptions I saw were California, North Dakota, Ohio, and Vermont).
For those states with an income tax, the median and mean rate for MFJ with taxable income of $100,000 is about 6%, which surprised me – 6% is pretty significant if your federal bracket or LTCG/QD rate is only 15%. The mean and median rise to about 6.6% if you cherry pick the high tax cities and counties to represent each state.
I would also appreciate your help on the local taxes. I think it’s important to consider that NY is 6.85% but NYC is 10.45%, PA is 3.07% but Philly is 7.07%, MD is 4.75% but most counties bump that to 7.95%, etc. My numbers are again based on casual surfing, so corrections are welcome. In some cases the local tax is collected separately, such as by payroll deduction, and the Backdoor Both benefit is limited to the state tax, but in other cases the local tax is collected with and indistinguishable from the state tax. I don't know how NYC and Wilmington, for example, treat TIRA contributions and Roth conversions.
Alabama (5%, 6% in Birmingham) no Backdoor Both
Arizona (4.24%) no Backdoor Both (thanks Alan S)
Arkansas (7%, 7.7% in some school districts) Taxpayers over 59.5 can each exclude $6,000 of a TIRA conversion, so a couple can save up to $840/year with the Backdoor Both.
California (9.3%) no Backdoor Both (thanks Alan S)
Colorado (4.63%) Exempts $20,000 of IRA withdrawals and other pension income per taxpayer over 55 (or a taxpayer of any age who is a beneficiary due to death of the IRA owner), so a couple can save $556/year with the Backdoor Both.
Connecticut (5%) no Backdoor Both
Delaware (6.95%, 8.2% in Wilmington) Taxpayers over 60 can each exclude $12,500 of dividends, interest, capital gains, and IRA distributions, so Backdoor Boths could save a couple $764/year. It looks like taxpayers aged 59.5 but not yet 60 can each exclude $2,000 of a TIRA conversion (that is, there's a mismatch because a distribution at age 59.5 will not be coded as an early distribution, and therefore appears to be eligible for Delaware's $2,000 exemption for taxpayers under 60).
Georgia (6%) Up to $70,000 of retirement income is exempt for a couple both 62 or over ($35,000 if only one is 62), so a full Backdoor Both is possible. A couple can save $720/year.
Hawaii (8.25%) no Backdoor Both
Idaho (7.8%) no Backdoor Both
Illinois (5%) Does not tax TIRA contributions or withdrawals, so TIRA is favored over Roth in higher brackets and a state-deductible back door Roth is possible for those eligible for a deductible TIRA. A couple can avoid $500/year ($600/year if over 50) of state taxes this way.
Indiana (3.4%, as high as 6.3% in some counties) no Backdoor Both
Iowa (8.98%, up to 10.8% in some school districts; 8.98% is effectively 7.6% because federal taxes are deducted -- thanks grabiner) Taxpayers 55 or older can exclude $6,000 each of IRA distributions, so a back door Roth from a deductible TIRA can save a couple $915/year in state taxes.
Kansas (6.45%) no Backdoor Both
Kentucky (6%, 8.25% in Lexington) Exempts $41,000 of retirement income, including conversions to Roth, so a couple could save up to $600/year ($720/year if over 50) with the Backdoor Both.
Louisiana (6%) no Backdoor Both
Maine (7.95%) $6,000/person exclusion covers 401k distributions but not IRA distributions
Maryland (7.95% including local taxes for most counties) no Backdoor Both
Massachusetts (5.25%) Taxes TIRA contributions but not 401k contributions, so 401k is favored over TIRA. No Backdoor Both.
Michigan (4.25%, 6.75% in Detroit) Had a $90,000 exemption for taxpayers over 59.5, but in 2012 that’s reduced to $40,000 and the age requirement is raised to 67 for persons born after 1952 (thanks to cheese_breath for explaining this). Still, today’s 59.5-year-olds can exploit this for their remaining working years to save $522/year in state taxes on a Backdoor Both. And of course they should convert more than this year’s contributions to make full use of the exemption.
Minnesota (7.05%) no Backdoor Both
Mississippi (5%) Non-early retirement plan distributions aren’t taxed, so Backdoor Both is allowed for taxpayers over 59.5.
Missouri (6%, 7% in Kansas City and St Louis) no Backdoor Both
Montana (6.9%) no Backdoor Both
Nebraska (6.84%) no Backdoor Both
New Hampshire none
New Jersey (5.525% excluding local taxes) Taxes IRA contributions and 403b contributions but not 401k contributions
New Mexico (4.9%) no Backdoor Both (thanks xerty24)
New York (6.85%, 10.45% for NYC residents and municipal employees, 7.5% in Yonkers) Per MarkNYC, taxpayers over 59.5 get to exclude $20K of IRA income, so a couple could save $822/year in state taxes on Backdoor Both ($1,254 NYC, $900 Yonkers). And of course they should convert more than this year’s contributions to make full use of the exemption. (thanks xerty24)
North Carolina (5.8%), for tax years prior to 2014 exempted $2,000 of TIRA conversions ($4,000 for a couple) regardless of age
North Dakota (3.44%) no Backdoor Both (thanks tfb)
Ohio (4.695%, 7.695% in Parma Heights) no Backdoor Both
Oklahoma (5.5%) Looks like there's a $10,000 exemption, so a couple can avoid $550/year ($660/year if over 50) with the Backdoor Both.
Oregon (9%, 9.69% in Portland) no Backdoor Both, but there appears to be an exemption for low-income 62-year-olds
Pennsylvania (3.07%, plus 4% payroll tax for Philadelphia and a 4% local tax on interest, dividends, and STCG) Taxes TIRA and 401k contributions, but exempts withdrawals from both after 59.5, so I guess for PA taxes everything's a Roth.
Rhode Island (4.75%) no Backdoor Both
South Carolina (7%) Exempts $3,000 of TIRA conversions ($6,000 for a couple) regardless of age, so a partially state-deductible back door Roth is possible for those eligible for a deductible TIRA (a couple can avoid $420/year of state taxes this way).
South Dakota none
Tennessee (6% on investment income only, including taxable interest, stock dividends, and mutual fund capital gains distributions, for singles with income over $33,000 and couples with income over $59,000)
Utah (5%) no Backdoor Both
Vermont (6.8%) no Backdoor Both
Virginia (5.75%) no Backdoor Both (thanks xerty24)
West Virginia (6.5%) no Backdoor Both
Wisconsin (6.5%) no Backdoor Both
District of Columbia (8.5%) no Backdoor Both
Backdoor Both as Emergency Fund
Further down in this thread you will see discussion of whether a Backdoor Both can serve as an Emergency Fund, as can a direct Roth contribution. It is well known that you can withdraw a direct Roth contribution (but not the earnings) for any reason without paying tax or penalty.
The short answer is: pretty much. The long answer is:
-- After the 5-year period starting with the first day of your tax year in which you converted, you can withdraw your converted amount without tax or penalty. For example, if you convert in November 2012, the 5-year period is satisifed on January 1, 2017.
-- Within that 5-year period, you can withdraw your converted amount without tax or penalty if any of the TIRA withdrawal exceptions apply (read on). For Backdoor Boths in Arkansas, Michigan, Mississippi, New York and Georgia, the 59.5 exception always applies, since you have to be that old anyway.
-- If none of the exceptions apply and you withdraw within the 5-year period, you will not owe tax but there will be a 10% penalty. For Backdoor Boths in Delaware, Illinois, Kentucky, Oklahoma, North Carolina, South Carolina, Colorado, and Iowa, you saved 5-8% going in, so your net penalty is 2-5%. Note, however, that the TIRA exceptions cover most major emergencies and life events:
-- unreimbursed medical expenses over 7.5% of AGI
-- medical insurance premiums after losing your job
-- higher education expenses for you, your spouse, your kids, your grandchildren, etc.
-- buying your first home after at least two years of not owning a home ($10,000 lifetime limit) for you, your kids, your parents, etc.
-- series of substantially equal payments
-- IRS levy
-- qualified reservist
Last edited by Bob's not my name
on Mon Aug 25, 2014 6:45 am, edited 58 times in total.