Help with Roth IRA & Retirement Strategies

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Topic Author
dpusa
Posts: 133
Joined: Thu May 19, 2011 8:07 am

Help with Roth IRA & Retirement Strategies

Post by dpusa »

All,
We have started to read the Bogleheads Guide to Investment, however we are still confused about strategies for retirement. Particularly as we think about whether we should or not do Back door ROTH IRAs. We have a number of accounts, and think its a bit of a jumbled mess and thought I would ask here for help.

Savings/Emergency funds: $63,000
Debt: $250,000 (Mortgage, should be paid off in the next 6-7 years)
Tax Filing Status: MFJ
Tax Rate: 33% Federal / 8% State
Combined Salary: $319,000 (2012 AGI I think was around $260/270k)
Age: Mid 30s for both

Current Yearly Contributions:
His: $17,500 401k
His: $5,500 Traditional Non-Deductible IRA
Her: $17,500 401k
Her: $5,500 Traditional Non-Deductible IRA
Combined: $24,000 Taxable Brokerage Account

Here is how our current retirement accounts stack up:
His
401k Old Employer: $210,628
Roth 401k Old Employer: $987
401k Current Employer: $14,974
Traditional Non-Deductible IRA: $27,569

Her
Rollover IRA: $94,831
401k Current Employer: $139,000
Traditional Non-Deductible IRA: $35,125
Roth IRA: $3005

Combined Taxable Brokerage Account: $63,000

I would welcome thoughts on whether we should even be considered a Back door ROTH, costs associated to it we should consider or whether we continue with just 401k, trad. nondeductible IRA and brokerage account contributions.

Thank you
Dylan
HouseStark
Posts: 324
Joined: Mon Oct 15, 2012 2:31 pm
Location: Minneapolis, MN

Re: Help with Roth IRA & Retirement Strategies

Post by HouseStark »

dpusa wrote: Here is how our current retirement accounts stack up:
His
Traditional Non-Deductible IRA: $27,569

Her
Traditional Non-Deductible IRA: $35,125

I would welcome thoughts on whether we should even be considered a Back door ROTH, costs associated to it we should consider or whether we continue with just 401k, trad. nondeductible IRA and brokerage account contributions.

Thank you
Dylan
A quibbling note: there is no such thing as a "non-deductible IRA", only non-deductible IRA contributions, as you noted also. Your and your wife's Trad IRAs may have been funded with non-deductible contributions, either entirely or in part. That means those TIRAs have basis, perhaps more clearly understood as contribution basis. The contribution basis is the total cumulative amount of non-deductible contributions made to those TIRAs. That amount is important because it is used in determining the amount subject to being included in taxable income in the case of a conversion to a Roth, such as in doing a back door Roth contribution. If the cumulative non-deductible contributions to your TIRA were $20,000, then that would be your contribution basis and the additional $7569 would be earnings. If you converted the entire TIRA to a Roth, only the earnings would be included in taxable income. Converting only a $5500 new non-deductible contribution would involve applying a formula to include a pro-rata portion of the earnings in the conversion amount, as you may already be aware.
Topic Author
dpusa
Posts: 133
Joined: Thu May 19, 2011 8:07 am

Re: Help with Roth IRA & Retirement Strategies

Post by dpusa »

HouseStark - agree my contributions where non-deductible!
HouseStark
Posts: 324
Joined: Mon Oct 15, 2012 2:31 pm
Location: Minneapolis, MN

Re: Help with Roth IRA & Retirement Strategies

Post by HouseStark »

Since your prior TIRA contributions were non-deductible, then you can determine your contribution basis for your and your wife's TIRAs. That piece of information is needed to determine either 1) the tax implication of any conversions of the existing TIRA balance to a Roth without additional non-deductible contributions, or 2) the tax implication of new non-deductible TIRA contributions for purposes of converting to Roth, that is, a back-door Roth contribution. Just knowing the balance of the TIRAs does not provide that information, since it is lacking information on the amount of gain (earnings) in those TIRAs that is subject to tax on conversion.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Help with Roth IRA & Retirement Strategies

Post by DSInvestor »

Your Traditional IRAs have IRA basis due to non-deductible contributions. His and Her IRA basis should have been tracked in His/Her form 8606 each year. Please look in your 2012 tax return for Form 8606. If you've been making non-deductible contributions for many years and not done any withdrawals or conversions, the IRA basis would have increased with each yearly contribution and carried forward to next tax year. I believe 8606 line 14 carries forward to 8606 line 2 for the following year.

For example if you have Traditional IRA of 27K and have 24K IRA basis, you can convert all 27K and pay taxes on the 3K in excess of basis. If you do partial conversion, the IRA basis has to be prorated, and the remaining basis carries forward to next tax year's 8606.
dpusa wrote:His
401k Old Employer: $210,628
Roth 401k Old Employer: $987
401k Current Employer: $14,974
Traditional Non-Deductible IRA: $27,569

Her
Rollover IRA: $94,831
401k Current Employer: $139,000
Traditional Non-Deductible IRA: $35,125
Roth IRA: $3005
Her Rollover IRA is treated as a Traditional IRA and could pose problems for Roth conversion. Let's say you find out she has 20K of IRA basis. Roth conversion is going to consider the Traditional IRA 35K and Rollover IRA 95K as one big 130K IRA. In this situation, she would not be a good candidate for Roth conversion because the prorata calculation will make much of the conversion taxable. If she can isolate her IRA basis by rolling over to 401k, she would be able to an amount equal to her IRA basis tax free.

Example: Lets say IRA basis is 25K after you make your 2013 and/or 2014 contributions.
1) Find out if Her 401k can accept rollover from rollover IRA and Traditional IRA. Do not call it a non-deductible IRA.
2) Convert an amount equal to your IRA basis to Roth IRA (25K in this example).
3) Rollover all remaining assets in her Rollover IRA and Traditional IRA to Roth IRA. This will isolate the basis. Make sure the rollover is completed before Dec 31, 2014. Her Rollover IRA and Traditional IRA balances must be ZERO in order for the Roth conversion to be tax free.

His IRA is simpler as there is only the Traditional IRA account. Depending on the amount of IRA basis relative to Traditional IRA balance, you may or may not want to rollover to isolate basis. For example, if you have 26K IRA basis and have 27K IRA balance, you can simply convert the entire TIRA paying tax on the 1K that is in excess of basis. OTOH, if IRA basis is 5K on 27K IRA balance, it would make sense to convert 5K tax free and rollover 22K to 401k.

If you don't do the Roth conversion to move the IRA basis to Roth IRA, your Traditional IRA and Roth IRA will always have to track IRA basis so you and your heirs don't get double taxed. If the basis is not tracked those IRS will treat those IRAs as entirely pre-tax making all contributions 100% taxable.

If your 401ks have low cost investment options and will accept inbound rollovers from Traditional IRA and Rollover IRA, you should consider the rollovers and tax free Roth conversion of IRA basis. The rollover to isolate your basis is just for the first year 2014. Once your Traditional IRAs are zeroed out, you can use the backdoor into IRA cleanly every year going forward. Your new IRA contributions for 2015 can be immediately converted to Roth IRA after the contribution posts. Just be careful if you change jobs - don't rollover 401k to rollover IRA.
Wiki
Topic Author
dpusa
Posts: 133
Joined: Thu May 19, 2011 8:07 am

Re: Help with Roth IRA & Retirement Strategies

Post by dpusa »

DSInvestor wrote:Your Traditional IRAs have IRA basis due to non-deductible contributions. His and Her IRA basis should have been tracked in His/Her form 8606 each year. Please look in your 2012 tax return for Form 8606. If you've been making non-deductible contributions for many years and not done any withdrawals or conversions, the IRA basis would have increased with each yearly contribution and carried forward to next tax year. I believe 8606 line 14 carries forward to 8606 line 2 for the following year.

For example if you have Traditional IRA of 27K and have 24K IRA basis, you can convert all 27K and pay taxes on the 3K in excess of basis. If you do partial conversion, the IRA basis has to be prorated, and the remaining basis carries forward to next tax year's 8606.
dpusa wrote:His
401k Old Employer: $210,628
Roth 401k Old Employer: $987
401k Current Employer: $14,974
Traditional Non-Deductible IRA: $27,569

Her
Rollover IRA: $94,831
401k Current Employer: $139,000
Traditional Non-Deductible IRA: $35,125
Roth IRA: $3005
Her Rollover IRA is treated as a Traditional IRA and could pose problems for Roth conversion. Let's say you find out she has 20K of IRA basis. Roth conversion is going to consider the Traditional IRA 35K and Rollover IRA 95K as one big 130K IRA. In this situation, she would not be a good candidate for Roth conversion because the prorata calculation will make much of the conversion taxable. If she can isolate her IRA basis by rolling over to 401k, she would be able to an amount equal to her IRA basis tax free.

Example: Lets say IRA basis is 25K after you make your 2013 and/or 2014 contributions.
1) Find out if Her 401k can accept rollover from rollover IRA and Traditional IRA. Do not call it a non-deductible IRA.
2) Convert an amount equal to your IRA basis to Roth IRA (25K in this example).
3) Rollover all remaining assets in her Rollover IRA and Traditional IRA to Roth IRA. This will isolate the basis. Make sure the rollover is completed before Dec 31, 2014. Her Rollover IRA and Traditional IRA balances must be ZERO in order for the Roth conversion to be tax free.

His IRA is simpler as there is only the Traditional IRA account. Depending on the amount of IRA basis relative to Traditional IRA balance, you may or may not want to rollover to isolate basis. For example, if you have 26K IRA basis and have 27K IRA balance, you can simply convert the entire TIRA paying tax on the 1K that is in excess of basis. OTOH, if IRA basis is 5K on 27K IRA balance, it would make sense to convert 5K tax free and rollover 22K to 401k.

If you don't do the Roth conversion to move the IRA basis to Roth IRA, your Traditional IRA and Roth IRA will always have to track IRA basis so you and your heirs don't get double taxed. If the basis is not tracked those IRS will treat those IRAs as entirely pre-tax making all contributions 100% taxable.

If your 401ks have low cost investment options and will accept inbound rollovers from Traditional IRA and Rollover IRA, you should consider the rollovers and tax free Roth conversion of IRA basis. The rollover to isolate your basis is just for the first year 2014. Once your Traditional IRAs are zeroed out, you can use the backdoor into IRA cleanly every year going forward. Your new IRA contributions for 2015 can be immediately converted to Roth IRA after the contribution posts. Just be careful if you change jobs - don't rollover 401k to rollover IRA.
DSInvestor - thank you so much! This helped a lot... Now I need to go figure out my basis for both and the 401k situation.

Any thoughts from the experts, on whether my strategy for max'g out our 401k and Trad.IRAs and then taxable brokerage account is in line with what I should be doing?
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Help with Roth IRA & Retirement Strategies

Post by DSInvestor »

You're in high fed and state tax brackets. I think it a great plan to max out both Traditional 401(k), IRA, invest in taxable accounts and pay off mortgage in 6-7 years.
Wiki
Topic Author
dpusa
Posts: 133
Joined: Thu May 19, 2011 8:07 am

Re: Help with Roth IRA & Retirement Strategies

Post by dpusa »

Sorry all, one follow up question.

I think I am starting to have my ducks in a row. I have a few more questions:

1. a) For my traditional IRA, I have worked out I have a cost basis of about $23,000 so with its value being $27,569. Am I right in thinking as part of the conversion I would owe taxes on the difference of $4569.
b) Secondly, once converted I would be able to add $5500 to an IRA for this year and convert it straight away to the Roth IRA?

2. For my wife, who has both a Rollover IRA: $94,831 and a Traditional IRA: $35,125, what would be the best approach going forward? Could I not rollover her Rollover IRA to her 401k, and then for her Trad. IRA workout the basis and convert to a Roth IRA and pay taxes on the difference?

Thanks for the advice...
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Help with Roth IRA & Retirement Strategies

Post by DSInvestor »

dpusa wrote:Sorry all, one follow up question.

I think I am starting to have my ducks in a row. I have a few more questions:

1. a) For my traditional IRA, I have worked out I have a cost basis of about $23,000 so with its value being $27,569. Am I right in thinking as part of the conversion I would owe taxes on the difference of $4569.
Yes, conversion of basis is not taxable. Amount converted in excess of basis is taxable.

b) Secondly, once converted I would be able to add $5500 to an IRA for this year and convert it straight away to the Roth IRA?
Yes. If you contribute $5,500 that increases account balance to 33,069 with 28,500 basis. Convert everything to Roth IRA after the contribution clears and the amount in excess of basis will be taxable. Will your $5,500 contribution be for 2013 or 2014? If 2013, please make sure to note this contribution to your 2013 tax return and 2013 8606 form. The conversion will have be done in 2014, so that must be handle by 2014 tax return and 2014 8606.

2. For my wife, who has both a Rollover IRA: $94,831 and a Traditional IRA: $35,125, what would be the best approach going forward? Could I not rollover her Rollover IRA to her 401k, and then for her Trad. IRA workout the basis and convert to a Roth IRA and pay taxes on the difference?

IRS views her Rollover IRA and Traditional IRA as one big Traditional IRA. The IRA basis applies for the BIG IRA, even if she has never made non-deductible contributions to the Rollover IRA. Although she may have made after-tax contributions to 401k and then rolled over to Rollover IRA. You will need to find out her IRA basis (from IRA contributions and after-tax 401k contributions if any). Once you know her IRA basis, she can convert to Roth IRA an amount equal to basis, then rollover all remaining assets in Rollover IRA and Traditional IRA accounts to her 401k. Hopefully her 401k has low cost options. If her Rollover IRA and Traditional IRA accounts have zero balance on Dec 31, 2014, her conversion will not be taxable. This gives her a clean slate for future backdoor into Roth IRA for 2015 and beyond.
Wiki
placeholder
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Joined: Tue Aug 06, 2013 12:43 pm

Re: Help with Roth IRA & Retirement Strategies

Post by placeholder »

You have to first find out if the 401ks will take the rollovers before you do anything else.
Topic Author
dpusa
Posts: 133
Joined: Thu May 19, 2011 8:07 am

Re: Help with Roth IRA & Retirement Strategies

Post by dpusa »

Thanks all...

Her Rollover IRA ($94,831) is a rollover from a previous 401k, so it is all pre-tax contributions. Her current employers 401k plan does allow for Rollover IRAs to be rolled in... if this is the case then I assume there is no tax associated to it correct?

Now, for her Traditional IRA ($35,125) - it is a combo of both deductible IRA contributions and non-deductible IRA contributions - I would say the vast majority is probably non-deductible IRA contributions but I need to do more work.

Any additional guidance based on the above?

Thanks in advance.
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ps56k
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Location: Chicago area

Re: Help with Roth IRA & Retirement Strategies

Post by ps56k »

just happen to see this thread... and was wondering...

What happens to a non-deduct IRA later... after retirement ?
ie -
1 - how does the Basis come into play ?
2 - when you withdraw funds, how does Basis play a roll

What's the overall difference - again in Retirement -
between having a non-deduct IRA with Basis - vs - a totally deduct IRA ?

I've been thinking of converting wife's non-deduct IRA to Roth -
for simplicity later in Retirement with her withdrawals..
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Help with Roth IRA & Retirement Strategies

Post by DSInvestor »

ps56k wrote:just happen to see this thread... and was wondering...

What happens to a non-deduct IRA later... after retirement ?
ie -
1 - how does the Basis come into play ?
2 - when you withdraw funds, how does Basis play a roll

What's the overall difference - again in Retirement -
between having a non-deduct IRA with Basis - vs - a totally deduct IRA ?

I've been thinking of converting wife's non-deduct IRA to Roth -
for simplicity later in Retirement with her withdrawals..
Your wife does not have a non-deductible IRA. She has an IRA with IRA basis if she has made non-deductible contributions to Traditional IRA. The issue is whether there is any basis.

If there is no basis, all IRA assets are pretax so every dollar withdrawn or converted is taxable. Easy.

If there is IRA basis:
IRA basis is the sum of after-tax contributions. Since this money has already been taxed, it will not be taxed upon withdrawal or conversion. Let's say your wife has 500K IRA with 5K basis. IRS views all non-Roth IRAs as one big Traditional IRA, so she could have a TIRA with 10K and a rollover IRA with 490K.

She withdraws 50K one year (10K from TIRA, 40K from Rollover IRA). She withdrew 10% of the IRA so 10% of the basis will be consumed. Taxable amount is 49,500, Non-taxable is $500.
After this withdrawal, her IRA will be 450K with $4500 basis.

Form 8606 will need to be filed every year to track basis after contribution (adding basis) and withdrawal (using basis).
Wiki
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