Backdoor Roth IRA Timing Question

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Topic Author
fdeanw
Posts: 62
Joined: Tue Jan 22, 2013 6:14 pm

Backdoor Roth IRA Timing Question

Post by fdeanw »

My wife and I have been doing backdoor Roth IRA conversions for the past couple of years. She has both an IRA account and a solo 401(K) account at Schwab. A couple of years ago, she rolled all of her deductible IRA funds into the solo 401(K) account, leaving only the non-deductible contributions, which she then converted tax-free into a Roth IRA account. For each of the past several years, including earlier this year, she has been making a non-deductible contribution into her IRA account, then converting it a few weeks later into her Roth IRA. So far, so good.

Last month, she retired from teaching, and she has some retirement savings in a 403(b) plan with her former employer that we would like to rollover to her solo 401(k) account in order to consolidate the investments and avoid the higher-fee investments in her 403(b) plan. Schwab, like several other brokerages, has an Investment Reward program that will give her a bonus for transferring additional funds into her account at Schwab. Like a true Boglehead, I am determined not to lose the opportunity to cash in on this "free money." The catch is that for some reason, Schwab's Investment Reward program does not apply to funds transferred into a solo 401(k) account, only to funds transferred into an individual IRA account. The Schwab customer representative suggested that we could work around this simply by transferring the funds into her zero-balance IRA account, keeping them in the account for 12 months (a requirement of the Investment Reward program), and then rolling the funds over to the solo 401(k) plan.

I am concerned, however, that this will prevent her from taking advantage of the Backdoor Roth conversion for one or possibly two years, and it would require me to recharacterize this year's conversion (causing complications in preparing next year's tax return) because she already made a non-deductible contribution to her IRA earlier this year and converted it to her Roth IRA. Am I correct that all of the tax calculations involved in the Backdoor Roth IRA conversion are done on a calendar-year basis? In other words, at the time my wife converted her $6,000 2014 non-deductible IRA contribution to her Roth IRA, she had no made no other IRA contributions for 2014 and had no deductible contributions or earnings in her IRA account, so no taxes were due on that conversion. If she were to now rollover $50,000 from her 401(b) into her IRA account, would that make 83% of this year's Roth conversion taxable, even though it would have been all non-taxable at the time of the conversion itself? And what about for next year: If we wait until the end of 2015 to make a non-deductible contribution, after she has rolled over the funds from her IRA into her solo 401(K) account, can we do the Backdoor IRA at that point without any of the conversion being taxable in 2015?

It seems like any way I time this, I will lose at least one year's ability to do a Backdoor Roth IRA conversion, and if I don't re-characterize this year's contribution, the additional taxes we have to pay on the conversion will far exceed the bonus we receive from Schwab. Am I analyzing this correctly? Does anyone see a way of doing this that would not at a minimum require losing the opportunity to do a Backdoor Roth IRA for at least one year? Is there any way to play around with the April-of-the-following-year-deadline to accomplish this without losing out on the Backdoor Roth IRA conversion? (I would probably wait until next year to make the transfer in order not to have to do the re-characterization of this year's Roth conversion.)
mhalley
Posts: 10432
Joined: Tue Nov 20, 2007 5:02 am

Re: Backdoor Roth IRA Timing Question

Post by mhalley »

So is that 200 bucks you get for transferring 50k?
http://content.schwab.com/web/retail/pu ... or_reward/
Doesn't seem worth losing the roth conversion at low tax rate to me.
Mike
sport
Posts: 12094
Joined: Tue Feb 27, 2007 2:26 pm
Location: Cleveland, OH

Re: Backdoor Roth IRA Timing Question

Post by sport »

Why not tell Schwab that if they want to keep you as a happy client, they should give you the bonus for adding to the 401k?
Jeff
Topic Author
fdeanw
Posts: 62
Joined: Tue Jan 22, 2013 6:14 pm

Re: Backdoor Roth IRA Timing Question

Post by fdeanw »

mhalley wrote:So is that 200 bucks you get for transferring 50k?
http://content.schwab.com/web/retail/pu ... or_reward/
Doesn't seem worth losing the roth conversion at low tax rate to me.
Mike
Yeah, it's 200 bucks. But I think if I wait until next year, then I'm not really losing the tax-free conversion of IRA funds to a Roth IRA, but only losing the opportunity of effectively transferring $6,000 from my taxable account to my wife's Roth IRA account for one year. I think that's still worth less than $200 to me, especially since we're in our 60's and may not be compounding our earnings tax free for that much longer, but I'd still like to figure out if there's a way to get the $200 without that sacrifice.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Backdoor Roth IRA Timing Question

Post by DSInvestor »

If she rolls over to IRA, the 12 month window ends AUG 2015. She can contribute for 2014 in 2014 and delay conversion step until 2015. For example, she contributes max $6500 (age 50+) to her Traditional IRA for 2014 in on Dec 29, 2014 and max $6500 for 2015 on Jan 2, 2015 and convert all $13,000 (IRA basis added for 2014 and 2015) to Roth IRA on Jan 04, 2015. The conversion done in 2015 will convert all the money contributed for 2014 and 2015 tax years.

This conversion will be tax free assuming she makes sure to rollover all pretax IRA assets to Solo 401k before Dec 31, 2015.

The key to tax free conversion of basis is to isolate the basis and as long as the TIRAs have zero balance on Dec 31, 2015 the basis will have been isolated.
Wiki
Topic Author
fdeanw
Posts: 62
Joined: Tue Jan 22, 2013 6:14 pm

Re: Backdoor Roth IRA Timing Question

Post by fdeanw »

If she rolls over to IRA, the 12 month window ends AUG 2015. She can contribute for 2014 in 2014 and delay conversion step until 2015.
Aha. That's what I was looking for. However, since I already converted her 2014 non-deductible IRA contribution to her Roth IRA, I'm going to have to recharacterize it in order to be able to wait to convert it in 2015 after the deductible IRA contributions from the rollover have been transferred into the 401(k) account, correct? How do I do that? Do I just have to transfer back the $6500 to the IRA, or do I have to somehow figure out how much investment income was earned on that money since it was converted to the Roth? If the latter, do I look at exactly what funds were purchased with that money, or do I make some pro-rata calculation of how much the entire Roth IRA account has earned since I converted the $6500?
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Backdoor Roth IRA Timing Question

Post by DSInvestor »

What about delaying the 403b rollover to IRA until 2015? If her TIRA balances are zero on Dec 31, 2014, this gives her a clean Roth conversion for 2014.

The 403b rollover happens in 2015 and she contributes to TIRA for 2015 in calendar 2015 but does no conversion. In 2016, she contributes to TIRA and converts an amount equal to contributions for 2015 and 2016 tax free.
Wiki
Topic Author
fdeanw
Posts: 62
Joined: Tue Jan 22, 2013 6:14 pm

Re: Backdoor Roth IRA Timing Question

Post by fdeanw »

What about delaying the 403b rollover to IRA until 2015?
Yes, thanks DSInvestor. I think that's what I'll do. It seems a lot easier than having to worry about the recharacterization for 2014. I'll just have to hope that Schwab still has the bonus offer available in 2015.

The key was your point that I did not have to make the Roth conversion in the same year that I made the TIRA contribution. Thanks for pointing that out. That's why I love these forums for help in sorting things out.
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Backdoor Roth IRA Timing Question

Post by DSInvestor »

fdeanw wrote:
What about delaying the 403b rollover to IRA until 2015?
Yes, thanks DSInvestor. I think that's what I'll do. It seems a lot easier than having to worry about the recharacterization for 2014. I'll just have to hope that Schwab still has the bonus offer available in 2015.

The key was your point that I did not have to make the Roth conversion in the same year that I made the TIRA contribution. Thanks for pointing that out. That's why I love these forums for help in sorting things out.
Also check on the expense ratios of the 403b and compare against the reward amount. For example, if the 403b total expense ratio is 2% and she stays for another 6 months, that's like 1% of $50K or $500.

That's correct, the Roth conversion and contribution does not have to happen in the same year. In form 8606 for 2015, she will add $6500 IRA basis and because there is no conversion done in calendar 2015, the IRA basis (line 14) will carry forward to the 2016 8606 form (line 2) and allow for tax free conversion in 2016.

She can do a conversion on Jan 4, 2016, contribute for 2016 in May, and convert again in May 2016. In this case, form 8606 for 2016 will have basis carried forward 6.5K and new basis added 6.5K to give her total basis of 13K. She can do one conversion or many conversions in 2016. Form 8606 wants to know the total conversion amount and will consume all the basis as necessary.
Wiki
Topic Author
fdeanw
Posts: 62
Joined: Tue Jan 22, 2013 6:14 pm

Re: Backdoor Roth IRA Timing Question

Post by fdeanw »

One more question for you, DSInvestor, if you are still with me: If I make the non-deductible contribution into the IRA and keep it there for a while, hopefully it will be earning some income while in the account. Before I make the Roth conversion the following year, do I have to rollover all of that income to the 401(K) account so that the only money that is left in the IRA at the time I do the conversion is the $6,500 of the non-deductible contribution?
DSInvestor
Posts: 11647
Joined: Sat Oct 04, 2008 11:42 am

Re: Backdoor Roth IRA Timing Question

Post by DSInvestor »

fdeanw wrote:Before I make the Roth conversion the following year, do I have to rollover all of that income to the 401(K) account so that the only money that is left in the IRA at the time I do the conversion is the $6,500 of the non-deductible contribution?
The portion of the conversion that is tax free is the IRA basis. If you contribute $6500 nondeductible and it grows to $8000, you still have $6500 basis. If you convert all $8000 (full conversion) $6500 is non-taxable because it is IRA basis which has already been taxed and $2500 is taxable.

If you contribute $6500 nondeductible and also have 50K pre-tax in the IRA, you have a 56,500 IRA with $6500 IRA basis. If your 56.5K grows to 60K, and you do not want to pay any tax for conversion, you can first convert $6500 (the exact amount of your IRA basis) and later rollover everything else to solo 401k before Dec 31. The prorata calculation only considers IRA values on Dec 31 so you can either:

1) Rollover pre-tax assets to Solo 401k first then convert remaining assets to Roth IRA. In this case, the remaining assets in the TIRA can fluctuate in value above or below your IRA basis amount.

2) Convert an amount equal to your IRA basis and then rollover all remaining assets in all of your Traditional IRA, Rollover IRA, SEP-IRA, SIMPLE-IRA into the Solo 401k before Dec 31. In this case, the conversion will definitely be equal to basis and the amount that fluctuates is the pretax assets. Just make sure that the Solo 401k will definitely accept the inbound rollover from all the IRA types that you have.
Wiki
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