Backdoor Roth IRA Contributions

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Backdoor Roth IRA Contributions

Post by ximmortla » Sat Feb 11, 2017 11:59 am

Hi all - first post here, so please be gentle. :)

I have some real concerns about a recently new account manager for my retirement planning, who works under a very well known company. Upon the account manager making a recent error regarding contributions to a Roth IRA, he informed me of this error, but it has left me concerned on his abilities going forward. I'm looking for facts only to help me better decide on some decisions to be made.

Some back story. I started this new account in November 2016 with transferring and existing traditional IRA, a Joint account, and rolling over my spouses 401k from a previous employer to a new traditional IRA. So, from this, you can assume that my spouse and I work full time, currently contribute to 401k(s). We both are under 50, and make more than $186,000 combined and file taxes jointly.

Given this, I was under the impression that Roth IRA contributions are out of the question, but the account manager assured me that there was a "backdoor" for transferring both Joint accounts and traditional IRA to a Roth over time and tax free. This is where the "error" comes in. He informed me after his back office informed him that I would have to pay taxes on the Roth contributions, which would be over $2,000. Even though this was not expected per his advice, he still suggests that in the long run, paying the taxes up front would be better in the long run and I should still consider going forward with converting the accounts to a Roth IRA. He did state that the conversion/transfers already occurred could be undone at a fee that he would try to have waived since it was his error.

I'm looking for answer to the following questions.

1. Is anything that I have described potentially illegal on the manager's behalf?
2. Can the transactions that occurred in 2016 and 2017 to the Roth IRA be undone, and should I be responsible for any costs?
3. Can a traditional IRA be converted to a Roth IRA over time, and tax free? If not, what are the tax implications given the above?
4. Can a Joint account be converted to a Roth IRA over time, and tax free? If not, what are the tax implications given the above?
5. Did I lose any ability to transfer the 401k to a Roth IRA when it was transferred to a traditional IRA first?
6. Is it a good idea to consider paying taxes up front to be able to convert to a Roth IRA?
+ I get the whole idea that my tax rate now may be lower than when I retire, thus the benefit of the Roth, but I intend to live on a much smaller income when I retire...

I know this is a lot of questions, and I really do appreciate any feedback that will be provided. I'm just at a loss on all the legalities and investment knowledge, hence looking for an account manager.

Thanks so much!

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Sat Feb 11, 2017 12:51 pm

There is much confusion here so I'll just start at the first one.


Given this, I was under the impression that Roth IRA contributions are out of the question,

Direct contributions to Roth IRA are out of the question. There is a "back door" but it works somewhat differently from what he said or you understood.


...but the account manager assured me that there was a "backdoor" for transferring both Joint accounts and traditional IRA to a Roth over time and tax free.

It appears that you or the account manager are getting "contributions" mixed up with "Roth conversions". More on that later.


This is where the "error" comes in. He informed me after his back office informed him that I would have to pay taxes on the Roth contributions, which would be over $2,000.

If the tax is only $2k, the amounts must be pretty small? Less than $10k?


Even though this was not expected per his advice, he still suggests that in the long run, paying the taxes up front would be better in the long run and I should still consider going forward with converting the accounts to a Roth IRA
.
This is incorrect. You are in a higher tax bracket (at least 25% and maybe 28%). Converting tax-deferred money to Roth is better done in a lower tax bracket such as 15%.


He did state that the conversion/transfers already occurred could be undone at a fee that he would try to have waived since it was his error.

Yes, these things can be "undone" and if he does not get the fee waived, you need to raise a great deal of stink. Fixing this may be something of a mess and that's enough price to pay for his mis-information.



1. Is anything that I have described potentially illegal on the manager's behalf?

It does not appear so to me. Depending on what he did, there might be some incompetence going on. Or not.


2. Can the transactions that occurred in 2016 and 2017 to the Roth IRA be undone, and should I be responsible for any costs?

Yes they can. No you shouldn't.


3. Can a traditional IRA be converted to a Roth IRA over time, and tax free? If not, what are the tax implications given the above?

Non-deductible contributions to a traditional IRA can be converted to Roth with no tax, but that does not seem to be the case here. Any money that has never been taxed that is converted to Roth is fully taxable.


4. Can a Joint account be converted to a Roth IRA over time, and tax free? If not, what are the tax implications given the above?

No, not directly. You could make non-deductible contributions to tIRA and convert that to Roth (this is the "back door), but this would not work well in your case since there are other IRAs in your names.


5. Did I lose any ability to transfer the 401k to a Roth IRA when it was transferred to a traditional IRA first?

No. You can convert the tIRA to Roth IRA. You will pay tax on whatever you convert. However, it hardly makes sense to defer tax on your income and then turn around just to pay the tax on it, possibly at an even higher rate.


6. Is it a good idea to consider paying taxes up front to be able to convert to a Roth IRA?
+ I get the whole idea that my tax rate now may be lower than when I retire, thus the benefit of the Roth, but I intend to live on a much smaller income when I retire...

Yes and no. Yes it makes sense to use the back door (although you should not use the back door until all the IRAs are out of the way). No, it does not make sense to convert tax-deferred money to Roth at the 25% to 28% bracket except in the circumstance that your income is rapidly rising to way on up there and you will never see the 25% bracket again.

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Sat Feb 11, 2017 1:06 pm

In getting this figured out, you need to learn and pay close attention to some terms such as "recharacterize a Roth conversion", "return of an IRA contribution" and "convert to Roth" which is the same as "Roth conversion". Otherwise, when tax time comes, you are going to have difficulty knowing how to fill out the forms. We can get into the intricacies of the terms as they come up.

It appears there were 3 accounts.

    Your traditional IRA

    Spouse's 401k which was rolled into a traditional IRA

    Joint taxable account

1) About how large was Your Traditional IRA before anything happened? Round numbers will do. Did you ever make any non-deductible contributions to Your Traditional IRA? If yes, did you fill out Form 8606 on your taxes?

2). What happened to the money in Your Traditional IRA? Where is it now?

3) About how large was Spouse's Traditional IRA before anything happened? Was all of this tax-deferred money?

4) What happened to the money in Spouse's Traditional IRA? Where is it now?

5) About how large was the Joint Taxable Account before anything happened?

6) Did the manager take any money from the Joint Taxable Account and put it into IRA in your name and/or spouse's name? If so, how much and when? Did it happen more than one time?

We'll start with these questions and then people can help you figure out what to do from there.

ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Re: Backdoor Roth IRA Contributions

Post by ximmortla » Sat Feb 11, 2017 5:58 pm

@retiredjg - thanks so much for taking the time to answer my questions!

1) About how large was Your Traditional IRA before anything happened? Round numbers will do. Did you ever make any non-deductible contributions to Your Traditional IRA? If yes, did you fill out Form 8606 on your taxes?


My tIRA was around $160,000 when I opened the new account(s). The tIRA was created from my previous employer 401k rollover. I have not made any other contributions to it.

2). What happened to the money in Your Traditional IRA? Where is it now?


It is mostly there, some capital gains and dividends. There are transfers from the Joint, followed by partial conversion to Roth.

3) About how large was Spouse's Traditional IRA before anything happened? Was all of this tax-deferred money?


My spouse's tIRA was a 401k up until 11/2016 when it was rolled over into a tIRA with a value of $230,000. So, yes this was all tax-deferred.

4) What happened to the money in Spouse's Traditional IRA? Where is it now?


Again, like my tIRA it is mostly the same, some capital gains and dividends.

5) About how large was the Joint Taxable Account before anything happened?


It was about $80,000 when I opened it with the new account manager.

6) Did the manager take any money from the Joint Taxable Account and put it into IRA in your name and/or spouse's name? If so, how much and when? Did it happen more than one time?


Yes, but it looks like my tIRA account only. It looks to be about $11,000, which all took place around 01/10/2017. I don't see any transactions for 2016, so I think it was this one time only.

Again, thanks so much for clearing this stuff up!

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Sat Feb 11, 2017 6:23 pm

ximmortla wrote:
It is mostly there, some capital gains and dividends. There are transfers from the Joint, followed by partial conversion to Roth.

Tell us more about what this means. Be as specific as you can.

It will be tomorrow before I can get back to you on this.

ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Re: Backdoor Roth IRA Contributions

Post by ximmortla » Sat Feb 11, 2017 7:40 pm

ximmortla wrote:There are transfers from the Joint, followed by partial conversion to Roth.


This means, when I look at the activity associated with my tIRA, there are a number of transactions that are typed "2017 TRAD CONTRIBUTION" that are transfers from my Joint account on 01/10/2017 and then on 01/13/2017 there are a number of transactions with type "PARTIAL CONVERSION TO ROTH IRA". These are Class A funds transferred to my rIRA.

No urgency, and again I really appreciate your help.

User avatar
Duckie
Posts: 5013
Joined: Thu Mar 08, 2007 2:55 pm

Re: Backdoor Roth IRA Contributions

Post by Duckie » Sat Feb 11, 2017 8:19 pm

ximmortla wrote:This means, when I look at the activity associated with my tIRA, there are a number of transactions that are typed "2017 TRAD CONTRIBUTION" that are transfers from my Joint account on 01/10/2017 and then on 01/13/2017 there are a number of transactions with type "PARTIAL CONVERSION TO ROTH IRA". These are Class A funds transferred to my rIRA.

This just means you used the cash in your taxable joint account to fund the IRA contributions. This is normal.

For people who can't deduct their TIRA contributions and make too much to contribute directly to Roth IRAs there is a backdoor method. Basically you make a non-deductible contribution to a TIRA and then convert the TIRA assets to a Roth IRA. The purpose is to get money into the Roth IRA without paying extra taxes. However, because of the pro-rata rule, if you have money in any non-Roth IRA (Traditional IRA, Rollover IRA, SEP IRA, SIMPLE IRA) at the end of the year in which you convert, you will be paying taxes on that conversion.

So in your case, your TIRA assets triggered the pro-rata rule. Can you roll the TIRA assets into a current employer plan like a 401k? That would "hide" the IRA assets and make the backdoor method viable. It won't do anything for your 2016 contributions but will help out for 2017.

ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Re: Backdoor Roth IRA Contributions

Post by ximmortla » Sun Feb 12, 2017 8:56 am

Duckie wrote:Can you roll the TIRA assets into a current employer plan like a 401k?


Thanks so much for this suggestion! This is interesting and I will find out. I know that there is a maximum contribution to a 401k per year. Would a rollover to a 401k count against this contribution? Would there be additional fees to rollover to a 401k?

By the way, I think this answer's my question about the whether the adviser messed things up by rolling over my spouses previous employer 401k to a tIRA (currently the larger tIRA) before trying to convert the Joint into a rIRA, ugh... I guess there are pros/cons here to be considered.

Thank you so much for your response!

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Sun Feb 12, 2017 9:56 am

ximmortla wrote:This means, when I look at the activity associated with my tIRA, there are a number of transactions that are typed "2017 TRAD CONTRIBUTION" that are transfers from my Joint account on 01/10/2017 and then on 01/13/2017 there are a number of transactions with type "PARTIAL CONVERSION TO ROTH IRA".

No urgency, and again I really appreciate your help.

You can only contribute $5,500 to IRA each year. Since you said it was $11k, this is probably a 2016 and a 2017 contribution done at the same time (this is legal). Check your paperwork to see if it also says 2016 TRAD Contribution.


These are Class A funds transferred to my rIRA.

This is a possible red flag. Check to see if you got charged a load (a commission - maybe something like 5.5%) each time something was bought. If yes, and if you decide to back out of all this, you should INSIST that the money you paid in loads is returned. Settle for nothing less than your account the way it was before your manager started fiddling with it.

You should know that "churning" an account is unethical and can be illegal. Churning is buying and selling unnecessarily in order to make a commission on the sale. If you determine (for sure - don't jump to conclusions) that churning has occurred, your manager and the firm should be reported.

I'm not saying that churning did happen. It is entirely possible the Class A funds got transferred in kind from account to account or that they did get sold and rebought without a second load (commission). All I'm saying is this is something to watch for.

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Sun Feb 12, 2017 10:18 am

Thank you for the answers. There are a couple of things you can do. But first, let's define the problem.

Your manager made non-deductible contributions to your tIRA and then did a partial conversion to Roth. Since this is a mix of pre-tax and after-tax money, this action did two things.

    -First, the Roth conversion is not free - it is mostly taxable at your current tax rate so there is no benefit to you.

    -Second, it leaves some basis (already taxed money) in your tIRA.

This is not illegal, but it becomes a paperwork hassle because that tIRA will have some basis until it is completely empty. Every time you take money out, you will have to figure out what part is taxable and what part is not and how much basis is left in your IRA. It's an extra form on your taxes each year. You will be doing this for the rest of your life unless you use up the IRA before then. Most people in their 70's and 80's and 90's are wanting things to be simpler, not more complex.

There is nothing "wrong" with this, but it is an unnecessary burden and if the paperwork gets lost or forgotten over the years, you will end up paying tax on that money a second time. Of course, paying tax on $11k a second time is not going to break the bank, but you should not have to do it.

So that's the problem that needs to be accepted or fixed. It is good that Spouse's IRA is not involved as well.

There are 2 fixes I can think of. The first is to back out of it all completely. The second is what Duckie mentioned about rolling the rest of the pre-tax money in the IRA into a 401k if you have a good 401k. Whatever is left would be the leftover basis and could be converted to Roth IRA with little or no tax.

You should know that some 401k plans are very picky about the IRAs they allow to be rolled in. Find out as much as you can about that.

If you want to unwind this back to the beginning, you have until tax day (April 18 I think) to get a return on your 2016 IRA contribution. After that, I'm not sure. I need to think this part over before going further.

User avatar
Duckie
Posts: 5013
Joined: Thu Mar 08, 2007 2:55 pm

Re: Backdoor Roth IRA Contributions

Post by Duckie » Sun Feb 12, 2017 8:07 pm

ximmortla wrote:I know that there is a maximum contribution to a 401k per year. Would a rollover to a 401k count against this contribution?

No. A rollover is not a contribution.

Would there be additional fees to rollover to a 401k?

Unlikely. Although some IRA custodians have a fee to close the account.

ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Re: Backdoor Roth IRA Contributions

Post by ximmortla » Mon Feb 13, 2017 9:27 pm

retiredjg wrote:Most people in their 70's and 80's and 90's are wanting things to be simpler, not more complex.


And even people in their 40's! Thanks so much for pointing this out. I contacted my adviser today and asked to back everything out, and requested that all costs incurred with such be covered by his company. He assumed it would be a couple hundred, so hopefully that is not an issue.

retiredjg wrote:You should know that some 401k plans are very picky about the IRAs they allow to be rolled in. Find out as much as you can about that.


I'm still trying to figure out my 401k options - thanks Duckie!

retiredjg wrote:If you want to unwind this back to the beginning, you have until tax day (April 18 I think) to get a return on your 2016 IRA contribution. After that, I'm not sure. I need to think this part over before going further.


No problem, like I said, already asked to unwind and got an acknowledgement. Thanks again for offering your expertise and helping me understand, it was very appreciated!

ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Re: Backdoor Roth IRA Contributions

Post by ximmortla » Tue Feb 14, 2017 12:14 pm

I've got another question... Thanks in advance!

So the advisor is offering two options:

1. Re-characterize the rIRA as a tIRA
2. Roll everything all the way back to the Joint account

#1 seems straight forward, no taxes to be paid...
#2 there are taxes to be paid on the gains and maybe other unknowns, he is working to figure out how much the "company" is willing to cover, which is currently up in the air.

Can you please offer pros/cons for these options, other than I would have non-deductible contributions in my tIRA with #1

Thanks!

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Tue Feb 14, 2017 3:42 pm

The only thing that comes to mind is that you probably do not want to make non-deductible contributions to your IRA.

What's the point of having a little $5,500 basis that you will have to deal with every time you do anything with your IRA? This will be a PITA for the rest of your life. Make him fix it back to the way you were and be sure it is done very soon. There might be an April deadline (I'm not real clear on that part) in getting your 2016 contribution returned as if it never happened.

I doubt there would be a lot of gains to pay tax on. The company should cover everything (except maybe the tax on the increase in value). Their representative gave you horrible advice. What he suggested you do is a very poor plan in light of your tIRA accounts which he was well aware of.

To put it bluntly, he did not know what he was talking about and you should not have to pay the price for that.

You have not mentioned it yet, but I hope you are considering moving your money to somewhere else. Are you willing to share which "very well known company" this is and how much you are paying them to help you make these bad decisions?

You seem smart enough to do this yourself. Have you considered that?

ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Re: Backdoor Roth IRA Contributions

Post by ximmortla » Tue Feb 14, 2017 4:07 pm

retiredjg wrote:The only thing that comes to mind is that you probably do not want to make non-deductible contributions to your IRA.


Agree, as you mentioned before I'll be stuck with a 8606 form for the rest of the tIRA's life.

retiredjg wrote:I doubt there would be a lot of gains to pay tax on.


Yes, he mentioned gains, so I would be good to cover that part.

retiredjg wrote:You have not mentioned it yet, but I hope you are considering moving your money to somewhere else. Are you willing to share which "very well known company" this is and how much you are paying them to help you make these bad decisions?


I don't know about moving yet. The whole reason I moved in Oct. 2016 was the other company's mutual funds were losing me too much money and didn't have individual stock choices and no hands on advice. After this debacle, I'm planning on giving it a year and see if produces any better. I really don't feel like shaming any company, mistakes are made, and yes, this really seems like a junior mistake.

retiredjg wrote:You seem smart enough to do this yourself. Have you considered that?


Thank you, I appreciate that. I think if I was to just buy into S&P 500 Index funds, I could stomach that. I don't have the time or expertise to delve into individual stocks, which would make me a nervous wreck, hence picking a company to manage.

Thanks again for your advice, I'm going to press him to roll everything back and just plan on covering the gains taxes.
Last edited by ximmortla on Tue Feb 14, 2017 9:24 pm, edited 1 time in total.

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Tue Feb 14, 2017 6:57 pm

Not suggesting you (or anybody else) should be picking individual stocks. In fact, that is generally discouraged here although there are some who dabble a bit.

Why don't you take a look at this link - read a few Wiki Pages and be sure to watch the videos. You will find that costs are what really drive down portfolio performance. You are likely paying 1 to 2% more at RJ that you would pay if you did this yourself or used a low cost advisor. That sounds like a small amount, but it is a HUGE portion of your profit. Costs matter a lot.

https://www.bogleheads.org/wiki/Getting_started

Investing can be very simple. Even if you are not ready to go this route now, keep it in mind for some day in the future.

ximmortla
Posts: 8
Joined: Sat Feb 11, 2017 11:28 am

Re: Backdoor Roth IRA Contributions

Post by ximmortla » Sat Mar 18, 2017 2:54 pm

I thought I would ask a follow-on question here as it would document the whole process of undoing a botched backdoor-IRA contribution.

Contributions for 2016 were made and undone, but I received a 1099-R during the process. How do I deal with this on my taxes? Is there another form to be filled out, or do I just omit it and assume that the broker will not file with the IRS? I'm hopeful that I will not even get a 1099-R for 2017 as it should be like it never happened.

Thanks!

retiredjg
Posts: 30326
Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth IRA Contributions

Post by retiredjg » Sun Mar 19, 2017 8:34 am

ximmortla wrote:I thought I would ask a follow-on question here as it would document the whole process of undoing a botched backdoor-IRA contribution.

Contributions for 2016 were made and undone, but I received a 1099-R during the process. How do I deal with this on my taxes? Is there another form to be filled out, or do I just omit it and assume that the broker will not file with the IRS? I'm hopeful that I will not even get a 1099-R for 2017 as it should be like it never happened.

Thanks!

I was hoping someone would respond to this because I'm not sure.

I think the instructions should say something about not including a recharacterization and I think you need to give an explanatory comment about why it is not included.

You can't just pretend it never happened because the IRS has gotten the same 1099-R you got and they don't know you recharacterized )I guess they will get that next year). You have to find a way on your form to say "this was recharacterized".

User avatar
Duckie
Posts: 5013
Joined: Thu Mar 08, 2007 2:55 pm

Re: Backdoor Roth IRA Contributions

Post by Duckie » Sun Mar 19, 2017 6:13 pm

ximmortla wrote:Contributions for 2016 were made and undone, but I received a 1099-R during the process. How do I deal with this on my taxes? Is there another form to be filled out, or do I just omit it and assume that the broker will not file with the IRS? I'm hopeful that I will not even get a 1099-R for 2017 as it should be like it never happened.

You will get a 1099-R and you will need to report it (see here). If you do your taxes by hand you add a statement on an separate piece of paper explaining exactly what and when you did things. If you use tax software, when figuring out the IRA contributions and whether anything is deductible the software should ask if anything was recharacterized. If you answer YES then it should provide a place to make a statement.

User avatar
prudent
Moderator
Posts: 4738
Joined: Fri May 20, 2011 2:50 pm

Re: Backdoor Roth IRA Contributions

Post by prudent » Sun Mar 19, 2017 6:29 pm

Topic moved to Investing - Help with Personal Investments.

Post Reply