Backdoor Roth - do I understand it ?

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Good Listener
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Backdoor Roth - do I understand it ?

Postby Good Listener » Sat Mar 18, 2017 3:23 pm

For my adult child who will earn too much in 2017 to do a deductible IRA or Roth deposit... Do I have this right?

To do a backdoor Roth she will make a deposit into a traditional IRA and that doesn't specify whether deductible or not (that is only addressed on the tax returnl). Then either 1 nanosecond or a day or two later, she converts the IRA to a Roth. (There is no current traditional IRA). It will all be done in the same calendar year so she will get a 1099R from Vanguard and up with a Form 8606 for her 2017 tax return where everything washes out except she will pay ordinary income tax on any investment gains during the time between starting the process and the conversion. And then nothing carries forward to the next year. If there is a loss she can recharacterize or if tiny, just eat the loss. So in essence any taxable gain is not so horrible as functionally it is a larger Roth, right?

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Duckie
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Re: Backdoor Roth - do I understand it ?

Postby Duckie » Sat Mar 18, 2017 5:37 pm

Good Listener wrote:For my adult child who will earn too much in 2017 to do a deductible IRA or Roth deposit... Do I have this right?

Yes.

Then either 1 nanosecond or a day or two later, she converts the IRA to a Roth.

It takes a day or so for the contribution to post.

she will pay ordinary income tax on any investment gains during the time between starting the process and the conversion. And then nothing carries forward to the next year. If there is a loss she can recharacterize or if tiny, just eat the loss.

To minimize gains and avoid losses use a money market or settlement fund in the TIRA.

Have her do a test Form 8606 with paper and pencil. That way she will know what it should look like.

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Re: Backdoor Roth - do I understand it ?

Postby Good Listener » Sat Mar 18, 2017 6:34 pm

Duckie wrote:
Good Listener wrote:For my adult child who will earn too much in 2017 to do a deductible IRA or Roth deposit... Do I have this right?

Yes.

Then either 1 nanosecond or a day or two later, she converts the IRA to a Roth.

It takes a day or so for the contribution to post.

she will pay ordinary income tax on any investment gains during the time between starting the process and the conversion. And then nothing carries forward to the next year. If there is a loss she can recharacterize or if tiny, just eat the loss.

To minimize gains and avoid losses use a money market or settlement fund in the TIRA.

Have her do a test Form 8606 with paper and pencil. That way she will know what it should look like.


Thank you. The Vanguard Prime money market sounds good.

retiredjg
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Re: Backdoor Roth - do I understand it ?

Postby retiredjg » Sat Mar 18, 2017 7:05 pm

AS you know, a traditional IRA gets in the way. That includes rollover IRA, SEP IRA, and SIMPLE IRA as well. She must also not roll anything into IRA before the end of the year.

I don't think anyone should use the back door without working through the Form 8606 AHEAD OF TIME. Tell her to do it in pencil first, not with software. Do not depend on tax preparers to know how to do this because they usually don't.

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Re: Backdoor Roth - do I understand it ?

Postby The Wizard » Sat Mar 18, 2017 7:15 pm

Skip the money market foolishness.
Put the $5500 directly into the desired stock fund in her tIRA and then do a direct transfer/conversion to the Roth IRA.
If she gets a $50 STCG out of the two days of holding then just pay $12 additional tax.
No biggie...
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retiredjg
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Re: Backdoor Roth - do I understand it ?

Postby retiredjg » Sat Mar 18, 2017 8:39 pm

I don't think the money market idea is foolishness. I would not be worried about a few dollars of earnings, but if the investment loses money before the conversion, you have to deal with the carried forward basis. If, in fact, there is a carried forward basis.

Smart people on both sides of that discussion. :twisted:

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Re: Backdoor Roth - do I understand it ?

Postby The Wizard » Sun Mar 19, 2017 8:36 am

retiredjg wrote:I don't think the money market idea is foolishness. I would not be worried about a few dollars of earnings, but if the investment loses money before the conversion, you have to deal with the carried forward basis. If, in fact, there is a carried forward basis.

Smart people on both sides of that discussion. :twisted:

I admit to being unfamiliar with carried forward basis in this situation, but I let my tax software fill out my form 8606.
Sounds like a $50 decline in my tIRA prior to conversion this year could be used to offset a $50 gain in subsequent years. Good...
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retiredjg
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Re: Backdoor Roth - do I understand it ?

Postby retiredjg » Sun Mar 19, 2017 8:52 am

The Wizard wrote:I admit to being unfamiliar with carried forward basis in this situation, but I let my tax software fill out my form 8606.
Sounds like a $50 decline in my tIRA prior to conversion this year could be used to offset a $50 gain in subsequent years. Good...

There are people who think it carries over and people who think it does not carry over.

To make it worse, my understanding is that we have seen tax software carry it over and not carry it over. It may depend on which route the software takes to get there. It is both a frustrating and fascinating subject.

The easiest way to avoid this issue is not to make a conversion at a loss. You can avoid it by using money market for the few days before the conversion. Or if a person wants a wait time before the conversion and does not wish to have money sitting in money market....wait till there is no loss and then make the conversion.

It might be interesting to see what your tax software does with Form 8606 if you pretend to have a loss when you convert. If you do, let us know?

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Epsilon Delta
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Re: Backdoor Roth - do I understand it ?

Postby Epsilon Delta » Sun Mar 19, 2017 12:08 pm

retiredjg wrote:
The Wizard wrote:I admit to being unfamiliar with carried forward basis in this situation, but I let my tax software fill out my form 8606.
Sounds like a $50 decline in my tIRA prior to conversion this year could be used to offset a $50 gain in subsequent years. Good...

There are people who think it carries over and people who think it does not carry over.

To make it worse, my understanding is that we have seen tax software carry it over and not carry it over. It may depend on which route the software takes to get there. It is both a frustrating and fascinating subject.

If it's $50 let the tax software do what the tax software does. Yes it's your return, and you are supposed to do it correctly, but the IRS expects due diligence, not undue diligence. For $50 entering the correct number into TT is all that is due. If the IRS thinks it's a big deal they'll publish guidance and TT will adapt.

If it's a lot more than $50 you may want to take a view, the easiest thing to do is leave a buck in the tIRA to keep it open. I don't think there is any question the excess basis remains in the tIRA if you only do a partial conversion.

The MM for the tIRA contribution is harmless but not particularly useful. Rather like making deductible and non-deductible contributions to separate IRAs.

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Re: Backdoor Roth - do I understand it ?

Postby billthecat » Sun Mar 19, 2017 12:32 pm

The Wizard wrote:Skip the money market foolishness.
Put the $5500 directly into the desired stock fund in her tIRA and then do a direct transfer/conversion to the Roth IRA.
If she gets a $50 STCG out of the two days of holding then just pay $12 additional tax.
No biggie...


When you do a conversion, are investments sold and then converted (automatically)? Or are investments converted "in place"? I only ever converted cash.

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Re: Backdoor Roth - do I understand it ?

Postby Good Listener » Sun Mar 19, 2017 3:28 pm

The Wizard wrote:Skip the money market foolishness.
Put the $5500 directly into the desired stock fund in her tIRA and then do a direct transfer/conversion to the Roth IRA.
If she gets a $50 STCG out of the two days of holding then just pay $12 additional tax.
No biggie...


Interesting thought as I too like simplicity. But wizard, a question. One will need to choose 1 fund in the tIRA and 1 fund in the Roth. So one could choose a money market in the tIRA and then transfer it to the fund of choice in the Roth. Right?
Last edited by Good Listener on Sun Mar 19, 2017 5:45 pm, edited 2 times in total.

retiredjg
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Re: Backdoor Roth - do I understand it ?

Postby retiredjg » Sun Mar 19, 2017 5:19 pm

Epsilon Delta wrote:If it's a lot more than $50 you may want to take a view, the easiest thing to do is leave a buck in the tIRA to keep it open. I don't think there is any question the excess basis remains in the tIRA if you only do a partial conversion.

I too think there is no question the excess basis remains if you do a partial conversion, but then you have to pro-rate your conversion. Every year. Wouldn't it be simpler just to avoid converting when there is a loss by using money market?

I don't understand why you don't see using money market is useful. It seems to me that it doesn't cost anything (for a few days). It seems to me it makes things easier.

Am I missing something?

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Epsilon Delta
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Re: Backdoor Roth - do I understand it ?

Postby Epsilon Delta » Sun Mar 19, 2017 8:35 pm

retiredjg wrote:I don't understand why you don't see using money market is useful. It seems to me that it doesn't cost anything (for a few days). It seems to me it makes things easier.

Am I missing something?

I don't see any particular difficulty to filling out the 8606 with a modest gain or loss, so I don't see it as easier to avoid the gain or loss.

---
A year or so ago people where advising use of a MM account to avoid any gain or loss and convert exactly the amount contributed.

Then interest rates rose above .03% and people started asking what to do about the pennies that started showing up, and some people people say it's less than $.50 so it rounds to zero.

In a few more years if interest rates rise above 3% a days interest will not round to zero and new advice will be needed.

Maybe someday we'll get negative interest rates on MMs and have to go through another couple of rounds.

OTOH I've been saying all along learn how to fill in the form with a gain or loss, it presents no great difficulty. Learn how to do it right and you won't have to learn how to do it over and over.

retiredjg
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Re: Backdoor Roth - do I understand it ?

Postby retiredjg » Mon Mar 20, 2017 7:42 am

I think that makes perfect sense. And I wish everyone would figure it out. But I don't see that happening. Thus, the suggestions on how to keep things simpler.

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Re: Backdoor Roth - do I understand it ?

Postby The Wizard » Mon Mar 20, 2017 8:09 am

billthecat wrote:
The Wizard wrote:Skip the money market foolishness.
Put the $5500 directly into the desired stock fund in her tIRA and then do a direct transfer/conversion to the Roth IRA.
If she gets a $50 STCG out of the two days of holding then just pay $12 additional tax.
No biggie...


When you do a conversion, are investments sold and then converted (automatically)? Or are investments converted "in place"? I only ever converted cash.

The one I did last year with Vanguard effectively got converted in place. I contributed to a particular stock fund in my (new) tIRA for a few months until I got to $6500 contributed and then converted it to the same fund in my existing Roth IRA.
This was part-time earned income last year on top of my "unearned" retirement income, for what it matters...
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Re: Backdoor Roth - do I understand it ?

Postby The Wizard » Mon Mar 20, 2017 8:11 am

Good Listener wrote:
The Wizard wrote:Skip the money market foolishness.
Put the $5500 directly into the desired stock fund in her tIRA and then do a direct transfer/conversion to the Roth IRA.
If she gets a $50 STCG out of the two days of holding then just pay $12 additional tax.
No biggie...


Interesting thought as I too like simplicity. But wizard, a question. One will need to choose 1 fund in the tIRA and 1 fund in the Roth. So one could choose a money market in the tIRA and then transfer it to the fund of choice in the Roth. Right?

Definitely. Or split the converted amount between multiple funds in your Roth, assuming minimums are met...
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Epsilon Delta
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Re: Backdoor Roth - do I understand it ?

Postby Epsilon Delta » Mon Mar 20, 2017 10:13 am

retiredjg wrote:I think that makes perfect sense. And I wish everyone would figure it out. But I don't see that happening. Thus, the suggestions on how to keep things simpler.

I have a fair amount of sympathy for the keep it simpler view.

My intention, if not my wording, is to show that it's not serious problem if the keep it simpler method fails.

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Re: Backdoor Roth - do I understand it ?

Postby LadyGeek » Thu Mar 23, 2017 4:00 pm

New member TxInjun has some questions which I've moved into a stand-alone thread: [Questions about my company's "In-Plan Roth Conversion"]
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