IRA questions - back door roth when tIRA is co-mingled

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sbaTexas
Posts: 17
Joined: Sat Nov 29, 2014 1:07 pm

IRA questions - back door roth when tIRA is co-mingled

Post by sbaTexas » Sun Oct 08, 2017 10:06 am

Hello everyone. I have a couple of questions regarding my Traditional IRA's for myself and for my wife:

1. Both of our traditional IRA's are comprised of old 401k rollovers and also non-deductible, after tax deposits over the past few years. If i were to do a back door roth conversion, how would one go about doing that when their traditional IRA has co-mingled funds like this? Could I transfer all the "old 401k" funds to my current employers 401k and then do a Roth conversion on the remaining funds in the tIRA?

2. On a separate note, all of my contributions (other than old 401k of course) are after tax and non deductible. Does it still make sense to use a traditional IRA if your new contributions are both after tax AND non-deductible? For reference I also have 401k and taxable accounts and I diversify with a 3 fund portfolio across the board. Others have suggested before that i quit contributing to the tIRA's and put that money in taxable accounts instead. I have continued to make deposits over the past few years to my tIRA's for the idea of tax free growth over the next 25-30 years (we are 36 and 37). But frankly, I'm not sure if that's the best move since these are after tax, non deductible deposits.

Thank you in advance for your feedback!

DSInvestor
Posts: 10797
Joined: Sat Oct 04, 2008 11:42 am

Re: IRA questions - back door roth when tIRA is co-mingled

Post by DSInvestor » Sun Oct 08, 2017 11:43 am

If your employer plans offer low cost investment options and will accept inbound rollovers from IRA, you can transfer the assets in excess of your IRA basis into your employer plans. This would isolate the IRA basis in your TIRA and allow you to convert that IRA basis to Roth IRA tax free.

For example, you have 300K TIRA where 15K is IRA basis (tracked in form 8606). If you rollover 285K to 401k and leave 15K behind in TIRA, you'd have 15K IRA with 15K IRA basis. Convert all 15K to Roth IRA and this will be non-taxable. Form 8606 handles the calculation of the taxable and non-taxable amounts of the conversion. They key is line 6 on form 8606 which asks for account balances as of DEC 31 in your TIRA, Rollover IRA, SEP-IRA and SIMPLE-IRA accounts. If line 6 is zero, your conversion is treated as full conversion. If line 6 is non-zero, the conversion is a partial conversion and IRA basis will be prorated. Since form 8606 asks for the IRA balances as of DEC 31 of the year that you converted, you can actually do the conversion first of the exact amount of your IRA basis and then rollover ALL remaining assets in your TIRAs into your 401k before DEC 31.

form 8606: https://www.irs.gov/pub/irs-pdf/f8606.pdf

I used a 300K TIRA size to stress the importance of low cost options in the 401k. If you have a high cost 401k say 1%, a rollover of 300K would mean $3000/yr in expense ratio. This is a very high cost to pay for $5500 backdoor into Roth IRA.
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Spirit Rider
Posts: 8102
Joined: Fri Mar 02, 2007 2:39 pm

Re: IRA questions - back door roth when tIRA is co-mingled

Post by Spirit Rider » Sun Oct 08, 2017 12:26 pm

sbaTexas wrote:
Sun Oct 08, 2017 10:06 am
Hello everyone. I have a couple of questions regarding my Traditional IRA's for myself and for my wife:

1. Both of our traditional IRA's are comprised of old 401k rollovers and also non-deductible, after tax deposits over the past few years. If i were to do a back door roth conversion, how would one go about doing that when their traditional IRA has co-mingled funds like this? Could I transfer all the "old 401k" funds to my current employers 401k and then do a Roth conversion on the remaining funds in the tIRA?
If both of your employer's 401k accepts rollovers, you should most definitely rollover all pre-tax balances from all IRA accounts. It doesn't matter that they are co-mingled in one account since all your IRA accounts are treated as one. Then you should rollover all non-deductible basis to a Roth IRA.
2. On a separate note, all of my contributions (other than old 401k of course) are after tax and non deductible. Does it still make sense to use a traditional IRA if your new contributions are both after tax AND non-deductible? For reference I also have 401k and taxable accounts and I diversify with a 3 fund portfolio across the board. Others have suggested before that i quit contributing to the tIRA's and put that money in taxable accounts instead. I have continued to make deposits over the past few years to my tIRA's for the idea of tax free growth over the next 25-30 years (we are 36 and 37). But frankly, I'm not sure if that's the best move since these are after tax, non deductible deposits.
Non-deductible IRA deposits that remain in the IRA are not the best option, because they do not have tax-free growth. All the earnings in an traditional IRA regardless of the deduction basis in the contribution are taxable. Generally, it is better to invest in taxable than make non-deductible contributions, because all distributions are taxed as ordinary income, when equities in a taxable account can receive the more favorable long tern capitial gains treatment.

However, what has happened in the past is done and the only thing that matters is what is the best option moving forward. In 1. above rolling the pre-tax balances to the 401k and doing a Roth conversion with little to no tax liability moves the non-deductible basis to the Roth IRA where future earnings are tax-free.

Since you no longer have pre-tax balances, you are eligible for a Backdoor Roth every year. Read the Wiki on this, but basically you make non-deductible traditional IRA contributions and do a minimal tax liability rollover to the Roth IRA.

P.S. DSInvestor's point about the costs in the 401k are an important consideration for making new Backdoor Roth's.

This maybe less important for determining if it would be best to isolate the current non-deductible basis. If your plan supports it, you could rollover the pre-tax IRA balance to the 401k and do the Roth conversion this year and roll the pre-tax balance back into the IRA next year. What matters for tax purposes of the Roth conversion is that there are little to no pre-tax assets on 12/31 of the year of the Roth conversion.

Then if you have a really high cost 401k plan. In the future it is probably better to just make taxable investments than non-deductible contributions regardless of what you would do with them.

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