Backdoor Roth IRA worth it?

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cbr shadow
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Backdoor Roth IRA worth it?

Post by cbr shadow » Wed Dec 13, 2017 5:25 pm

I'm trying to figure out if doing a backdoor Roth IRA contribution is worth it, vs not doing one at all. Normal contribution to a Roth IRA is no longer an option as my household income is over the $194k MAGI limit.

I'll try to be as concise as possible:

- I have an existing rollover IRA from a previous job's 401k plan (Now a Vanguard IRA)
- My current 401k plan custodian is willing to take the money from my Vanguard rollover IRA and add it to my current 401k
- My current 401k has somewhat high fees. Somewhere between 1.25% - 2%

Option A)
Move my Vanguard Rollover IRA ($75k) to my current 401k. Pay fees on that new money in my 401k. Then proceed to do a backdoor Roth IRA. It's my understanding that doing a backdoor roth IRA contribution isn't possible if you have an existing rollover IRA, which I do.

Option B)
Keep my Vanguard Rollover IRA right where it is. Don't contribute to a Roth IRA at all.

Thanks for any input.

Thesaints
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Re: Backdoor Roth IRA worth it?

Post by Thesaints » Wed Dec 13, 2017 5:29 pm

1% of 75k is $750. That's the kind of money you'd be paying in order to invest $5,500 in a Roth every year.
kind of a 13.6% front load...

cbr shadow
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Re: Backdoor Roth IRA worth it?

Post by cbr shadow » Wed Dec 13, 2017 6:11 pm

I agree that it sounds pretty rough.. What are other people doing in my situation? Is there a 3rd option, or should I just forget about doing a Roth IRA?

HornedToad
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Re: Backdoor Roth IRA worth it?

Post by HornedToad » Wed Dec 13, 2017 6:19 pm

I wouldn't bother in your case. Just invest in taxable or non-deductable IRA... probably taxable

Thesaints
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Re: Backdoor Roth IRA worth it?

Post by Thesaints » Wed Dec 13, 2017 6:20 pm

How much would it cost you to backdoor while keepng the rollover IRA ?

onourway
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Re: Backdoor Roth IRA worth it?

Post by onourway » Wed Dec 13, 2017 6:26 pm

Option 3. Petition your current employer for a better plan. They have a fiduciary responsibility in managing the plan. It may be that they are failing that test. https://www.bogleheads.org/wiki/How_to_ ... 01(k)_plan

cbr shadow
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Re: Backdoor Roth IRA worth it?

Post by cbr shadow » Wed Dec 13, 2017 6:59 pm

Thesaints wrote:
Wed Dec 13, 2017 6:20 pm
How much would it cost you to backdoor while keepng the rollover IRA ?
I'm not sure! How do I figure this out? Clearly I'm new to this :-/

Thesaints
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Re: Backdoor Roth IRA worth it?

Post by Thesaints » Wed Dec 13, 2017 7:07 pm

If you have 75k in the rollover, put (new) 5.5k in a non-deductible IRA and convert those 5.5k, you will be taxed on an extra 75/80.5 x 5.5k = $5,124 added to your income.

For future conversions, you’ll treat the amount in the rollover IRA as if they were 75k - 5,124 = $69,886 and modify the formula accordingly.I’m assuming your rollover IRA doesn’t change in value, otherwise use the new 12/31 value instead of 75k in the year you convert.

Form 8606, and equivalent for state taxes, walk you though the process.

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TomatoTomahto
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Re: Backdoor Roth IRA worth it?

Post by TomatoTomahto » Wed Dec 13, 2017 7:09 pm

Often some 401k have one fund whose ERs aren’t horrible. Does yours? Perhaps a Stable Value Fund?

We would need to know more about your tax situation to figure out how much converting your tIRA to a rIRA would cost. I have a sizable Rollover tIRA and no 401k, so I gave up on backdoor.

cbr shadow
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Re: Backdoor Roth IRA worth it?

Post by cbr shadow » Wed Dec 13, 2017 7:43 pm

TomatoTomahto wrote:
Wed Dec 13, 2017 7:09 pm
Often some 401k have one fund whose ERs aren’t horrible. Does yours? Perhaps a Stable Value Fund?

We would need to know more about your tax situation to figure out how much converting your tIRA to a rIRA would cost. I have a sizable Rollover tIRA and no 401k, so I gave up on backdoor.
Good questions.

My 401k does have a "Vanguard S&P 500 Index Admiral Fund" which is where I put all of my money. I calculated my total fees (including the ER of the Vanguard fund) and I'm at 1.04% total fees.

What about my tax situation is needed to figure out how much converting my tIRA to a rIRA would cost?
I'm a CA resident
MFJ with $221k MAGI
No mortgage, no kids

Thesaints
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Re: Backdoor Roth IRA worth it?

Post by Thesaints » Wed Dec 13, 2017 8:34 pm

How do you get to 1.04% ? That vanguard fund must have an ER below 0.1%

How much taxes you pay depends on how much you convert. If you contribute 5.5k for 2017, you can convert anywhere from 0 to 75+5.5=80.5k.
Assuming you contribute to a non deductible IRA for 2017, how much of your conversion is taxable depends on the ratio between converted amount and total IRA value at 12/31.
I showed you the calculation assuming you only convert this year's contribution.

If your taxable income increases by $5,124 you know your federal and state marginal rates and you know if you itemize deductions. Calculating the tax is straightforward.

ulrichw
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Re: Backdoor Roth IRA worth it?

Post by ulrichw » Wed Dec 13, 2017 8:44 pm

Another option if you're in a field like mine where job-switching happens semi-regularly is to simply put money into an after-tax tIRA and keep it there without converting it.

When you find an employer with a better 401(k) plan, or your employer changes their investment offerings, move your rollover IRA back into the 401(k), and do the Roth conversion on whatever you've accumulated. You'll have to pay taxes on any gains in the account, but that should be a relatively small amount.

I did this - I had a couple of years worth of after-tax contributions squirreled away in an account for 5+ years. I'm finally at a point now where I was able to roll my tIRA money into my current 401(k) plan and am planning to do the Roth conversion once the rollovers complete.

DSInvestor
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Re: Backdoor Roth IRA worth it?

Post by DSInvestor » Wed Dec 13, 2017 8:48 pm

If your spouse has no rollover IRA assets, he or she can use the backdoor into Roth IRA without problems. Your assets in Rollover IRA only affects your use of the backdoor into Roth IRA. Form 8606 treats assets separately for each individual.
Wiki

retiredjg
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Re: Backdoor Roth IRA worth it?

Post by retiredjg » Wed Dec 13, 2017 8:57 pm

I would not roll the IRA into a high cost 401k. Put the money in a taxable account. Not quite as good as Roth IRA, but a good place for retirement money anyway.

I would not use the back door with the current IRA in place. This means you will be paying tax at a higher rate than when you deferred the money in the first place. Doesn't make sense to me.

Your spouse may be able to use the back door - your IRA does not affect your spouse.

People were fine before the back door got invented. Just save money in taxable instead. Having a good retirement is about saving more than what kind of account you save in.

cbr shadow
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Re: Backdoor Roth IRA worth it?

Post by cbr shadow » Thu Dec 14, 2017 5:08 pm

Most of the above makes sense to me. It sounds like my best bet in the future is to just keep my rollover IRA where it is, and put all extra money into a taxable account. Easy Peasy.

So here's where i'm confused. I accidentally contributed to my Roth IRA for 2017 in April the "Normal Way" (Aka, not a backdoor) directly through Vanguard. I did this for both my wife and I.

I feel like it's urgent that we remove that money from our accounts before 2017 ends to simplify taxes - is that correct? What's the simplest solution here? To be clear: I contribute to a Roth IRA but the rules say we can't because of our income. What now?

Thanks for any help - having trouble wrapping my head around the pre/post tax part of this, and figuring out if we will owe tax money or be penalized.

retiredjg
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Re: Backdoor Roth IRA worth it?

Post by retiredjg » Thu Dec 14, 2017 5:38 pm

The only solution I see is to call the custodian and get a return of your contribution (and it's earnings). I believe you can also use the words "withdrawal of the contribution", but it has to be clear you want to un-do what you did. This is not an ordinary withdrawal.

It has to be done by tax day 2018. I'd probably do it by the end of the year.

The earnings will come back with the contributions and the earnings part will be reported as taxable income. No big deal.

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TomatoTomahto
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Re: Backdoor Roth IRA worth it?

Post by TomatoTomahto » Thu Dec 14, 2017 5:43 pm

My son did one of those a few years ago when what he thought was earned income was reported as a stipend. It took 2 minutes on the phone. Simple and painless.

JBTX
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Re: Backdoor Roth IRA worth it?

Post by JBTX » Thu Dec 14, 2017 5:55 pm

75000 * 1% = $750 every year in extra fees

Tax savings on a $5500 Roth vs taxable account is probably about

$5500 * 8% annual gain including dividends = 440 gain. 440 * 15% tax = $66 tax on a taxable account.

You pay an extra $750 per year in fees and you get maybe $66 in tax savings. Ignoring compounding you would have to contribute to backdoor Roth’s about 12 years before breaking even.

Those are really rough numbers but no I wouldn’t roll into a high fee 401k.

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Epsilon Delta
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Re: Backdoor Roth IRA worth it?

Post by Epsilon Delta » Thu Dec 14, 2017 9:27 pm

Option 4 (or is it 5?)
Convert the $75k in the rollover IRA to a Roth while you make Backdoor Roth contributions. You could do this over several (perhaps 5) years if you're near a tax bracket boundary.

This is only likely to be a good thing to do if you foresee you will remain in or near your current marginal tax bracket for quite a long time, if you could be certain to remain in a high bracket for the rest of your life this doing converting the $75k would be a sure thing.

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grabiner
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Re: Backdoor Roth IRA worth it?

Post by grabiner » Thu Dec 14, 2017 9:33 pm

cbr shadow wrote:
Wed Dec 13, 2017 7:43 pm
TomatoTomahto wrote:
Wed Dec 13, 2017 7:09 pm
Often some 401k have one fund whose ERs aren’t horrible. Does yours? Perhaps a Stable Value Fund?

We would need to know more about your tax situation to figure out how much converting your tIRA to a rIRA would cost. I have a sizable Rollover tIRA and no 401k, so I gave up on backdoor.
Good questions.

My 401k does have a "Vanguard S&P 500 Index Admiral Fund" which is where I put all of my money. I calculated my total fees (including the ER of the Vanguard fund) and I'm at 1.04% total fees.

What about my tax situation is needed to figure out how much converting my tIRA to a rIRA would cost?
I'm a CA resident
MFJ with $221k MAGI
No mortgage, no kids
It looks like you are in the 28% federal, and 9.3% state tax bracket, for an overall 34.7% tax bracket (state is deductible from federal, which is why it isn't 37.7%). With no kids, you aren't subject to the phase-out of the child tax credit, so your marginal tax rate is probably the same 34.7%. You will probably retire in a lower bracket, particularly if you don't retire in CA, so this conversion is costly.

How long do you expect to stay with your employer? When you leave your employer, you can get rid of the extra 1% per year in expenses, by rolling your high-cost 401(k) into an IRA. Unless you expect to stay for a long time, contributing more to the 401(k) may even be better than contributing to a Roth IRA. If you pay five years of an extra 1% expense, but retire in a 25% tax bracket (say, in a state with no income tax), you get the 34.7% deduction and lose 30% to fees and taxes when you withdraw.
Wiki David Grabiner

cbr shadow
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Re: Backdoor Roth IRA worth it?

Post by cbr shadow » Fri Dec 15, 2017 5:41 pm

Wow so many great points brought up.. Much appreciated.
I'm unsure how long I'll be at my current employer. Right now I'm in a contract that gets renewed every year, but there's no guarantee work wont dry up at some point.
We're likely to stay in the high tax bracket until we retire, which ideally is in ~12 years.. at that point we move back to the midwest and have much lower expenses and income.

Based on all the advice above, it sounds like I may be best off just "undo'ing" my (and wife's) Roth IRA contributions from 2017 and then contributing everything to our taxable account, along with continuing to max our 401k's.

Is there an argument against doing this? Is the "undo" process simple enough? To be clear I'd just call Vanguard and explain I want to undo the Roth IRA contribution for 2017. They'll give me back the $5,500 plus associated gains and I'll pay taxes on the gains as if they were regular income at tax time. Repeat process for wife's 2017 Roth IRA contribution.

retiredjg
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Re: Backdoor Roth IRA worth it?

Post by retiredjg » Sat Dec 16, 2017 7:22 am

Your IRA does not affect your spouse's ability to use the back door.

If your spouse has no IRA, that contribution could be recharacterized to a non-deductible contribution to tIRA and then converted to Roth. Or it may be easier to just forget the whole thing and put it in taxable.

cbr shadow
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Re: Backdoor Roth IRA worth it?

Post by cbr shadow » Sun Dec 17, 2017 11:25 pm

retiredjg wrote:
Sat Dec 16, 2017 7:22 am
Your IRA does not affect your spouse's ability to use the back door.

If your spouse has no IRA, that contribution could be recharacterized to a non-deductible contribution to tIRA and then converted to Roth. Or it may be easier to just forget the whole thing and put it in taxable.
Understood, but my wife is in the same situation as I am where she's in a 1% fee 401k and has a rollerover IRA

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