Backdoor Roth with Existing Traditional IRAs

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nszzya
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Joined: Wed Feb 22, 2012 2:19 pm

Backdoor Roth with Existing Traditional IRAs

Post by nszzya » Sun Jan 21, 2018 6:28 pm

Hello Bogleheads,

My wife and I each have traditional nondeductible IRAs each with balances of about 80k. I have existing rollover IRAs with Schwab and a current employer 401k with Fidelity that allows IRA roll in and roll out with no penalty. My wife has no additional retirement accounts. I plan to retire within the year but don't anticipate that my tax bracket will change.

For my wife, my understanding is that if we convert her traditional IRA to a Roth, we will pay federal (and CA state?) tax on earnings at our current income tax rate. After the conversion, there will be no tax on earnings and withdrawals for the Roth account and we will be able to make backdoor Roth contributions.

In my case, we've been considering rolling my rollover IRAs to my 401k, making the traditional IRA to Roth conversion, paying the tax on traditional IRA earnings and then returning the rollover IRAs to Schwab because of superior investment options. After the conversion, there will be no tax on earnings and withdrawals for the Roth account. We will be able to make a backdoor contribution for 2018. However, in order to make additional contributions to the Roth and avoid the pro-rata rule, I would have to repeat the process.

I think in my wife's case, the conversion makes sense. In my case, I'm not sure that the costs and hassle would net any real benefit.

Please let me know your thoughts which are, as always, greatly appreciated.

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Duckie
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Re: Backdoor Roth with Existing Traditional IRAs

Post by Duckie » Sun Jan 21, 2018 8:14 pm

nszzya wrote:My wife and I each have traditional nondeductible IRAs each with balances of about 80k.
Since you made non-deductible contributions, how much of that $80K is already-taxed basis?
I have existing rollover IRAs with Schwab and a current employer 401k with Fidelity that allows IRA roll in and roll out with no penalty. My wife has no additional retirement accounts. I plan to retire within the year but don't anticipate that my tax bracket will change.
Are you going to totally retire, or will you have some part-time earned income? At least one of you needs earned income to contribute to an IRA.
For my wife, my understanding is that if we convert her traditional IRA to a Roth, we will pay federal (and CA state?) tax on earnings at our current income tax rate. After the conversion, there will be no tax on earnings and withdrawals for the Roth account and we will be able to make backdoor Roth contributions.
Is she working? If she is, when is she planning to retire? And yes, you'll pay CA state taxes on the conversion.
In my case, we've been considering rolling my rollover IRAs to my 401k, making the traditional IRA to Roth conversion, paying the tax on traditional IRA earnings and then returning the rollover IRAs to Schwab because of superior investment options. After the conversion, there will be no tax on earnings and withdrawals for the Roth account. We will be able to make a backdoor contribution for 2018. However, in order to make additional contributions to the Roth and avoid the pro-rata rule, I would have to repeat the process.
I wouldn't go through all that fuss. It doesn't seem worth the effort especially if you're retiring next year.
I think in my wife's case, the conversion makes sense. In my case, I'm not sure that the costs and hassle would net any real benefit.
I'm not sure it makes sense in her case either.

nszzya
Posts: 52
Joined: Wed Feb 22, 2012 2:19 pm

Re: Backdoor Roth with Existing Traditional IRAs

Post by nszzya » Sun Jan 21, 2018 8:23 pm

Duckie wrote:
Sun Jan 21, 2018 8:14 pm
nszzya wrote:My wife and I each have traditional nondeductible IRAs each with balances of about 80k.
Since you made non-deductible contributions, how much of that $80K is already-taxed basis?
I have existing rollover IRAs with Schwab and a current employer 401k with Fidelity that allows IRA roll in and roll out with no penalty. My wife has no additional retirement accounts. I plan to retire within the year but don't anticipate that my tax bracket will change.
Are you going to totally retire, or will you have some part-time earned income? At least one of you needs earned income to contribute to an IRA.
For my wife, my understanding is that if we convert her traditional IRA to a Roth, we will pay federal (and CA state?) tax on earnings at our current income tax rate. After the conversion, there will be no tax on earnings and withdrawals for the Roth account and we will be able to make backdoor Roth contributions.
Is she working? If she is, when is she planning to retire? And yes, you'll pay CA state taxes on the conversion.
In my case, we've been considering rolling my rollover IRAs to my 401k, making the traditional IRA to Roth conversion, paying the tax on traditional IRA earnings and then returning the rollover IRAs to Schwab because of superior investment options. After the conversion, there will be no tax on earnings and withdrawals for the Roth account. We will be able to make a backdoor contribution for 2018. However, in order to make additional contributions to the Roth and avoid the pro-rata rule, I would have to repeat the process.
I wouldn't go through all that fuss. It doesn't seem worth the effort especially if you're retiring next year.
I think in my wife's case, the conversion makes sense. In my case, I'm not sure that the costs and hassle would net any real benefit.
I'm not sure it makes sense in her case either.
Thanks for the reply.

To answer:

About $65K in each TIRA is already taxed.

Rather than "retire", I should have said that I plan to leave my current job (and the ability to roll in/out to the 401k). I will have earned income.

Wife does not work.

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Duckie
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Re: Backdoor Roth with Existing Traditional IRAs

Post by Duckie » Sun Jan 21, 2018 8:31 pm

nszzya wrote:About $65K in each TIRA is already taxed.
<snip>
Wife does not work.
In that case she should convert her TIRA and pay the taxes on the $15K growth. She could then do the backdoor method based on your income.
Rather than "retire", I should have said that I plan to leave my current job (and the ability to roll in/out to the 401k). I will have earned income.
Do you have self-employment income? Because if so you could open a solo 401k at Schwab (since you like them) and have excellent options and not need to do the convoluted rollovers mentioned above.

kaneohe
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Re: Backdoor Roth with Existing Traditional IRAs

Post by kaneohe » Sun Jan 21, 2018 8:47 pm

nszzya wrote:
Sun Jan 21, 2018 6:28 pm
................................................
In my case, we've been considering rolling my rollover IRAs to my 401k, making the traditional IRA to Roth conversion, paying the tax on traditional IRA earnings and then returning the rollover IRAs to Schwab because of superior investment options. After the conversion, there will be no tax on earnings and withdrawals for the Roth account. We will be able to make a backdoor contribution for 2018. However, in order to make additional contributions to the Roth and avoid the pro-rata rule, I would have to repeat the process.

......................................................
Be careful about rolling IRAs back to Schwab..........they need to be in the 401K on Dec. 31 for the yr the conversion is made. Otherwise the pro-rata rule applies and the conversion will be mostly taxable.

Also after the conversion, depending on age at withdrawal , age of conversion or age of oldest Roth, there could be taxes/penalty on withdrawals from Roth. http://fairmark.com/forum/read.php?2,63970

nszzya
Posts: 52
Joined: Wed Feb 22, 2012 2:19 pm

Re: Backdoor Roth with Existing Traditional IRAs

Post by nszzya » Sun Jan 21, 2018 9:08 pm

Duckie wrote:
Sun Jan 21, 2018 8:31 pm
nszzya wrote:About $65K in each TIRA is already taxed.
<snip>
Wife does not work.
In that case she should convert her TIRA and pay the taxes on the $15K growth. She could then do the backdoor method based on your income.
Rather than "retire", I should have said that I plan to leave my current job (and the ability to roll in/out to the 401k). I will have earned income.
Do you have self-employment income? Because if so you could open a solo 401k at Schwab (since you like them) and have excellent options and not need to do the convoluted rollovers mentioned above.
Roger that on the wife's scenario. Thank you.

I have a little self-employment income now, but this will grow after I leave my current job making the solo 401(k) is a brilliant idea - $59K in pretax contributions is very appealing. As for my TIRA, sounds like I should just leave it alone.

Thanks again!

nszzya
Posts: 52
Joined: Wed Feb 22, 2012 2:19 pm

Re: Backdoor Roth with Existing Traditional IRAs

Post by nszzya » Sun Jan 21, 2018 9:09 pm

kaneohe wrote:
Sun Jan 21, 2018 8:47 pm
nszzya wrote:
Sun Jan 21, 2018 6:28 pm
................................................
In my case, we've been considering rolling my rollover IRAs to my 401k, making the traditional IRA to Roth conversion, paying the tax on traditional IRA earnings and then returning the rollover IRAs to Schwab because of superior investment options. After the conversion, there will be no tax on earnings and withdrawals for the Roth account. We will be able to make a backdoor contribution for 2018. However, in order to make additional contributions to the Roth and avoid the pro-rata rule, I would have to repeat the process.

......................................................
Be careful about rolling IRAs back to Schwab..........they need to be in the 401K on Dec. 31 for the yr the conversion is made. Otherwise the pro-rata rule applies and the conversion will be mostly taxable.

Also after the conversion, depending on age at withdrawal , age of conversion or age of oldest Roth, there could be taxes/penalty on withdrawals from Roth. http://fairmark.com/forum/read.php?2,63970
Thanks. Sounds like a major headache for not a clear worthwhile gain.

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Duckie
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Re: Backdoor Roth with Existing Traditional IRAs

Post by Duckie » Mon Jan 22, 2018 3:53 pm

nszzya wrote:I have a little self-employment income now, but this will grow after I leave my current job making the solo 401(k) is a brilliant idea - $59K in pretax contributions is very appealing. As for my TIRA, sounds like I should just leave it alone.
Once your solo 401k is set up you can roll all your pre-tax IRA assets (TIRA, Rollover IRA) into it. This assumes Schwab's solo 401k allows incoming rollovers, I haven't checked. Then you can convert all the after-tax basis to your Roth IRA with minimal taxes. Since this process will empty all your non-Roth IRAs you can then use the backdoor method.

Once you quit your current W-2 job you can either leave the 401k where it is or roll it to the solo 401k. Avoid rolling to a Rollover IRA because this will mess up the backdoor method.

Hopefully all your after-tax basis is documented on Form 8606 for previous years.

nszzya
Posts: 52
Joined: Wed Feb 22, 2012 2:19 pm

Re: Backdoor Roth with Existing Traditional IRAs

Post by nszzya » Tue Jan 23, 2018 3:22 pm

The benefits of a solo 401(k) are compelling for my near future situation. BTW, Schwab doesn't allow incoming rollovers, but others do (Fidelity is one). Thanks again for this insight - very helpful!

nszzya
Posts: 52
Joined: Wed Feb 22, 2012 2:19 pm

Re: Backdoor Roth with Existing Traditional IRAs

Post by nszzya » Wed Feb 14, 2018 3:41 pm

Duckie wrote:
Sun Jan 21, 2018 8:31 pm
In that case she should convert her TIRA and pay the taxes on the $15K growth. She could then do the backdoor method based on your income.
Growth has actually been about $26K.

Just want to make sure I have this right:

The TIRA balance is $81K and basis through 2016 is $55K.

My understanding is that federal and CA CG tax would be due on the earnings of 26K. With 15% federal and 10% CA CG tax, I would owe about $6500.

Does taking the $6500 tax hit make sense if we don't plan on accessing the funds for 10+ years?

MotoTrojan
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Re: Backdoor Roth with Existing Traditional IRAs

Post by MotoTrojan » Wed Feb 14, 2018 4:01 pm

nszzya wrote:
Wed Feb 14, 2018 3:41 pm
Duckie wrote:
Sun Jan 21, 2018 8:31 pm
In that case she should convert her TIRA and pay the taxes on the $15K growth. She could then do the backdoor method based on your income.
Growth has actually been about $26K.

Just want to make sure I have this right:

The TIRA balance is $81K and basis through 2016 is $55K.

My understanding is that federal and CA CG tax would be due on the earnings of 26K. With 15% federal and 10% CA CG tax, I would owe about $6500.

Does taking the $6500 tax hit make sense if we don't plan on accessing the funds for 10+ years?
I may be wrong but I thought you paid regular income tax on the gains from a non-deductible IRA (and pay regular income tax when pulling funds out down the road, if you don't backdoor).

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Duckie
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Re: Backdoor Roth with Existing Traditional IRAs

Post by Duckie » Wed Feb 14, 2018 5:51 pm

MotoTrojan wrote:
nszzya wrote:My understanding is that federal and CA CG tax would be due on the earnings of 26K. With 15% federal and 10% CA CG tax, I would owe about $6500.
I may be wrong but I thought you paid regular income tax on the gains from a non-deductible IRA (and pay regular income tax when pulling funds out down the road, if you don't backdoor).
MotoTrojan is correct. You don't pay the lower capital gains tax rates on the earnings. You pay regular rates.
nszzya wrote:Does taking the $6500 tax hit make sense if we don't plan on accessing the funds for 10+ years?
It'll be more than $6500. If she wants to use the backdoor method she'll need to convert and pay the taxes. Only the two of you can decide whether it's worth it.

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