What would be an optimal annual plan for contributions including a Backdoor Roth?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by foodhype » Thu Apr 26, 2018 6:13 pm

I understand that it is generally optimal to invest sooner rather than later, especially for tax-advantaged accounts, because it allows more time in the market. And it's even better if the money is growing tax-free, so you want to contribute to tax-advantaged accounts first. Hence, a lot of high-income people dump $5500 into their Backdoor Roth IRA on January 1st, max out their 401(k) contribution rate until it's full, and then return to investing in taxable.

What I'm trying to figure out is, if they were actively investing, where did all that cash come from on January 1st? Did they stop investing in taxable in November to accumulate the cash? Personally I would also need to save extra cash to account for the lost cash flow from maxing 401(k) contributions.

The plan I have listed on my IPS is:

1. Max out 401(k) contribution rate (75%). Fill up 401(k) and Backdoor Roth IRA ASAP starting on January 1st.
2. Then contribute all stock-based compensation and a high enough percentage of salary to equate to a total savings rate of 50% to taxable Vanguard account
3. Let up on taxable investments right before January 1st, saving enough to fill up next year’s Backdoor Roth IRA and to maintain checking account minimum cash requirements after accounting for 401(k) contributions.

Is this optimal? (Just seems mildly annoying to let up on taxable investments every year around November and then resume them after filling up tax advantaged.)

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by foodhype » Thu Apr 26, 2018 6:37 pm

Or do you just sell from taxable at the beginning of the year?

Bacchus01
Posts: 1944
Joined: Mon Dec 24, 2012 9:35 pm

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by Bacchus01 » Thu Apr 26, 2018 7:14 pm

We usually hold about $100K in cash deposits. In January we fully fund two Backdoor Roths ($11K) pay half oroperty tax payments ($7K) and fund five 529s for $15,500. The 401k and HSA kicks in and just comes out of paycheck.

I then have to pay income taxes in April. By that point we’ve recovered from our deposit dropping to about $65K and then taxes so we’re about $85k. By mid-may we will be back above $100K in deposits. Each month, as we go over $100K, we invest in after tax whatever is left. That runs through the end of the year except in July/August when we make our other set of property tax payments.

Wash, rinse, repeat.

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by foodhype » Thu Apr 26, 2018 7:51 pm

Bacchus01 wrote:
Thu Apr 26, 2018 7:14 pm
We usually hold about $100K in cash deposits. In January we fully fund two Backdoor Roths ($11K) pay half oroperty tax payments ($7K) and fund five 529s for $15,500. The 401k and HSA kicks in and just comes out of paycheck.

I then have to pay income taxes in April. By that point we’ve recovered from our deposit dropping to about $65K and then taxes so we’re about $85k. By mid-may we will be back above $100K in deposits. Each month, as we go over $100K, we invest in after tax whatever is left. That runs through the end of the year except in July/August when we make our other set of property tax payments.

Wash, rinse, repeat.
That sounds like a lot of cash drag, although it sounds like you have a spouse, a home, and five kids. Personally I only carry $18k for my emergency savings fund. I neither want to dip into it nor carry unnecessary cash drag all year.

The two options I've come up with to avoid both of these are:
(1) Let off on taxable investments in November to save enough so I have just barely enough that I can fund the Backdoor Roth and survive for 2-3 months while maxing out 401(k) contributions without dipping into my emergency savings.
(2) Instead of letting up on investments to save cash, simply sell investments with the most recent cost basis.

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by foodhype » Thu Apr 26, 2018 8:11 pm

[Thread merged into here, see below. --admin LadyGeek]

Do you let up on your normal taxable investing around November so you have a enough cash to fill the Backdoor Roth and survive for the first few months of the year doing 401(k) contributions?
Do you sell from your taxable investments with the most recent cost basis?

I know some people just keep a big pile of cash all the time and dip into that, but that seems suboptimal because of the cash drag. I only need the extra cash at the beginning of the year when I need to fund the Roth and when my take-home income is really low because of 401(k) contributions. And I don't want to dip into my emergency savings fund, which should only carry just enough money to last me six months and nothing more.

bling
Posts: 294
Joined: Sat Jan 21, 2012 12:49 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions on Jan 1st without dipping into emergency savings?

Post by bling » Thu Apr 26, 2018 8:25 pm

this is an odd question considering the only reason you would do a backdoor is because you make too much money to go through the normal method.

assuming you're single, the cut off is $118k AGI. since you're maxing out your 401k, that means your income is at least 136k. 118k puts you in the 24% federal rate, so that leaves you with roughly 90k a year.

you're struggling to put away 6% of your after-tax income away into a roth?

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions on Jan 1st without dipping into emergency savings?

Post by foodhype » Thu Apr 26, 2018 8:32 pm

bling wrote:
Thu Apr 26, 2018 8:25 pm
this is an odd question considering the only reason you would do a backdoor is because you make too much money to go through the normal method.

assuming you're single, the cut off is $118k AGI. since you're maxing out your 401k, that means your income is at least 136k. 118k puts you in the 24% federal rate, so that leaves you with roughly 90k a year.

you're struggling to put away 6% of your after-tax income away into a roth?
There's no difficulty in being able to fund it. It's a question of optimality. I'm not carrying around extra cash, just barely enough for my emergency savings fund so I minimize cash drag. I currently invest everything that I can afford, leaving no excess cash on January 1st. So the question is: where should the cash come from? Should I stop making taxable investments in early November to accumulate the necessary cash? Should I sell from my most recent taxable investments?

User avatar
fortyofforty
Posts: 1163
Joined: Wed Mar 31, 2010 12:33 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by fortyofforty » Thu Apr 26, 2018 8:42 pm

I agree it is an odd question. I think you are allowing the minute differences in returns from keeping six months of emergency reserves, seven months, or five months, to weigh down your thinking.

Keep six months reserve. Over the year, bump it up to seven months. Then in January pull it back down to six months. The "cash drag" will be minimal, and if the stock market tanks, you'll look like a genius.

Also, you might need more than six months of emergency income. What if you are unable to restore the source of your income within six months? What if it takes seven or ten or even a whole year? No real harm in varying between six and seven months over the year.
"In a time of universal deceit, telling the truth becomes a revolutionary act." - George Orwell | There are many roads to doublin'. | Original Vanguard Diehard

User avatar
corn18
Posts: 1007
Joined: Fri May 22, 2015 6:24 am

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by corn18 » Thu Apr 26, 2018 8:49 pm

why do you feel the need to have to fund the backdoor roth in Jan? Put in 1/12 of your max over the year and do the backdoor in Jan. God forbid you make some earnings, though.

Bacchus01
Posts: 1944
Joined: Mon Dec 24, 2012 9:35 pm

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by Bacchus01 » Thu Apr 26, 2018 8:50 pm

foodhype wrote:
Thu Apr 26, 2018 7:51 pm
Bacchus01 wrote:
Thu Apr 26, 2018 7:14 pm
We usually hold about $100K in cash deposits. In January we fully fund two Backdoor Roths ($11K) pay half oroperty tax payments ($7K) and fund five 529s for $15,500. The 401k and HSA kicks in and just comes out of paycheck.

I then have to pay income taxes in April. By that point we’ve recovered from our deposit dropping to about $65K and then taxes so we’re about $85k. By mid-may we will be back above $100K in deposits. Each month, as we go over $100K, we invest in after tax whatever is left. That runs through the end of the year except in July/August when we make our other set of property tax payments.

Wash, rinse, repeat.
That sounds like a lot of cash drag, although it sounds like you have a spouse, a home, and five kids. Personally I only carry $18k for my emergency savings fund. I neither want to dip into it nor carry unnecessary cash drag all year.

The two options I've come up with to avoid both of these are:
(1) Let off on taxable investments in November to save enough so I have just barely enough that I can fund the Backdoor Roth and survive for 2-3 months while maxing out 401(k) contributions without dipping into my emergency savings.
(2) Instead of letting up on investments to save cash, simply sell investments with the most recent cost basis.
Not a lot of cash drag at all. And I do not have 5 kids, we have 3. And we have 3 houses, not one.

$100K is about <5% of my portfolio.

I don't understand your conclusions. Why would you willing stay out of the market for months so that you can lump into the market, only to stay out of the market (Potentially) again. Just keep averaging into the market and flip back and forth between tax preferred and non tax preferred.

seawolf21
Posts: 258
Joined: Tue Aug 05, 2014 7:33 am

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by seawolf21 » Thu Apr 26, 2018 8:57 pm

How much cash drag does $5500 ($11K) really have? Just view it as part of your diversification strategy so there is no drag.

ryanhan
Posts: 8
Joined: Tue Mar 06, 2018 11:01 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by ryanhan » Thu Apr 26, 2018 9:01 pm

Interesting question. I'll be interested to read the other replies.

My wife and I generally each make an annual back door Roth IRA contribution in early January. For ease of budgeting, we simply set aside 1/12 of the annual contribution amount in each month of the preceding year. For example, beginning in January 2017 we set aside $1,000 each month (I like round numbers and simple math) and by December 31, 2017 we had $12,000 set aside to fund the 2018 backdoor Roth IRA contributions in early January.

This method works for us mostly because it makes for easy budgeting. Like others, we're trying to budget for maxing out 401(k)s, making contributions to 529s, etc. I've never given too much thought to the "cash drag" of setting aside the funds for the Roth IRA Contribution. I just think of it in terms of our cash reserves swelling by $12,000 during the course of the year and I don't lose too much sleep over the oppertunity cost of not having those funds invested.

Again, I'm always interested in how others approach things, and I'm open to a better strategy.

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by foodhype » Thu Apr 26, 2018 9:06 pm

fortyofforty wrote:
Thu Apr 26, 2018 8:42 pm
I agree it is an odd question. I think you are allowing the minute differences in returns from keeping six months of emergency reserves, seven months, or five months, to weigh down your thinking.

Keep six months reserve. Over the year, bump it up to seven months. Then in January pull it back down to six months. The "cash drag" will be minimal, and if the stock market tanks, you'll look like a genius.

Also, you might need more than six months of emergency income. What if you are unable to restore the source of your income within six months? What if it takes seven or ten or even a whole year? No real harm in varying between six and seven months over the year.
After thinking about it more, I think I like this approach the best. Always keep enough for six months' expenses. Contribute year-round to the emergency savings fund so that I have exactly enough to fund the backdoor Roth and cover me for the low cash flow in January and February caused by 401(k) contributions without dipping into six months' expenses. It's a little cash drag but pales compared to the tax-free gains of the Roth, and it's way less headache.

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by foodhype » Thu Apr 26, 2018 9:14 pm

Bacchus01 wrote:
Thu Apr 26, 2018 8:50 pm
foodhype wrote:
Thu Apr 26, 2018 7:51 pm
Bacchus01 wrote:
Thu Apr 26, 2018 7:14 pm
We usually hold about $100K in cash deposits. In January we fully fund two Backdoor Roths ($11K) pay half oroperty tax payments ($7K) and fund five 529s for $15,500. The 401k and HSA kicks in and just comes out of paycheck.

I then have to pay income taxes in April. By that point we’ve recovered from our deposit dropping to about $65K and then taxes so we’re about $85k. By mid-may we will be back above $100K in deposits. Each month, as we go over $100K, we invest in after tax whatever is left. That runs through the end of the year except in July/August when we make our other set of property tax payments.

Wash, rinse, repeat.
That sounds like a lot of cash drag, although it sounds like you have a spouse, a home, and five kids. Personally I only carry $18k for my emergency savings fund. I neither want to dip into it nor carry unnecessary cash drag all year.

The two options I've come up with to avoid both of these are:
(1) Let off on taxable investments in November to save enough so I have just barely enough that I can fund the Backdoor Roth and survive for 2-3 months while maxing out 401(k) contributions without dipping into my emergency savings.
(2) Instead of letting up on investments to save cash, simply sell investments with the most recent cost basis.
Not a lot of cash drag at all. And I do not have 5 kids, we have 3. And we have 3 houses, not one.

$100K is about <5% of my portfolio.

I don't understand your conclusions. Why would you willing stay out of the market for months so that you can lump into the market, only to stay out of the market (Potentially) again. Just keep averaging into the market and flip back and forth between tax preferred and non tax preferred.
I wouldn't be staying out of the market for many months. I would simply be saving cash from late November to the end of December rather than investing in taxable. Other people save 1/12 of the cash needed to fund the Roth IRA every month until January. I'm simply packing that into a short period at the end of the year to minimize cash drag.

bling
Posts: 294
Joined: Sat Jan 21, 2012 12:49 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by bling » Thu Apr 26, 2018 9:19 pm

foodhype wrote:
Thu Apr 26, 2018 9:06 pm
fortyofforty wrote:
Thu Apr 26, 2018 8:42 pm
I agree it is an odd question. I think you are allowing the minute differences in returns from keeping six months of emergency reserves, seven months, or five months, to weigh down your thinking.

Keep six months reserve. Over the year, bump it up to seven months. Then in January pull it back down to six months. The "cash drag" will be minimal, and if the stock market tanks, you'll look like a genius.

Also, you might need more than six months of emergency income. What if you are unable to restore the source of your income within six months? What if it takes seven or ten or even a whole year? No real harm in varying between six and seven months over the year.
After thinking about it more, I think I like this approach the best. Always keep enough for six months' expenses. Contribute year-round to the emergency savings fund so that I have exactly enough to fund the backdoor Roth and cover me for the low cash flow in January and February caused by 401(k) contributions without dipping into six months' expenses. It's a little cash drag but pales compared to the tax-free gains of the Roth, and it's way less headache.
why would you contribute to your emergency fund at all? it's already funded -- just put your savings into the ira->backdoor roth every month and DCA, which has no drag.

Bacchus01
Posts: 1944
Joined: Mon Dec 24, 2012 9:35 pm

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by Bacchus01 » Thu Apr 26, 2018 9:22 pm

foodhype wrote:
Thu Apr 26, 2018 9:14 pm
Bacchus01 wrote:
Thu Apr 26, 2018 8:50 pm
foodhype wrote:
Thu Apr 26, 2018 7:51 pm
Bacchus01 wrote:
Thu Apr 26, 2018 7:14 pm
We usually hold about $100K in cash deposits. In January we fully fund two Backdoor Roths ($11K) pay half oroperty tax payments ($7K) and fund five 529s for $15,500. The 401k and HSA kicks in and just comes out of paycheck.

I then have to pay income taxes in April. By that point we’ve recovered from our deposit dropping to about $65K and then taxes so we’re about $85k. By mid-may we will be back above $100K in deposits. Each month, as we go over $100K, we invest in after tax whatever is left. That runs through the end of the year except in July/August when we make our other set of property tax payments.

Wash, rinse, repeat.
That sounds like a lot of cash drag, although it sounds like you have a spouse, a home, and five kids. Personally I only carry $18k for my emergency savings fund. I neither want to dip into it nor carry unnecessary cash drag all year.

The two options I've come up with to avoid both of these are:
(1) Let off on taxable investments in November to save enough so I have just barely enough that I can fund the Backdoor Roth and survive for 2-3 months while maxing out 401(k) contributions without dipping into my emergency savings.
(2) Instead of letting up on investments to save cash, simply sell investments with the most recent cost basis.
Not a lot of cash drag at all. And I do not have 5 kids, we have 3. And we have 3 houses, not one.

$100K is about <5% of my portfolio.

I don't understand your conclusions. Why would you willing stay out of the market for months so that you can lump into the market, only to stay out of the market (Potentially) again. Just keep averaging into the market and flip back and forth between tax preferred and non tax preferred.
I wouldn't be staying out of the market for many months. I would simply be saving cash from late November to the end of December rather than investing in taxable. Other people save 1/12 of the cash needed to fund the Roth IRA every month until January. I'm simply packing that into a short period at the end of the year to minimize cash drag.
So what’s your question?

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by foodhype » Thu Apr 26, 2018 9:24 pm

It does seem like a fair amount of money, however--at least when compared to some of the other things Bogleheads optimize, like W4 withholding and foreign tax credit efficiency.

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by foodhype » Thu Apr 26, 2018 9:26 pm

bling wrote:
Thu Apr 26, 2018 9:19 pm
foodhype wrote:
Thu Apr 26, 2018 9:06 pm
fortyofforty wrote:
Thu Apr 26, 2018 8:42 pm
I agree it is an odd question. I think you are allowing the minute differences in returns from keeping six months of emergency reserves, seven months, or five months, to weigh down your thinking.

Keep six months reserve. Over the year, bump it up to seven months. Then in January pull it back down to six months. The "cash drag" will be minimal, and if the stock market tanks, you'll look like a genius.

Also, you might need more than six months of emergency income. What if you are unable to restore the source of your income within six months? What if it takes seven or ten or even a whole year? No real harm in varying between six and seven months over the year.
After thinking about it more, I think I like this approach the best. Always keep enough for six months' expenses. Contribute year-round to the emergency savings fund so that I have exactly enough to fund the backdoor Roth and cover me for the low cash flow in January and February caused by 401(k) contributions without dipping into six months' expenses. It's a little cash drag but pales compared to the tax-free gains of the Roth, and it's way less headache.
why would you contribute to your emergency fund at all? it's already funded -- just put your savings into the ira->backdoor roth every month and DCA, which has no drag.
I didn't know that you could contribute to the backdoor roth easily in pieces. Never done one before.

ryanhan
Posts: 8
Joined: Tue Mar 06, 2018 11:01 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by ryanhan » Thu Apr 26, 2018 9:27 pm

bling wrote:
Thu Apr 26, 2018 9:19 pm
foodhype wrote:
Thu Apr 26, 2018 9:06 pm
fortyofforty wrote:
Thu Apr 26, 2018 8:42 pm
I agree it is an odd question. I think you are allowing the minute differences in returns from keeping six months of emergency reserves, seven months, or five months, to weigh down your thinking.

Keep six months reserve. Over the year, bump it up to seven months. Then in January pull it back down to six months. The "cash drag" will be minimal, and if the stock market tanks, you'll look like a genius.

Also, you might need more than six months of emergency income. What if you are unable to restore the source of your income within six months? What if it takes seven or ten or even a whole year? No real harm in varying between six and seven months over the year.
After thinking about it more, I think I like this approach the best. Always keep enough for six months' expenses. Contribute year-round to the emergency savings fund so that I have exactly enough to fund the backdoor Roth and cover me for the low cash flow in January and February caused by 401(k) contributions without dipping into six months' expenses. It's a little cash drag but pales compared to the tax-free gains of the Roth, and it's way less headache.
why would you contribute to your emergency fund at all? it's already funded -- just put your savings into the ira->backdoor roth every month and DCA, which has no drag.
I think the OP is trying to make the backdoor Roth IRA contribution in January -- on the front end of the year -- to maximize the tax free growth of the contribution. This is the same reason some people choose to "front-end load" their annual 401(k) contributions; trying to get more of their funds contributed and invested earlier in the year rather than spacing evenly of the course of the entire year.
Last edited by ryanhan on Thu Apr 26, 2018 9:30 pm, edited 1 time in total.

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by foodhype » Thu Apr 26, 2018 9:29 pm

Contributing monthly is still less optimal than filling it up as early as possible. Filling it up early overrides the cash drag.

foodhype
Posts: 127
Joined: Thu May 25, 2017 10:38 pm

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by foodhype » Thu Apr 26, 2018 9:33 pm

What is the most optimal way to come up with this cash?

Do I save up cash as fast as possible at the end of the year?

Do I change nothing and simply sell my taxable investments in January? If selling from my taxable investments, do I just sell from the most recent contribution with the most recent cost basis?

bling
Posts: 294
Joined: Sat Jan 21, 2012 12:49 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by bling » Thu Apr 26, 2018 9:39 pm

foodhype wrote:
Thu Apr 26, 2018 9:29 pm
Contributing monthly is still less optimal than filling it up as early as possible. Filling it up early overrides the cash drag.
it depends on when you started the first contribution.

if you've contributed nothing for 2018 so far (presumably because you're busying maxing out your 401k), then you should DCA into the backdoor roth for the remainder of the year. then you will always get money in as fast as possible with no drag.

if you've already maxed out 2018 and have no more space, put it into your taxable and hope the market goes up, and TLH if it goes down (and readjust AA as necessary) and lump sum in 2019.

User avatar
Epsilon Delta
Posts: 7430
Joined: Thu Apr 28, 2011 7:00 pm

Re: How do you fund your Backdoor Roth and 401(k) contributions starting Jan 1st without dipping into emergency savings?

Post by Epsilon Delta » Thu Apr 26, 2018 9:44 pm

How do you fund property taxes and other lumpy expenses?

Personally I do it opportunistically. If I have cash on hand from a year end bonus, tax lost harvesting, dividends or maturing CDs it feeds the IRA. If not I may sell some bonds or other funds without gains. Failing those I feed the IRA from income later in the year. If it got to next April and I still hadn't funded the IRA then I'd sell something and pay the capital gains tax.

User avatar
LadyGeek
Site Admin
Posts: 48687
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Re: What would be an optimal annual plan for contributions including a Backdoor Roth?

Post by LadyGeek » Thu Apr 26, 2018 10:08 pm

foodhype - In order to give appropriate advice, it's best to keep all the information in one spot. You are asking two questions which have much in common. The information in your first post is needed to answer your second question.

If you have any questions, ask them here. If you don't understand something, by all means let us know and we'll try again.

(The combined thread is in the Investing - Help with Personal Investments forum.)
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

Post Reply