Hypothetical Roth IRA question

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JD2775
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Hypothetical Roth IRA question

Post by JD2775 » Wed Dec 05, 2018 3:51 pm

Let's say I max out my ROTH IRA on January 1st. What happens if later that month(or the following month etc...) I get a new job that puts me over the contribution limit? Anything? This hypothetical could be realistic for me next month, so I want to make sure I approach this correctly

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BL
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Re: Hypothetical Roth IRA question

Post by BL » Wed Dec 05, 2018 3:54 pm

Why not just wait until you know for sure?

There are ways to undo it.

sarabayo
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Re: Hypothetical Roth IRA question

Post by sarabayo » Wed Dec 05, 2018 5:26 pm

JD2775 wrote:
Wed Dec 05, 2018 3:51 pm
Let's say I max out my ROTH IRA on January 1st. What happens if later that month(or the following month etc...) I get a new job that puts me over the contribution limit? Anything? This hypothetical could be realistic for me next month, so I want to make sure I approach this correctly
Do a backdoor Roth IRA contribution instead of a normal one, just in case. That seems to me like the easiest way.
BL wrote:
Wed Dec 05, 2018 3:54 pm
Why not just wait until you know for sure?
OP doesn't want the money to spend too much time out of the market, I guess.

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grabiner
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Re: Hypothetical Roth IRA question

Post by grabiner » Wed Dec 05, 2018 5:29 pm

sarabayo wrote:
Wed Dec 05, 2018 5:26 pm
JD2775 wrote:
Wed Dec 05, 2018 3:51 pm
Let's say I max out my ROTH IRA on January 1st. What happens if later that month(or the following month etc...) I get a new job that puts me over the contribution limit? Anything? This hypothetical could be realistic for me next month, so I want to make sure I approach this correctly
Do a backdoor Roth IRA contribution instead of a normal one, just in case. That seems to me like the easiest way.
Assuming that you can do a backdoor; if you have an existing traditional IRA, you have to move the traditional IRA into a 401(k) or convert it to a Roth IRA to use the backdoor.

If you can't use the backdoor, then you can contribute to a Roth IRA, and if you find that you are ineligible, recharacterize to a traditional IRA. The IRS will treat this as if you had contributed to a traditional IRA in the first place; all earnings will transfer over. (The new tax law disallows recharacterizations of conversions, but still allows them for contributions.)
Wiki David Grabiner

JD2775
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Re: Hypothetical Roth IRA question

Post by JD2775 » Wed Dec 05, 2018 5:35 pm

Thank you everyone...

Some additional details...

I have no TIRA. I have a traditional 401k that I max out currently, and the Roth IRA that I max out currently. I will need to read up on backdoor Roth to see if that is something I should pursue if and when I encounter this scenario.....

pdavi21
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Re: Hypothetical Roth IRA question

Post by pdavi21 » Wed Dec 05, 2018 5:39 pm

1. You are going to want to ROTH contribute immediately then recharacterize as Trad and convert to ROTH if need be.

OR

2. Just do the backdoor conversion RIGHT AWAY and be over with it.

OR

3. Step 1 but DCA your contributions throughout the year as ROTH.

Option 1 is simpler with a high chance of paying the lowest tax. Option 2 is more complex with the highest chance of paying the least tax. Option 3 will fit your income better and avoid market timing better (since IRAs are a predictable event) but have the highest chance of paying highest taxes.

sarabayo
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Re: Hypothetical Roth IRA question

Post by sarabayo » Wed Dec 05, 2018 5:46 pm

JD2775 wrote:
Wed Dec 05, 2018 5:35 pm
I have no TIRA. I have a traditional 401k that I max out currently, and the Roth IRA that I max out currently. I will need to read up on backdoor Roth to see if that is something I should pursue if and when I encounter this scenario.....
If you have no Traditional IRA, then the backdoor Roth IRA contribution process is very easy. See https://www.physicianonfire.com/backdoor/ for a walkthrough of how to do it at Vanguard. If your IRA is at some other custodian the process is probably similar.
pdavi21 wrote:
Wed Dec 05, 2018 5:39 pm
1. You are going to want to ROTH contribute immediately then recharacterize as Trad and convert to ROTH if need be.

OR

2. Just do the backdoor conversion RIGHT AWAY and be over with it.

OR

3. Step 1 but DCA your contributions throughout the year as ROTH.

Option 1 is simpler with a high chance of paying the lowest tax. Option 2 is more complex with a higher chance of paying the least tax. Option 3 will fit your income better and avoid market timing better (since IRAs are a predictable event).
I disagree that Option 2 is more complex than Option 1. With Option 1, when you do the recharacterization and conversion you need to worry about how to deal with possible gains/losses between when you made the contribution and when you did the recharacterization and conversion. It's also three steps instead of two, and is harder to understand (IMO). You say "convert to Roth if need be", but if OP's MAGI ends up being too high to make an ordinary Roth contribution, it's also too high to make a deductible Traditional IRA contribution, so OP would always want to convert to Roth in such a scenario.

With Option 2, the backdoor Roth contribution, since you do the conversion instantly there are no gains or losses, and you don't have to worry about revisiting the situation later based on later changes to your income. You just do the backdoor contribution and that's it. Simple.

As for Option 3, I agree with the common wisdom that DCA is suboptimal, so I wouldn't recommend that. Actually, interesting point about market timing... I don't know how I feel about that. I think that if you max out your IRA contribution immediately in January, the benefit of having all your money in the market all year long outweighs the possible downside of your contribution being a "predictable event", but I'm not sure.
Last edited by sarabayo on Wed Dec 05, 2018 6:37 pm, edited 1 time in total.

JD2775
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Re: Hypothetical Roth IRA question

Post by JD2775 » Wed Dec 05, 2018 5:57 pm

sarabayo wrote:
Wed Dec 05, 2018 5:46 pm
JD2775 wrote:
Wed Dec 05, 2018 5:35 pm
I have no TIRA. I have a traditional 401k that I max out currently, and the Roth IRA that I max out currently. I will need to read up on backdoor Roth to see if that is something I should pursue if and when I encounter this scenario.....
If you have no Traditional IRA, then the backdoor Roth IRA contribution process is very easy. See https://www.physicianonfire.com/backdoor/ for a walkthrough of how to do it at Vanguard. If your IRA is at some other custodian the process is probably similar.
I just skimmed that link...That is PERFECT. Thank you. My Roth is in Vanguard so I can just follow those step by step instructions. Stupid question, do I need to then do that every year? Or is that a one time thing (TIRA to Roth). Also if I choose to DCA instead of lump sum into the Roth, is the process the same? Maybe lump sum is an easier, cleaner way to take care of it that will get it out of the way quicker.

sarabayo
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Re: Hypothetical Roth IRA question

Post by sarabayo » Wed Dec 05, 2018 6:07 pm

JD2775 wrote:
Wed Dec 05, 2018 5:57 pm
I just skimmed that link...That is PERFECT. Thank you. My Roth is in Vanguard so I can just follow those step by step instructions. Stupid question, do I need to then do that every year? Or is that a one time thing (TIRA to Roth). Also if I choose to DCA instead of lump sum into the Roth, is the process the same? Maybe lump sum is an easier, cleaner way to take care of it that will get it out of the way quicker.
Yes, you'd need to do it every year. Basically the "problem" when your MAGI is sufficiently high is that you are neither able to deduct contributions to a TIRA, nor are you able to even make contributions to a Roth IRA. So the "backdoor" is that you make contributions to a TIRA, after-tax (since you can't deduct them), and then immediately convert the money into your Roth IRA (which is allowed, even though directly contributing to the Roth IRA isn't allowed).

You can contribute to the TIRA as much as you want, and I think you can convert the funds in it into your Roth IRA whenever you want, as well. (I always just do one lump sum contribution per year so I haven't tried doing multiple conversions per year.) The only issue is that if the funds have earned any returns while they were sitting in the TIRA, you have to pay taxes on them as part of the conversion process. That's why I (and the article I linked) recommend buying money market funds with the initial contribution and then converting to Roth as soon as possible. That way you avoid having to worry about any earnings occurring while the money was in the TIRA.

Operationally the way it works at Vanguard is that you will have one TIRA open and one Roth IRA open, but the TIRA will usually have $0 in it. When you want to make a contribution, you contribute to the TIRA, and then do a conversion to Roth -- what actually ends up physically happening is that the funds move from your TIRA to your existing Roth IRA, and the TIRA remains sitting there afterwards, with $0 in it again.

billfromct
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Re: Hypothetical Roth IRA question

Post by billfromct » Wed Dec 05, 2018 6:22 pm

If you are going to do the back door Roth IRA & want to DCA, just open a Money Market Fund in your Roth IRA & fund the Roth IRA MM fund via a back door Roth IRA contribution.

Then transfer $500 each month from the Roth IRA MM fund to whatever Roth IRA fund you want.

This way you will only have to do 1 back door Roth IRA contribution each year & DCA however you want.

bill

sarabayo
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Re: Hypothetical Roth IRA question

Post by sarabayo » Wed Dec 05, 2018 6:29 pm

billfromct wrote:
Wed Dec 05, 2018 6:22 pm
If you are going to do the back door Roth IRA & want to DCA, just open a Money Market Fund in your Roth IRA & fund the Roth IRA MM fund via a back door Roth IRA contribution.

Then transfer $500 each month from the Roth IRA MM fund to whatever Roth IRA fund you want.

This way you will only have to do 1 back door Roth IRA contribution each year & DCA however you want.

bill
Good idea. The one downside is that this does require more liquidity since you need to come up with the whole $6,000 at the beginning of the 2019 even though you're investing it $500 at a time over the course of the year.

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