Backdoor Roth

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Topic Author
Ned Nederlander
Posts: 25
Joined: Tue May 28, 2019 8:55 pm

Backdoor Roth

Post by Ned Nederlander » Tue May 28, 2019 9:31 pm

Hello,

First time, long time. I’ve always wanted to say that. I currently have a 401K through my employer, a SEP IRA(withTD) for 1099 income from a side business, and a Traditional IRA which is a rollover from my previous employer. The traditional IRA is with ML. I’m late to the game with IRAs and I’m trying to set up a backdoor Roth. I spoke with my accountant and he told me to open a “non-deductible” IRA and a Roth. Once I do that I should make contributions to the non-deductible IRA while making sure it’s an investment that doesn’t earn interest. After 1 day he said I could transfer into the Roth IRA. I was all set to do this with ML and I started seeing some conflicting information on this forum. One thread I was reading said that the money has to sit in the traditional IRA for a longer period of time. Peoples opinions varied on length of time. Someone else mentioned that you should roll the other IRA back into your current 401k. I’d rather not do that. I’d really like to avoid getting taxed twice and want to make sure I do this correctly. Is there a minimum amount of time the money has to sit? Does it matter how often I make contributions? Can I backdoor $500 monthly or should I try to do $6000 at once? Thanks in advance for your help.

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luminous
Posts: 136
Joined: Sat Dec 30, 2017 10:28 pm

Re: Backdoor Roth

Post by luminous » Tue May 28, 2019 10:09 pm

Hello, welcome to the forum.
Someone else mentioned that you should roll the other IRA back into your current 401k. I’d rather not do that.
If you keep your existing IRAs you will have a tax bill at the end of the year. Please read the wiki page on Backdoor Roth, it has a lot of great examples: https://www.bogleheads.org/wiki/Backdoor_Roth
Is there a minimum amount of time the money has to sit?
Opinions vary, but I didn't wait any longer than it took the money to clear into the IRA.
Does it matter how often I make contributions? Can I backdoor $500 monthly or should I try to do $6000 at once?
I believe you can do it as often as you'd like.
50/20/30 US stock/international stock/bonds. Hope to semi-retire in 2022.

mhalley
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Re: Backdoor Roth

Post by mhalley » Tue May 28, 2019 10:24 pm

There used to be a small minority of financial bloggers who were concerned about the step transaction doctrine and recommended keeping the traditional Ira for a period of time before rolling it over to the Roth. The IRS has since clarified its stance on the backdoor Roth, making it fully sanctioned. So rolling it over the next day is the way to go.
You don’t want to do backdoor roths if you have money in traditional IRAs, so you want to roll any traditional ira money into your 401k or roll it to a Roth and pay taxes on it due to the irs aggregation rule.
In general, the stock market goes up 2/3 of the time so if you have money to invest you should do so ASAP.
If you don’t wan5 to roll the Ira into the 401k, then just invest the money in a taxable brokerage account. POF discusses the actual value of the backdoor Roth here.
https://www.physicianonfire.com/value-of-backdoor-roth/

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Earl Lemongrab
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Re: Backdoor Roth

Post by Earl Lemongrab » Wed May 29, 2019 3:18 am

If you don't clear out the existing taxable IRAs by the end of the year, you have a pro-rata situation. That's messy and will result in you paying taxes. Assuming those IRAs are a significant amount, either roll into your 401(k) or forget about backdoor Roth.

retiredjg
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Re: Backdoor Roth

Post by retiredjg » Wed May 29, 2019 6:25 am

Both your SEP IRA and your rollover IRA will interfere with using the back door to contribute to Roth IRA. Unless these can be rolled into another account (such as your current 401k), I would not use the back door. Put that money into a taxable account instead.

retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth

Post by retiredjg » Wed May 29, 2019 6:28 am

It would be interesting to know why your accountant suggested that you do this. Did he forget that you have the SEP IRA and rollover IRA? Not know they would be pro-rated in the conversion step of the back door? Or think that it is OK for them to be pro-rated in the conversion step of the back door?

Topic Author
Ned Nederlander
Posts: 25
Joined: Tue May 28, 2019 8:55 pm

Re: Backdoor Roth

Post by Ned Nederlander » Wed May 29, 2019 9:17 am

This is what my accountant wrote me when I asked about the tax consequences,

“Any after tax money in an ira is considered your basis and therefore not taxable. It is up to you to track that.
If you established a non deductible ira and then rolled it into a Roth there is no tax and assuming it accumulates no tax later. We would track those contributions on your return.”

The balances are as follows:

$45,000 Traditional Deductible IRA(ML)
$5,500 SEP IRA(TD)
$6,500 HSA (TD via Lively)
$35,000 401K

I just created another traditional IRA and Roth IRA with ML but I haven’t funded it yet. I was about to do the same thing for my wife with Fidelity and the person there told me that the creation of another IRA wouldn’t help me in the eyes of the government. That’s when I started searching Backdoor Roth’s on this forum. Given the above numbers what would the tax consequences be of attempting to do a backdoor Roth of $6,000. One additional note, before I knew what I was doing was wrong, I contributed $500 in after tax money to my IRA in 2018, so $44,500 would be the rollover amount. I also didn’t record the information for tax purposes at the end of the year. I’m not sure how much this matters but wanted to give the full story.

Should I roll my SEP IRA and traditional into my 401K? Will the after tax money in my IRA pose a problem? There’s 2 issues with that from my perspective. The first is I’m expecting to get 1099 income in the future and possibly this year so can I keep the SEP open and just roll funds through to my 401K whenever I have 1099 income? The other “issue” is more minor but Bank of America offers a CC with a minimum of 2.625 up to 3.5 points for all transaction assuming you can maintain a balance over $100,000 across all B of A and ML accounts. The only reason I bring this up is I was planning on using these points to fund my IRA going forward. I figure I could fund half an IRA a year without thinking about it.

lkar
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Joined: Sat May 04, 2019 4:02 pm

Re: Backdoor Roth

Post by lkar » Wed May 29, 2019 9:54 am

If you attempt to contribute $6k to an IRA and then convert it to Roth, and you maintain the traditional and SEP IRAs, your Roth conversion will result in recognition of about $5k in income that will be subject to taxation. You won’t be able to figure out the exact amount until you know the values of those IRAs at year end. That amount of income will be tacked on to your $500 basis and so you would have a $5500 basis in your IRAs going forward for future years.

I’ve seen discussion of rolling IRAs with after tax money into 401k and I know it is kind of complicated and may depend on the plan.
Last edited by lkar on Wed May 29, 2019 9:55 am, edited 1 time in total.

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Earl Lemongrab
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Re: Backdoor Roth

Post by Earl Lemongrab » Wed May 29, 2019 11:45 am

If you haven't contributed any to the SEP this year, don't. Should you get some self-employment income, open a solo 401(k) instead. Use the 1099 income to make contributions there and roll in the old SEP and IRAs. You have until the end of the year to get the IRAs moved, but I would wait to make any more non-deductible contributions or conversions until that's sorted out. You can't recharacterize conversions anymore.

retiredjg
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Re: Backdoor Roth

Post by retiredjg » Wed May 29, 2019 12:57 pm

Ned Nederlander wrote:
Wed May 29, 2019 9:17 am
This is what my accountant wrote me when I asked about the tax consequences,

“Any after tax money in an ira is considered your basis and therefore not taxable. It is up to you to track that.
If you established a non deductible ira and then rolled it into a Roth there is no tax and assuming it accumulates no tax later. We would track those contributions on your return.”
All of this would be true if you had no other traditional IRAs (your SEP and your rollover).

Given the above numbers what would the tax consequences be of attempting to do a backdoor Roth of $6,000.
$45,000 Traditional Deductible IRA(ML)
$5,500 SEP IRA(TD)
$6,000
$56,500 is the total of your IRA accounts, $6,500 of which has already been taxed ($6k for this year's contribution and $500 from a past year).

That's 11.5% already taxed and 88.5% which has not been taxed. You would owe taxes on 88.5% if whatever you convert to Roth. So if you converted $6k, you'd pay tax at your marginal rate on $5,300 of it. This is assuming that today is the last day of the year. The numbers would be a little different in reality.
One additional note, before I knew what I was doing was wrong, I contributed $500 in after tax money to my IRA in 2018, so $44,500 would be the rollover amount. I also didn’t record the information for tax purposes at the end of the year. I’m not sure how much this matters but wanted to give the full story.
You can still fill out the 2018 Form 8606 to document that $500 contribution. The forms are available on the internet.

Should I roll my SEP IRA and traditional into my 401K?
If you simply must use the back door, this is what you will have to do. You should give consideration to just saving the money in a taxable account and let your spouse use the back door assuming that your spouse has no IRAs in the way.

Will the after tax money in my IRA pose a problem?
It might. Legally, you can drain off any amount of your IRA to the 401k and as long as you leave an amount equal to or larger than your basis, that's OK. However, some plans are not willing to do that. Some plans will only accept money from an uncontaminated IRA.

There’s 2 issues with that from my perspective. The first is I’m expecting to get 1099 income in the future and possibly this year so can I keep the SEP open and just roll funds through to my 401K whenever I have 1099 income?
The IRAs must be empty on the last day of the year.

Topic Author
Ned Nederlander
Posts: 25
Joined: Tue May 28, 2019 8:55 pm

Re: Backdoor Roth

Post by Ned Nederlander » Wed May 29, 2019 1:54 pm

If I have a 401K through my employer and a solo 401k is my combined contribution limited to $19,000?(I’m 39) my contributions should be somewhere around $15,000 to my employer plan, possibly more depending on commissions. I’m hoping my side income would make me $20,000-$30,000 or so this year.

Is there any advantage to a Roth for me? If I’m being taxed on 88% of the money transferred it begs the question, what’s the point? Should I just be contributing to a taxable IRA? Is it just a matter of trying to figure out what my tax rate is now compared to what it will be at retirement? Is this the right question to ask? Do I want to be double taxed now with historically low tax rates or double taxed in retirement at a more than likely higher tax rate? Another thing to consider, I suppose, is that the 88% taxable portion should only go down assuming I don’t roll any more 401ks into my existing IRA and the market at least stays flat. Is that right?

retiredjg
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Re: Backdoor Roth

Post by retiredjg » Wed May 29, 2019 2:14 pm

Ned Nederlander wrote:
Wed May 29, 2019 1:54 pm
If I have a 401K through my employer and a solo 401k is my combined contribution limited to $19,000?(I’m 39) my contributions should be somewhere around $15,000 to my employer plan, possibly more depending on commissions. I’m hoping my side income would make me $20,000-$30,000 or so this year.
Your contributions as an employee share the $19k limit. However, you should be able to contribute some to the Solo 401k as an employer.
Is there any advantage to a Roth for me?
In my opinion, Roth IRA is only attractive for you if you roll all the IRA money into 401k.
Is it just a matter of trying to figure out what my tax rate is now compared to what it will be at retirement? Is this the right question to ask?
To a certain extent, that is exactly the question you are asking. And most people are in a lower bracket after they quit working.
Do I want to be double taxed now with historically low tax rates or double taxed in retirement at a more than likely higher tax rate?
There is no double taxing.
Another thing to consider, I suppose, is that the 88% taxable portion should only go down assuming I don’t roll any more 401ks into my existing IRA and the market at least stays flat. Is that right?
If the market is flat and no money other than your annual non-deductible contribution goes in, the 88% does go down. However, it never gets near zero until the IRA is almost completely empty. And the market is not going to be flat.

Topic Author
Ned Nederlander
Posts: 25
Joined: Tue May 28, 2019 8:55 pm

Re: Backdoor Roth

Post by Ned Nederlander » Wed May 29, 2019 8:07 pm

Last question, I think. I was looking at it the wrong way. Assuming growth in the IRA the $6000 contribution every year will be a smaller and smaller percentage of the overall picture. Therefore, the percentage you’re paying taxes on would actually increase every year, wouldn’t it? For example, when the traditional IRA is $100,000 the $6000 contribution will only be 6%. Therefore the taxable portion of my contribution will be $5640(94% of $6000.) If this is correct I would definitely roll my IRAs into my 401k before attempting a backdoor.

retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth

Post by retiredjg » Wed May 29, 2019 8:15 pm

Yes, you should roll the IRAs into the 401k before attempting a back door. Or not use the back door at all.

Did you read the earlier posts????

Topic Author
Ned Nederlander
Posts: 25
Joined: Tue May 28, 2019 8:55 pm

Re: Backdoor Roth

Post by Ned Nederlander » Wed May 29, 2019 8:41 pm

Yes. I read them all. The pro-Rata rule is new to me and I was incorrectly assuming a larger IRA would mean the taxable portion of my annual $6,000 contribution would be smaller and smaller each year, when in fact it’s the exact opposite. I needed to work through it. I understand it now and the reasoning for it. Thank you for explaining it. Now I know how I am going to proceed. My next hurdle will be figuring out how to roll my IRA into my 401k with $500 of after tax money in it. I really hope that’s a smaller problem than I think.

lakpr
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Joined: Fri Mar 18, 2011 9:59 am

Re: Backdoor Roth

Post by lakpr » Wed May 29, 2019 9:02 pm

If it is just $500 that has been contributed on an after tax basis, I suggest you sell $500 from a main fund and invest it in a separate fund that you do not normally invest in. You might run into some fund investment minimums, so perhaps you may have to sell more than $500.

Once that is done, the main fund can be thought of as essentially completely pre-tax, then roll that over into your 401k.

Do not contribute to non-deductible tIRA or convert that to Roth IRA, unless your rollover to 401k is completed. Once that is done, then proceed with the steps for backdoor Roth.

The biggest risk here is that the rollover to 401k plan might run into hiccups that cannot be resolved before Dec 31,2019 for whatever reason, and therefore if you convert to Roth ahead of rollover it cannot be reverse, and subject you to pro-rata rule.

retiredjg
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Joined: Thu Jan 10, 2008 12:56 pm

Re: Backdoor Roth

Post by retiredjg » Thu May 30, 2019 6:09 am

Ned Nederlander wrote:
Wed May 29, 2019 8:41 pm
My next hurdle will be figuring out how to roll my IRA into my 401k with $500 of after tax money in it. I really hope that’s a smaller problem than I think.
I used to recommend that people use the back door, but so many people mess it up that I stopped suggesting it a few years ago. Before getting into this, you should get the tax paperwork figured out. The back door is a few clicks of a mouse. The paperwork is not so simple.

And you should also read at least a dozen threads that we get during tax time and in early summer from people who have some problem with their back door. Most often, the problem is caused by the tax-payer and/or their tax person, occasionally by the IRS and infrequently by tax software.

Good luck!

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