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Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 1:00 pm
by financeisfun
I'm not sure if my spouse and I are going to exceed the Roth IRA MFJ limit this year. A bit of background: we both contribute to our respective 403(b)/401(k)s, I have a Roth IRA but no existing tIRAs, and my spouse has both a Roth IRA and a tIRA (which currently consists of only pre-tax contributions). I have a few related questions to determine how best to proceed:
  1. I like to do our IRA contributions as early in the year as possible, to maximize time in the market. For me, since I don't have a tIRA, is it preferable to do the backdoor Roth immediately, even if it ends up being ultimately unnecessary (because we end up below the MFJ limit), or to wait until later this year until I will know more about what our combined income will be? Of course, in the latter scenario, that will mean investing perhaps 8-9 months later.
  2. For my spouse, if we decide not to roll their tIRA into their 401(k) because of subpar/expensive investment choices, is it worthwhile to still max out the nondeductible contribution to their tIRA? Is this nondeductible contribution double-taxed (taxed again during withdrawal, though it is already an after-tax contribution)? Also, is it up to me to keep track of the pre-tax vs. nondeductible/after-tax portions of the tIRA? Not entirely clear on the specifics here.
Thank you!

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 1:15 pm
by tashnewbie
financeisfun wrote: Tue Jan 12, 2021 1:00 pm I like to do our IRA contributions as early in the year as possible, to maximize time in the market. For me, since I don't have a tIRA, is it preferable to do the backdoor Roth immediately, even if it ends up being ultimately unnecessary (because we end up below the MFJ limit), or to wait until later this year until I will know more about what our combined income will be? Of course, in the latter scenario, that will mean investing perhaps 8-9 months later.
Yes, I would go ahead and do the backdoor Roth as soon as desired. There's nothing that prohibits you from using the backdoor, even if you later find out you could've used the front door.
financeisfun wrote: Tue Jan 12, 2021 1:00 pm For my spouse, if we decide not to roll their tIRA into their 401(k) because of subpar/expensive investment choices, is it worthwhile to still max out the nondeductible contribution to their tIRA? Is this nondeductible contribution double-taxed (taxed again during withdrawal, though it is already an after-tax contribution)? Also, is it up to me to keep track of the pre-tax vs. nondeductible/after-tax portions of the tIRA? Not entirely clear on the specifics here.
If you think spouse's workplace options aren't desirable, then I'd just do tax-efficient taxable investing instead of a non-deductible TIRA contribution. You can track the non-deductible basis using Form 8606, so you'd avoid double taxation on the basis, but you'd owe ordinary income tax on the earnings at withdrawal. Depending on what your tax bracket will be at withdrawal, the LTCG rate will probably be lower.

See this for help with the decision of n-d TIRA or taxable: Non-deductible Traditional IRA

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 3:03 pm
by financeisfun
Thanks for the reply.
There's nothing that prohibits you from using the backdoor
And is my understanding correct that, other than needing to fill out Form 8606 in any year that I do the backdoor Roth and making sure I don't withdraw the funds for 5 years, I won't really need to keep track of the backdoor Roth contributions separately from the regular Roth contributions? Is there anything else I need to be aware of (assuming tIRA balance is $0)?
I'd just do tax-efficient taxable investing instead of a non-deductible TIRA contribution

Depending on what your tax bracket will be at withdrawal, the LTCG rate will probably be lower.

See this for help with the decision of n-d TIRA or taxable: Non-deductible Traditional IRA
Thanks for the suggestion. I'll look into this more. I suppose that I would want to primarily buy an ETF like VT in the taxable account in order to minimize tax inefficiency while also getting total world equity exposure.

One potential risk that comes to mind is if the LTCG rate increases while income tax rates for comparable income levels stay fixed (or even decrease).

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 3:11 pm
by tashnewbie
financeisfun wrote: Tue Jan 12, 2021 3:03 pm And is my understanding correct that, other than needing to fill out Form 8606 in any year that I do the backdoor Roth and making sure I don't withdraw the funds for 5 years, I won't really need to keep track of the backdoor Roth contributions separately from the regular Roth contributions? Is there anything else I need to be aware of (assuming tIRA balance is $0)?
You don't even need to really track the 5-year rule on these non-taxable conversions to Roth IRA. The only reason you'd want to keep track of the 5-year rule on conversions is if you have a large taxable portion of the conversion (for example, if you invested money in the TIRA and let it stay invested for awhile before converting to Roth IRA and there was a lot of earnings in the interim). If you're doing regular, vanilla backdoor Roth contributions, then you won't have any appreciable taxable portions of the conversions.

See White Coat Investor's tutorial for information about how to do the backdoor at Vanguard and how to complete Form 8606: Backdoor Roth IRA Tutorial.
financeisfun wrote: Tue Jan 12, 2021 3:03 pm
Thanks for the suggestion. I'll look into this more. I suppose that I would want to primarily buy an ETF like VT in the taxable account in order to minimize tax inefficiency while also getting total world equity exposure.

One potential risk that comes to mind is if the LTCG rate increases while income tax rates for comparable income levels stay fixed (or even decrease).
Personally, I wouldn't want to keep track of the n-d basis in my TIRA. I suppose it's easy enough to do every year, but you have to remember to file Form 8606. It's probably easier to remember to do that if you'll also be filing Form 8606 to record your backdoor conversions.

If I were going to do taxable investing, I'd probably use VTSAX/VTI and VTIAX/VXUS instead of VT, because of the foreign earned income tax credit. I don't know enough about it to give you any advice, but search the forums about the topic.

Edited: to fix my typo with foreign tax credit.

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 3:19 pm
by anon_investor
tashnewbie wrote: Tue Jan 12, 2021 3:11 pm If I were going to do taxable investing, I'd probably use VTSAX/VTI and VTIAX/VXUS instead of VT, because of the foreign earned income tax credit. I don't know enough about it to give you any advice, but search the forums about the topic.
+1 using VTSAX/VTI and VTIAX/VXUS instead of VT in a taxable account. Not every year, but at least last year, VTWAX/VT did not qualify for the foreign tax credit (see https://www.bogleheads.org/wiki/Foreign_tax_credit) (NOT foreign earned income tax credit, which is something else entirely). This is a tax credit for the foreign taxes withheld on dividends distributed by the underlying stocks held in VT. Additionally, by separating out US equities from international equities, there may be more tax loss harvest opportunities (see https://www.bogleheads.org/wiki/Tax_loss_harvesting).

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 5:02 pm
by financeisfun
tashnewbie wrote: Tue Jan 12, 2021 3:11 pm I'd probably use VTSAX/VTI and VTIAX/VXUS instead of VT
anon_investor wrote: Tue Jan 12, 2021 3:19 pm +1 using VTSAX/VTI and VTIAX/VXUS instead of VT in a taxable account
Thanks for the advice. Will accordingly go that route instead of VT in our taxable accounts.

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 5:09 pm
by financeisfun
Have gotten helpful advice so far, but am also curious to hear the thoughts of a couple others on the second question in the original post. In particular, in deciding between non-deductible tIRA vs. taxable. One potential risk that comes to mind of choosing taxable over non-deductible tIRA is if the LTCG rate increases while income tax rates for comparable income levels stay fixed (or even decrease). On the other hand, I suppose it's a pain to keep track of the non-deductible basis, as tashnewbie mentioned already.

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 5:24 pm
by anon_investor
financeisfun wrote: Tue Jan 12, 2021 5:09 pm Have gotten helpful advice so far, but am also curious to hear the thoughts of a couple others on the second question in the original post. In particular, in deciding between non-deductible tIRA vs. taxable. One potential risk that comes to mind of choosing taxable over non-deductible tIRA is if the LTCG rate increases while income tax rates for comparable income levels stay fixed (or even decrease). On the other hand, I suppose it's a pain to keep track of the non-deductible basis, as tashnewbie mentioned already.
Under current tax laws, the growth on the non-deductable tIRA contribution would be taxed at ordinary income, versus the taxable account which would be likely taxed at long term capital gains rates. What tax rates will be in the future is anyone's guess. Personally I would use taxable over non-deductable tIRA contributions because current tax rates are more favorable, additionally taxable is just more flexible (you can sell anytime without restrictions). The other good thing about a taxable account is that it will not be subject to RMD in the future and you can control when you want to sell. Without going into a discussion of where tax rates may end up in the future; investing in tax efficient index ETFs in a taxable account, it would take long term capital gains rates ending up end up higher than ordinary income tax rates for a taxable account to end up worse than a non-deductable tIRA (this would only be due to the small tax drag annually from dividends, but maybe those could be offset by tax loss harvesting). I just do not see the benefit of non-deductable tIRA contributions if you are not able to convert them to Roth.

How bad is your spouse's 401k? How much in tIRA would need to be rolled into the 401k to allow for a clean backdoor Roth? Roth space is quite valuable.

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 5:40 pm
by Katietsu
Options for wife if 401k is bad:
1) Stick with taxable account
2) Make non deductible contribution IF you think there might be an opportunity to roll current pre tax traditional balance to a better 401 k in the next few years
3) Convert entire current traditional IRA to Roth IRA IF it is a smallish balance. Then do back door Roth.


What are fees in wife’s workplace 401k. Sometimes people post that statement here but then it turns out that there is a perfectly acceptable S&P500 index fund with a 0.3% ER. You only need one good fund choice. On the other hand, there are some atrocious plans with fees that total 1.5%-3% .

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 7:06 pm
by financeisfun
anon_investor wrote: Tue Jan 12, 2021 5:24 pm How bad is your spouse's 401k? How much in tIRA would need to be rolled into the 401k to allow for a clean backdoor Roth? Roth space is quite valuable.
Katietsu wrote: Tue Jan 12, 2021 5:40 pm What are fees in wife’s workplace 401k. Sometimes people post that statement here but then it turns out that there is a perfectly acceptable S&P500 index fund with a 0.3% ER. You only need one good fund choice. On the other hand, there are some atrocious plans with fees that total 1.5%-3% .
I guess I was saying that more to explore our options if the 401(k) options/fees are not optimal and/or we don't want to deal with the hassle of rolling the tIRA to their 401(k).

I will have to get back to you with exact fees, but there actually is a decent set of target-date index funds with an ER of 0.09%. The problem is that there are additional administrative and maintenance fees that we will have to inquire about.

The other major concern for me is the lack of freedom once we roll the tIRA into the 401(k). The tIRA money is stuck in the 401(k) along with the rest in that case, correct? So if investment options change and/or the fee structure becomes worse in the future, there is no recourse for us to return the money to the tIRA, right?

Re: Questions about backdoor Roth and nondeductible contributions

Posted: Tue Jan 12, 2021 7:17 pm
by anon_investor
financeisfun wrote: Tue Jan 12, 2021 7:06 pm
anon_investor wrote: Tue Jan 12, 2021 5:24 pm How bad is your spouse's 401k? How much in tIRA would need to be rolled into the 401k to allow for a clean backdoor Roth? Roth space is quite valuable.
Katietsu wrote: Tue Jan 12, 2021 5:40 pm What are fees in wife’s workplace 401k. Sometimes people post that statement here but then it turns out that there is a perfectly acceptable S&P500 index fund with a 0.3% ER. You only need one good fund choice. On the other hand, there are some atrocious plans with fees that total 1.5%-3% .
I guess I was saying that more to explore our options if the 401(k) options/fees are not optimal and/or we don't want to deal with the hassle of rolling the tIRA to their 401(k).

I will have to get back to you with exact fees, but there actually is a decent set of target-date index funds with an ER of 0.09%. The problem is that there are additional administrative and maintenance fees that we will have to inquire about.

The other major concern for me is the lack of freedom once we roll the tIRA into the 401(k). The tIRA money is stuck in the 401(k) along with the rest in that case, correct? So if investment options change and/or the fee structure becomes worse in the future, there is no recourse for us to return the money to the tIRA, right?
I think it depends on the plan, but some (at least mine does for a $5 fee) allows for roll out any rolled in funds at any time even while still an employee. So worth checking. Roth space is valuable and might make up for the higher cost 401k plan. It also depends on how much $ is being rolled in.