Question about Backdoor Roth conversion and existing tIRA

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Regulator23
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Question about Backdoor Roth conversion and existing tIRA

Post by Regulator23 »

Hey everyone,

Question about the backdoor roth strategy. Let me know if additional details are needed, or if you have any questions.

I am married (filing jointly) and make above the Roth IRA contribution limit (I believe it is $198K?).

The last two years, I have done the backdoor roth by putting money into a tIRA and then converting it to my Roth IRA. I created the Traditional IRA strictly for converting purposes, so have no money in the tIRA each time I convert it to my Roth.

My wife, on the other hand, has had a tIRA for ~5 years. The first few years we put money in that was tax deductible. The last two years, however, we were above the limit and that money was non-deductible.

Instead of doing another non-deductible contribution to her tIRA this year, I thought it would make more sense to have her create a new Roth account and do what I've been doing and do a backdoor Roth. Questions on this approach:

1) How does this work whereas she currently already has money in her Traditional IRA? Does this make things complicated?

2) Assuming the above is yes, what if we created a NEW Traditional IRA for her, and then did a Roth conversion out of that? Does that make things easier?

Sorry if I didn't explain this well. Any help is greatly appreciated!!!
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David Jay
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by David Jay »

Regulator23 wrote: Mon May 03, 2021 4:46 pm 1) How does this work whereas she currently already has money in her Traditional IRA? Does this make things complicated?
She will pay taxes on the pre-tax money in the tIRA on a pro-rated basis. There is a complete wiki on this topic here: https://www.bogleheads.org/wiki/Backdoor_Roth

2) Assuming the above is yes, what if we created a NEW Traditional IRA for her, and then did a Roth conversion out of that? Does that make things easier?
An additional account is no help, the IRS treats all tIRA accounts (as well as SEP accounts) as a single "pool", you can't get away from the pre-tax balance.
If the pre-tax balance is relatively small, it may well be worth doing a Roth conversion of the entire pre-tax balance in order to "clear out" her tIRA to simplify future years. See the information on the Wiki, specifically the three choices for addressing pre-tax balances under the "Cautions" heading.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
RubyTuesday
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by RubyTuesday »

All traditional IRAs are considered a single IRA. Any pre-tax amounts in the account(s) will require prorating the taxable portion if you convert funds to Roth.

Read up on the wiki more do a search here for more details.

If she has access to a 401(k) through an employer, or a solo 401(k), she should explore rolling the pre-tax contributions (and the earnings from both pre and post tax contributions) to the 401(k). This will leave only non-deductible contributions and simplify conversions.
“Doing nothing is better than being busy doing nothing.” – Lao Tzu
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celia
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by celia »

Regulator23 wrote: Mon May 03, 2021 4:46 pm The last two years, I have done the backdoor roth by putting money into a tIRA and then converting it to my Roth IRA. I created the Traditional IRA strictly for converting purposes, so have no money in the tIRA each time I convert it to my Roth.
I assume you are saying that you reported the NON-DEDUCTIBLE tIRA contributions on your tax return each year as well as the Roth conversions. And you had no other kinds of pre-tax IRAs (except, possibly, for an Inherited IRA). This will generate a Form 8606 with a remaining $0 balance (of the non-deductible basis) on line 14 if it was reported correctly.
My wife, on the other hand, has had a tIRA for ~5 years. The first few years we put money in that was tax deductible. The last two years, however, we were above the limit and that money was non-deductible.

Instead of doing another non-deductible contribution to her tIRA this year, I thought it would make more sense to have her create a new Roth account and do what I've been doing and do a backdoor Roth. Questions on this approach:

1) How does this work whereas she currently already has money in her Traditional IRA? Does this make things complicated?

2) Assuming the above is yes, what if we created a NEW Traditional IRA for her, and then did a Roth conversion out of that? Does that make things easier?
You can have as many Traditional IRAs, in all its variations (SEP IRA, SIMPLE IRA, Rollover IRA) and as many Roth IRAs as you want, even at multiple custodians. But the IRS regards all the tIRAs as one account. For example you can make a non-deductible contribution to one IRA but do the conversion from another one. There's no difference if you have lots of tIRAs or only one.

With about 3 years of deductible contributions and 2 years of non-deductible contributions and one more this year plus growth for all of it, if she converts the whole thing, it looks like a little less than half the conversion will be tax-free (3 times $6,000), and the rest will be taxed. Why not convert it all and get all that future growth going in a Roth where it won't be taxed.

And I assume she also filed a Form 8606 for each year she make a non-deductible contribution.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Regulator23
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by Regulator23 »

celia wrote: Mon May 03, 2021 9:45 pm
Regulator23 wrote: Mon May 03, 2021 4:46 pm The last two years, I have done the backdoor roth by putting money into a tIRA and then converting it to my Roth IRA. I created the Traditional IRA strictly for converting purposes, so have no money in the tIRA each time I convert it to my Roth.
I assume you are saying that you reported the NON-DEDUCTIBLE tIRA contributions on your tax return each year as well as the Roth conversions. And you had no other kinds of pre-tax IRAs (except, possibly, for an Inherited IRA). This will generate a Form 8606 with a remaining $0 balance (of the non-deductible basis) on line 14 if it was reported correctly.
My wife, on the other hand, has had a tIRA for ~5 years. The first few years we put money in that was tax deductible. The last two years, however, we were above the limit and that money was non-deductible.

Instead of doing another non-deductible contribution to her tIRA this year, I thought it would make more sense to have her create a new Roth account and do what I've been doing and do a backdoor Roth. Questions on this approach:

1) How does this work whereas she currently already has money in her Traditional IRA? Does this make things complicated?

2) Assuming the above is yes, what if we created a NEW Traditional IRA for her, and then did a Roth conversion out of that? Does that make things easier?
You can have as many Traditional IRAs, in all its variations (SEP IRA, SIMPLE IRA, Rollover IRA) and as many Roth IRAs as you want, even at multiple custodians. But the IRS regards all the tIRAs as one account. For example you can make a non-deductible contribution to one IRA but do the conversion from another one. There's no difference if you have lots of tIRAs or only one.

With about 3 years of deductible contributions and 2 years of non-deductible contributions and one more this year plus growth for all of it, if she converts the whole thing, it looks like a little less than half the conversion will be tax-free (3 times $6,000), and the rest will be taxed. Why not convert it all and get all that future growth going in a Roth where it won't be taxed.

And I assume she also filed a Form 8606 for each year she make a non-deductible contribution.
Correct, we have filed Form 8606 the last few years for her (non deductible contributions) and myself (the backdoor Roth). For some reason, I never thought about simply converting the whole thing so that future growth won't be taxed. That is a great idea. Would we have to talk to fidelity about a complete conversion? Or is that something she/I could do ourselves?
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David Jay
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by David Jay »

Regulator23 wrote: Tue May 04, 2021 9:43 amFor some reason, I never thought about simply converting the whole thing so that future growth won't be taxed. That is a great idea. Would we have to talk to fidelity about a complete conversion? Or is that something she/I could do ourselves?
I have never done a conversion at Fidelity but at Vanguard one can do this online. I would expect she can do it online, do a Fidelity site search for “Roth Conversion”.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
Topic Author
Regulator23
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by Regulator23 »

David Jay wrote: Tue May 04, 2021 9:47 am
Regulator23 wrote: Tue May 04, 2021 9:43 amFor some reason, I never thought about simply converting the whole thing so that future growth won't be taxed. That is a great idea. Would we have to talk to fidelity about a complete conversion? Or is that something she/I could do ourselves?
I have never done a conversion at Fidelity but at Vanguard one can do this online. I would expect she can do it online, do a Fidelity site search for “Roth Conversion”.
Is it wise to wait for a year where my income may be lower so I'm taxed less? Or is the IRA so small at this point that it doesn't really matter?
MrJedi
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by MrJedi »

Regulator23 wrote: Tue May 04, 2021 9:50 am
David Jay wrote: Tue May 04, 2021 9:47 am
Regulator23 wrote: Tue May 04, 2021 9:43 amFor some reason, I never thought about simply converting the whole thing so that future growth won't be taxed. That is a great idea. Would we have to talk to fidelity about a complete conversion? Or is that something she/I could do ourselves?
I have never done a conversion at Fidelity but at Vanguard one can do this online. I would expect she can do it online, do a Fidelity site search for “Roth Conversion”.
Is it wise to wait for a year where my income may be lower so I'm taxed less? Or is the IRA so small at this point that it doesn't really matter?
I didn't see the amount listed here, but you can easily calculate the tax that would be due of you know the IRA amount, basis amount, and your income tax rate. If it's relatively low, the simplicity of having a clean slate may be worth the small tax bill.
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Regulator23
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by Regulator23 »

MrJedi wrote: Tue May 04, 2021 10:01 am
Regulator23 wrote: Tue May 04, 2021 9:50 am
David Jay wrote: Tue May 04, 2021 9:47 am
Regulator23 wrote: Tue May 04, 2021 9:43 amFor some reason, I never thought about simply converting the whole thing so that future growth won't be taxed. That is a great idea. Would we have to talk to fidelity about a complete conversion? Or is that something she/I could do ourselves?
I have never done a conversion at Fidelity but at Vanguard one can do this online. I would expect she can do it online, do a Fidelity site search for “Roth Conversion”.
Is it wise to wait for a year where my income may be lower so I'm taxed less? Or is the IRA so small at this point that it doesn't really matter?
I didn't see the amount listed here, but you can easily calculate the tax that would be due of you know the IRA amount, basis amount, and your income tax rate. If it's relatively low, the simplicity of having a clean slate may be worth the small tax bill.
Makes sense. And how does the non deductible contributions work ($12K total)? Will I be taxed on that? And how does Fidelity know what amount has been deducted and what hasn't?
MrJedi
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by MrJedi »

Regulator23 wrote: Tue May 04, 2021 10:11 am
MrJedi wrote: Tue May 04, 2021 10:01 am
Regulator23 wrote: Tue May 04, 2021 9:50 am
David Jay wrote: Tue May 04, 2021 9:47 am
Regulator23 wrote: Tue May 04, 2021 9:43 amFor some reason, I never thought about simply converting the whole thing so that future growth won't be taxed. That is a great idea. Would we have to talk to fidelity about a complete conversion? Or is that something she/I could do ourselves?
I have never done a conversion at Fidelity but at Vanguard one can do this online. I would expect she can do it online, do a Fidelity site search for “Roth Conversion”.
Is it wise to wait for a year where my income may be lower so I'm taxed less? Or is the IRA so small at this point that it doesn't really matter?
I didn't see the amount listed here, but you can easily calculate the tax that would be due of you know the IRA amount, basis amount, and your income tax rate. If it's relatively low, the simplicity of having a clean slate may be worth the small tax bill.
Makes sense. And how does the non deductible contributions work ($12K total)? Will I be taxed on that? And how does Fidelity know what amount has been deducted and what hasn't?
Non deductible would not be taxed. You would be taxed on the total balance minus the nondeductible basis. The brokers do not keep track of basis, they have no idea what you actually deducted. It's up to the individual to file correctly on the form 8606.
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Regulator23
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by Regulator23 »

MrJedi wrote: Tue May 04, 2021 10:14 am
Regulator23 wrote: Tue May 04, 2021 10:11 am
MrJedi wrote: Tue May 04, 2021 10:01 am
Regulator23 wrote: Tue May 04, 2021 9:50 am
David Jay wrote: Tue May 04, 2021 9:47 am
I have never done a conversion at Fidelity but at Vanguard one can do this online. I would expect she can do it online, do a Fidelity site search for “Roth Conversion”.
Is it wise to wait for a year where my income may be lower so I'm taxed less? Or is the IRA so small at this point that it doesn't really matter?
I didn't see the amount listed here, but you can easily calculate the tax that would be due of you know the IRA amount, basis amount, and your income tax rate. If it's relatively low, the simplicity of having a clean slate may be worth the small tax bill.
Makes sense. And how does the non deductible contributions work ($12K total)? Will I be taxed on that? And how does Fidelity know what amount has been deducted and what hasn't?
Non deductible would not be taxed. You would be taxed on the total balance minus the nondeductible basis. The brokers do not keep track of basis, they have no idea what you actually deducted. It's up to the individual to file correctly on the form 8606.
Thank you! Sorry for the dumb questions :)

Walking through the steps, Fidelity asks me if I want to pay the taxes now, or pay the taxes later at my annual tax filing. I assume later is the option, correct?
Iorek
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by Iorek »

Later is the correct option but keep in mind that if the sum is substantial (and/or you don’t usually get a federal refund) you may want to pay it by estimated tax later this year to avoid underpayment penalties
MrJedi
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by MrJedi »

Regulator23 wrote: Tue May 04, 2021 10:18 am
MrJedi wrote: Tue May 04, 2021 10:14 am
Regulator23 wrote: Tue May 04, 2021 10:11 am
MrJedi wrote: Tue May 04, 2021 10:01 am
Regulator23 wrote: Tue May 04, 2021 9:50 am

Is it wise to wait for a year where my income may be lower so I'm taxed less? Or is the IRA so small at this point that it doesn't really matter?
I didn't see the amount listed here, but you can easily calculate the tax that would be due of you know the IRA amount, basis amount, and your income tax rate. If it's relatively low, the simplicity of having a clean slate may be worth the small tax bill.
Makes sense. And how does the non deductible contributions work ($12K total)? Will I be taxed on that? And how does Fidelity know what amount has been deducted and what hasn't?
Non deductible would not be taxed. You would be taxed on the total balance minus the nondeductible basis. The brokers do not keep track of basis, they have no idea what you actually deducted. It's up to the individual to file correctly on the form 8606.
Thank you! Sorry for the dumb questions :)

Walking through the steps, Fidelity asks me if I want to pay the taxes now, or pay the taxes later at my annual tax filing. I assume later is the option, correct?
Yes. This option is mostly for people who are withdrawing during retirement; this works as their tax withholding. If you take this option, the tax paid would come out of your account as a withdraw and be subject to early withdrawal penalty if you aren't qualified.

If it's a large amount you would consider making an estimated tax payment or increasing tax withholding. If small, it won't really affect your taxes though, especially if you normally end up with a refund.
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David Jay
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by David Jay »

Regulator23 wrote: Tue May 04, 2021 9:50 am
David Jay wrote: Tue May 04, 2021 9:47 am
Regulator23 wrote: Tue May 04, 2021 9:43 amFor some reason, I never thought about simply converting the whole thing so that future growth won't be taxed. That is a great idea. Would we have to talk to fidelity about a complete conversion? Or is that something she/I could do ourselves?
I have never done a conversion at Fidelity but at Vanguard one can do this online. I would expect she can do it online, do a Fidelity site search for “Roth Conversion”.
Is it wise to wait for a year where my income may be lower so I'm taxed less? Or is the IRA so small at this point that it doesn't really matter?
Lower income only matters if you cross into a different marginal tax bracket (i.e. 32% to 24%, etc.), then it might be worth running the numbers to see how much you save.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
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celia
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Re: Question about Backdoor Roth conversion and existing tIRA

Post by celia »

Don’t withhold from the converted amount since less money will go into the Roth. And if she is under 59.5, there will be a 10% early withdrawal penalty since the amount withheld is really going to Taxable (your taxes are paid from Taxable).

If this if the first time you two are converting, it will be safer to have the custodian walk you through it. Then, if there is a mistake, it is on them.

Follow them online doing it yourself, but let them press the final button to “Submit” (or whatever it is called).
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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