Backdoor Roth: How Long To Wait For Conversion?

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Alan S.
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by Alan S. » Sun Jan 07, 2018 1:36 pm

If Congress really wanted to end the back door, they wouldn't mess with unenforceable time limits for conversions.

The prior administration promoted this solution:
To shut down this perceived “abuse”, the Treasury Greenbook proposal would simply limit any/all Roth conversions to be only permissible for pre-tax dollars; in other words, to the extent that any of the IRA or employer retirement funds are after-tax, they would simply not be eligible for conversion at all. This would effectively stop all “backdoor” Roth contributions, whether through IRAs or 401(k) plans; in fact, it would even limit Roth conversions of after-tax retirement funds under the normal pro-rata conversion rules as well.
Note that such a restriction would undo Notice 2014-54 which allows non taxable conversions of after tax money in qualified plans.

In the last 17 years the tax code has incorporated a massive increase in retirement plan portability, and inevitably that increased strategic planning opportunities including transfers of basis into the most advantageous account, a Roth IRA or designated Roth account. Elimination of the conversion MAGI limit in 2010 is what really jump started the "back door" strategy. Elimination of the back door is going to require something like the above restriction which means a partial 180 on the portability revolution.

pshonore
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by pshonore » Sun Jan 07, 2018 3:28 pm

Earl Lemongrab wrote:
Sun Jan 07, 2018 11:36 am
Leesbro63 wrote:
Sun Jan 07, 2018 9:45 am
It’s not clear to me that the IRS even is focused on backdoor IRAs.
I don't know what priority it had. Like I said, they were aware because the administration floated suggestions for new legislation to close it.
I was quite surprised to find they (or at least Congress) were "focused" on Roth Conversion recharacterizations. I'll have to look at the IRS SOI (Statistics of Income) stuff to see if there's recent data on that (Back door), but I'm not even sure there's an easy way, if any, to identify those. I'll bet the number is very, very low especially if Bogleheads were excluded.

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Earl Lemongrab
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by Earl Lemongrab » Sun Jan 07, 2018 4:48 pm

The reason, I believe, for the removal of recharacterization doesn't have to do with backdoor Roth. Contributions can still be recharacterized. What they were going for there was the multiple conversions, keep the best result (horse race, leap frog, etc.).
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523HRR
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by 523HRR » Sun Jan 07, 2018 7:20 pm

For many years, we always did our backdoor Roth conversions instantaneously through Schwab. Traditional IRA contributions via internal transfer from Schwab taxable account are given instant credit in the tIRA. Funds are then immediately available to be converted to our Schwab Roth IRAs. The whole process takes about 40 seconds. We retired in 2012, so haven't done this in a while since we no longer have earned income.

antiqueman
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by antiqueman » Sun Jan 07, 2018 7:50 pm

Perhaps Alan S or others versed in this subject can answer the following questions:

What is the look back period on a backdoor Roth? Would the IRS disallow it after 3, 5, 10 or 20 years?

If it were disallowed what happens? Are the earnings taxes or can you transfer the earning and original ira back to a traditional ira/

If it is disallowed, is there a penalty. I would think that the IRS would just require it be transferred back to a traditional without a penalty.

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Earl Lemongrab
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by Earl Lemongrab » Mon Jan 08, 2018 12:54 am

What do you mean by "look-back period"? For what exactly?
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Spirit Rider
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by Spirit Rider » Mon Jan 08, 2018 2:19 pm

I am assuming they might be referring to the SOL which would be three years in this case, because there would be no fraud and no unreported income.

IANAL, but can we please finally put this FUD to rest.. Backdoor Roths are legitimate and allowed period.

Most of this angst about the legitimacy of the Backdoor Roth can probably be traced to a well known financial planner and blogger in 2012. He based his entire premise on third hand information from a CPA that supposedly had clients who were audited and told by a single IRS agent that a Backdoor Roth was a step transaction and thus not allowed. To my knowledge this has never been verified or replicated to any degree.

Now consider the following facts:
  • The time frame was right after the $100K MAGI limit for Roth conversions were removed in 2010. So it was a totally new concept then. Maybe a particular IRS went off the reservation on this. The IRS never promulgated any such information in the IRM or elsewhere. We have not heard anything since.
  • Michael Kites basic premise that you should wait a year between the non-deductible traditional IRA contribution and the Roth Conversion. Which makes no sense, when you consider that there is ample precedent that elapsed time does not alleviate step transaction doctrine concerns.
  • The step transaction doctrine only applies when the multi-step process achieves the same result as the single step. This is most definitely not true with a Backdoor Roth. A straight Roth contribution results in no tax liability and there are no restrictions on the withdrawal of contributions. The Roth conversion step of a Backdoor Roth requires a pro rata conversion of the non-deductible basis and pre-tax balances on 12/31. Then the conversion is also subject to the five year rule.
  • Two different IRS spokesmen stated to Financial Planning Magazine and the Wall Street Journal and other IRS personnel at IRS conferences have repeatedly stated that: “There is no caveat to waiting” and “This is settled law.” Michael Kite’s response was essentially that he knows better than the IRS and IRS’ opinion is not a Tax court ruling.
  • To pour salt in his wounds the IRS released Notice 2014-54, which essentially blessed the so called Mega Backdoor. Which allows tens of thousands of dollars of after-tax contributions followed by a direct rollover to a Roth IRA account. Starting this year, someone could actually do a Mega Backdoor rollover of $55K, ten (10) times a $5.5K Backdoor Roth. The Mega Backdoor Roth is blessed by the IRS, but the 1/10th Backdoor Roth is a problem. I think not.
  • Why did the previous administration include in the blue print for their last two budgets, proposed legislation to prohibit both the Backdoor Roth and the Mega Backdoor Roth. They were never shy about executive overreach in eight years, so why would they propose legislation to outlaw the backdoor Roth if it could be prohibited by the IRS under current law. Easy answer, the IRS told them they had no authority to disallow either one.
  • Putting a nail in the coffin of this FUD, on Feb 16, 2017 the U.S. 6th Circuit Court of Appeals ruled in related case that the IRS could not use the “substance-over-form doctrine,” AKA step-transaction doctrine to deny the ability to use two perfectly legal steps to avoid the Roth contribution limit. Here is one quote from the ruling; “But the substance-over-form doctrine does not authorize the Commissioner to undo a transaction just because taxpayers undertook it to reduce their tax bills.” and this direct reference to the Backdoor Roth; “Those rollovers permit high-income taxpayers to avoid the income limits on Roth IRA contributions, just as the DISC permitted Summa Holdings to avoid the contribution limits. The Commissioner cannot fault taxpayers for making the most of the tax-minimizing opportunities Congress created.

new2bogle
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by new2bogle » Mon Jan 08, 2018 3:11 pm

A bit off-topic but didn't want to create a separate thread:

when doing a mega backdoor roth ira conversion, can the gains on the after-tax amount go into a Rollover IRA? Or must it be a traditional IRA?

Spirit Rider
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Re: Backdoor Roth: How Long To Wait For Conversion?

Post by Spirit Rider » Mon Jan 08, 2018 4:48 pm

They probably should go into a rollover IRA. If you want to roll back them into a qualified plan. However, fewer and fewer plans restrict rollover contributions to those only from rollover IRAs. In 2014 the IRS gave the plans a safe harbor if the participant certified that the rollover contributions were all pre-tax.

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