Delayed IRA Conversion for Backdoor Roth?

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Topic Author
dboeger1
Posts: 60
Joined: Fri Jan 13, 2017 7:32 pm

Delayed IRA Conversion for Backdoor Roth?

Post by dboeger1 » Wed Nov 06, 2019 1:42 pm

Hello Bogleheads,

I'm not new to Boglehead investment philosophy or saving for retirement in tax-advantaged accounts; however, I have some questions regarding the backdoor Roth IRA method which seem to defy standard Googling for answers. I'm not looking for answers based on my own personal figures, so much as I want to understand which alternatives are generally available for people in my situation. My wife and I recently switched to higher-paying jobs within the same year, and as a result, we will be well over the Roth IRA income limit, as well as the traditional IRA tax deduction income limit, for the first time next year. The issue is that I have a relatively substantial pre-tax IRA balance from rolling over my previous employer's 401(k) balance.

My basic understanding of how the backdoor Roth IRA works is that you open a traditional IRA, contribute to it each year, and in each year that you make a contribution, you subsequently roll that amount over to a Roth IRA. This effectively replicates the effects of contributing to a Roth IRA directly, while managing to get around the income restrictions. However, when you have existing pre-tax IRA balances, you have to convert amounts in the same ratio as your balances across accounts, or more specifically, the before- or after- tax status of the dollars in those accounts. So for example, if I have a traditional IRA with $5k of pre-tax dollars in it, and I open a new IRA with $5k of post-tax dollars in it (presumably because my income level was beyond the threshold for getting a tax deduction), when I go to convert into a Roth IRA, I have to convert half and half, meaning I'll have to pay taxes on $1 pre-tax dollar from account A for every $1 post-tax dollar in account B, resulting in a net $2 Roth conversion.

This is all relatively well-documented and Googleable so far. What I'm having trouble finding are documented examples of what people in situations like mine actually do. Surely, we can't be the only couple who has ever increased our household income, lol. Do people generally go ahead with the conversion and pay the taxes on the existing balance? That seems counter-productive to me at a time when your income is such that you're paying a higher tax rate. Alternatively, is it possible to defer the conversion to a later year? For example, can I contribute to a traditional IRA each year, not take the tax deductions (because I'm ineligible), and convert the whole balance in a later year with a lower tax bracket? And even if that's possible, does anyone actually do that? It seems like tying up money for a long amount of time in the hopes of possibly making less income at some point in the near future, which is perhaps a little silly. Or is this just one of those good problems to have, where I simply don't get to take advantage of the Roth IRA anymore because we make too much? Knowing what I know now, I probably would've rolled my previous employer's 401(k) into my new employer's, keeping the backdoor Roth option open. But I went with an IRA instead for the flexibility. I did not expect to reach the Roth income threshold so soon, but life has been good to us.

Thanks for all your help!

Makefile
Posts: 59
Joined: Fri Apr 22, 2016 11:03 pm

Re: Delayed IRA Conversion for Backdoor Roth?

Post by Makefile » Wed Nov 06, 2019 1:48 pm

You have to have access to an employer plan that will let you reverse rollover from a traditional IRA to the plan. You are allowed to do so, so long as you rollover only the pre-tax amount. Search for basis isolation on the forum

Topic Author
dboeger1
Posts: 60
Joined: Fri Jan 13, 2017 7:32 pm

Re: Delayed IRA Conversion for Backdoor Roth?

Post by dboeger1 » Wed Nov 06, 2019 2:03 pm

@Makefile, I had no idea it was even possible to go from an IRA back to a 401k. It turns out there are actually good resources online for doing that in this particular situation. To be honest, I'm quite shocked it was so difficult for me to stumble on them. I didn't know what to search for specifically, so I searched for things like, "Can I delay backdoor Roth IRA conversion?", and nothing useful ever came up. Thanks a ton for clarifying the mechanism for me.

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

Re: Delayed IRA Conversion for Backdoor Roth?

Post by retiredjg » Wed Nov 06, 2019 2:04 pm

dboeger1 wrote:
Wed Nov 06, 2019 1:42 pm
This is all relatively well-documented and Googleable so far. What I'm having trouble finding are documented examples of what people in situations like mine actually do.
The usual suggestion is to roll your pre-tax IRA into a 401k or 403b. This gets it out of the way so that there is nothing to pro-rate.

Do people generally go ahead with the conversion and pay the taxes on the existing balance? That seems counter-productive to me at a time when your income is such that you're paying a higher tax rate
.In general, this is not a great approach.

Alternatively, is it possible to defer the conversion to a later year? For example, can I contribute to a traditional IRA each year, not take the tax deductions (because I'm ineligible), and convert the whole balance in a later year with a lower tax bracket?
Yes, you can do that but it will still be pro-rated with the rest of the IRA. That will happen until the IRA is empty. Most people want to avoid this.

Just see if your current 401k will accept the IRA. If yes, roll the IRA into the 401k. Then do the back door. Considering that it is late in the year, you might not get it all done by the end of the year.

Topic Author
dboeger1
Posts: 60
Joined: Fri Jan 13, 2017 7:32 pm

Re: Delayed IRA Conversion for Backdoor Roth?

Post by dboeger1 » Wed Nov 06, 2019 5:27 pm

retiredjg wrote:
Wed Nov 06, 2019 2:04 pm
Just see if your current 401k will accept the IRA. If yes, roll the IRA into the 401k. Then do the back door. Considering that it is late in the year, you might not get it all done by the end of the year.
Thanks for your clarification as well. Actually, the backdoor Roth contributions would be for 2020, so I believe I'm doing all of this early rather than late. I just want to get the IRA money into the 401(k) before the end of the year, and then I'll have a fresh slate for backdoor Roth going forward. I already did the max Roth IRA contribution for 2019 earlier in the year, which is a separate issue entirely I may have to contend with. I believe that because of the timing of when my wife specifically started her new job, we will still be able to squeak in just under the phase-out window, but it's going to be close... I haven't actually done the calculations.

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Ricchan
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Re: Delayed IRA Conversion for Backdoor Roth?

Post by Ricchan » Wed Nov 06, 2019 7:25 pm

One thing to keep in mind about the reverse rollover (tIRA to 401k) is that the 401k plan most likely can only accept pre-tax money from the reverse rollover. So if you have both pre-tax basis and post-tax basis commingled in your tIRA, make sure you know what the rules are and exactly how much is in each bucket.

I believe one common strategy to avoid the pro-rata rule is to use the reverse rollover to remove all pre-tax money from the tIRA, such that the remaining funds in the tIRA are entirely post-tax. Then you can convert the remaining tIRA to a Roth without having to worry about paying taxes on the conversion.

Topic Author
dboeger1
Posts: 60
Joined: Fri Jan 13, 2017 7:32 pm

Re: Delayed IRA Conversion for Backdoor Roth?

Post by dboeger1 » Fri Nov 08, 2019 4:39 pm

@Ricchan, Yes, thank you very much for your additional suggestions. Actually, I'm fortunate in that we have not contributed any additional funds to our rollover IRAs. My wife and I both simply rolled our old employers' 401(k) balances out to them, set the investments, and let them rest. All of our IRA contributions were to our Roth IRAs, which we did as a way of hedging our bets when it comes to tax rates, since we are far too young to have a firm grasp on the difference in tax rates pre- and post- retirement.

To my surprise, her company actually has representatives from their 401(k) provider on site today, so she was able to ask a lot of the same questions regarding her options. I did not plan that at all, it was purely coincidental. Turns out, she can also do the same type of transfer, so assuming we get those done in the coming days, we should have a clean slate and be free and clear to pursue the backdoor Roth method as of 2020.

Lee_WSP
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Location: Arizona

Re: Delayed IRA Conversion for Backdoor Roth?

Post by Lee_WSP » Sat Nov 09, 2019 9:23 am

dboeger1 wrote:
Wed Nov 06, 2019 1:42 pm
This is all relatively well-documented and Googleable so far. What I'm having trouble finding are documented examples of what people in situations like mine actually do. Surely, we can't be the only couple who has ever increased our household income, lol. Do people generally go ahead with the conversion and pay the taxes on the existing balance? That seems counter-productive to me at a time when your income is such that you're paying a higher tax rate. Alternatively, is it possible to defer the conversion to a later year? For example, can I contribute to a traditional IRA each year, not take the tax deductions (because I'm ineligible), and convert the whole balance in a later year with a lower tax bracket? And even if that's possible, does anyone actually do that? It seems like tying up money for a long amount of time in the hopes of possibly making less income at some point in the near future, which is perhaps a little silly. Or is this just one of those good problems to have, where I simply don't get to take advantage of the Roth IRA anymore because we make too much? Knowing what I know now, I probably would've rolled my previous employer's 401(k) into my new employer's, keeping the backdoor Roth option open. But I went with an IRA instead for the flexibility. I did not expect to reach the Roth income threshold so soon, but life has been good to us.

Thanks for all your help!
You convert all or none. It's not worth only converting half to a Roth, it doesn't add up. The advantage of the Roth is that it grows tax free with the initial penalty. Since you aren't able to take the deduction from the IRA, you're then faced with taxable vs tax deferred growth. Tax deferred is still better.

There are calculators to determine whether the Roth makes sense. Usually it's vs taking the deduction, so what you'd need to do is add back in that deduction to the trad IRA side.

Samaitch
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Joined: Sat Nov 09, 2019 2:38 pm

Re: Delayed IRA Conversion for Backdoor Roth?

Post by Samaitch » Sat Nov 09, 2019 2:46 pm

Hmmm So I have a question. My assumption has been if I have an old 401k rolled over into an IRA, I can move part of it to ROTH whenever I want to. I would pay taxes on the converted amount. So if I have a few years where I have no income I could move over 30 or 40K each year and pay a little tax. Is this not the case?

Thanks

Sam H

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

Re: Delayed IRA Conversion for Backdoor Roth?

Post by retiredjg » Sat Nov 09, 2019 3:09 pm

Samaitch wrote:
Sat Nov 09, 2019 2:46 pm
Hmmm So I have a question. My assumption has been if I have an old 401k rolled over into an IRA, I can move part of it to ROTH whenever I want to. I would pay taxes on the converted amount. So if I have a few years where I have no income I could move over 30 or 40K each year and pay a little tax. Is this not the case?
It sounds like you are talking about a plain old Roth conversion (not a backdoor Roth maneuver). If yes, you have the right idea about how it works if that is your only IRA.

Welcome to the forum. :happy

StandingRock
Posts: 323
Joined: Sat Feb 02, 2019 6:54 pm

Re: Delayed IRA Conversion for Backdoor Roth?

Post by StandingRock » Sat Nov 09, 2019 3:17 pm

retiredjg wrote:
Wed Nov 06, 2019 2:04 pm

Just see if your current 401k will accept the IRA. If yes, roll the IRA into the 401k. Then do the back door. Considering that it is late in the year, you might not get it all done by the end of the year.
A word of warning - if you are dealing with Vanguard you might not be able to get it done by EOY. I started this process in September and still haven't gotten my check from Vanguard. They've screwed up my address TWICE and after it was returned to them they had to go through the whole process again. They claimed on Monday that they had overnighted the third attempt to me but I have yet to see it.


In theory this should all be simple but I am learning the hard way about Vanguard's bungling ways. I hope to get this mess straightened out and will be moving the rest of my accounts to Fidelity as soon as I can.

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