taxes with megabackdoor roth

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sg77
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taxes with megabackdoor roth

Postby sg77 » Thu Aug 04, 2016 9:36 pm

I need help with figuring out how to do megabackdoor and if i should engage a financial or tax advisor before i execute.

Background:
140k in value in after tax 401k, 110k of which is in contributions. company allows in plan conversion to roth 401k (up to value in AT account), or convert in to external roth ira. in the latter case, i can only convert up to the contributions (110k) pro-rated by ratio of earnings and conversion. my company lets me do these once or twice a year. My company does not allow me to move money from ira to 401k.

i will be in 28 or 30% tax bracket in 2016 and i pay AMT.

options i have (as i understand)
1. in-plan rollover of all amount (140k) now: this is cleanest solution but has largest upfront taxes.
2. in-plan rollover, but wait until market dips to minimize taxes; obviously timing is uncertain; i may be in higher tax brackets next few years, so waiting has a risk
3. in-plan rollover in stages: i think this only makes sense (over #1 or #2) if the 30k earnings now will lead me to a different tax tranche, which i don’t believe is the case. not sure how AMT works though
4. convert to roth-ira; can only move up to 110k now. i can do these in multiple steps but it will take a while before all the money is converted. the longer it takes, the lower the benefit of converting to roth (less time for the money to grow tax free)
5. move earnings to t-ira, contributions to roth ira; messes up backdoor roth. if i want to continue to do backdoor roth, it seems this is no different than #3 from a tax perspective

I would like to minimize my taxes, and also minimize hassles. from a hassle point of view, in-plan rollover seems more favorable. On paper, #2 is most favorable from a tax stand-point. given that may tax rate will go up for the next few years, i am thinking of waiting until the end of the year until the market dips and going with #2

Any suggestions if that is a good approach? should i engage a financial or tax advisor in evaluating these options? am i missing something?

thanks in advance
Last edited by sg77 on Thu Aug 04, 2016 9:57 pm, edited 1 time in total.

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Re: taxes with megabackdoor roth

Postby LadyGeek » Thu Aug 04, 2016 9:38 pm

This thread is now in the Personal Finance (Not Investing) forum (taxes).
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Re: taxes with megabackdoor roth

Postby jane1 » Thu Aug 04, 2016 9:51 pm

You might want to assign a number to the options since you refer to them as #2, etc...

Why not just move 110k to Roth? Rest including any earnings are no different from a regular 401k or TIRA. Why pay 28-31% tax now vs potentially 15% (or even 28-31%) upon retirement. If you expect tax rate >31% upon retirement only then it may make sense (financially).
Assuming the 401k plan allows only contributions to be moved.

Edit: Or if not allowed, you can do #5 and then move back T-IRA to 401k if you want to do backdoor Roth. Of course, that is a hassle
Last edited by jane1 on Thu Aug 04, 2016 10:03 pm, edited 1 time in total.

sg77
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Re: taxes with megabackdoor roth

Postby sg77 » Thu Aug 04, 2016 10:01 pm

thanks for pointing out that i missed numbering the options.

i dont think any plan allows for just the contributions to be selectively moved to Roth. I can move 110k to Roth, but (30/140*100) percent of that will be earnings, and will be taxed at 28-31%.

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Re: taxes with megabackdoor roth

Postby jane1 » Thu Aug 04, 2016 10:34 pm

How about do #5 and then move back T-IRA to 401k if you want to do backdoor Roth. But then it doesn't take care of hassle factor.

sg77
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Re: taxes with megabackdoor roth

Postby sg77 » Thu Aug 04, 2016 10:57 pm

i dont believe my employer lets me move ira in to 401k

panhead
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Re: taxes with megabackdoor roth

Postby panhead » Fri Aug 05, 2016 8:37 am

How much does your employer allow you to put in the after-tax 401k sub-account every year?
If it's up to the maximum 401k amount, it's probably somewhere between 25-34k, depending on how much your employer contributes to your 401k. If this is the case, I would forget about the backdoor ($5500) Roth IRA and just focus on the Mega. If you are able to max out your mega each year, the extra $5500 is less important, and can be saved in a taxable account instead.

So, in your shoes, I would max out the mega backdoor 401k (after tax subaccount) each year. Once a year I would roll over the contributions to a Roth IRA and the earnings to a rollover tIRA and pay no taxes. On a low income year, you could always convert some of the rollover tIRA to your Roth.

(edited for clarification)

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Re: taxes with megabackdoor roth

Postby retiredjg » Fri Aug 05, 2016 8:52 am

sg77 wrote:i dont believe my employer lets me move ira in to 401k

In this case "don't believe" and "know" is an important distinction. Most 401k plans allow in-bound rollovers from IRA. A few don't. Make sure you know exactly what your plan allows.

Are you going to be at this company a very long time?

How much are you allowed to put into the after-tax account each year?

I'm thinking like panhead. Go ahead and max the mega back door (going to Roth IRA, not Roth 401k), forget about regular back door, when you move then roll your tIRA into the new 401k and start the back door again.

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Earl Lemongrab
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Re: taxes with megabackdoor roth

Postby Earl Lemongrab » Fri Aug 05, 2016 10:50 am

I question #4 there. Why can you only move 110k combination of after-tax and earnings? Are you sure that you aren't allowed to roll over the entire 110k of after-tax, in which case all of the earnings would come along as well?

That would allow you to split the rollover and have all 110k in a Roth IRA. Yes, it would prevent backdoor Roth (and do as Retiredjg suggests and find out for sure on roll back) but that's small potatoes compared to the large tax hit of the earnings conversion or having the 100k in tax-deferred generating new earnings.

Earl
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Re: taxes with megabackdoor roth

Postby retiredjg » Fri Aug 05, 2016 3:04 pm

Earl Lemongrab wrote:I question #4 there. Why can you only move 110k combination of after-tax and earnings? Are you sure that you aren't allowed to roll over the entire 110k of after-tax, in which case all of the earnings would come along as well?

I wondered about that as well. Different plans are allowed to have different rules, but this one seems odd to me. I did wonder if this was a misunderstanding.

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Re: taxes with megabackdoor roth

Postby panhead » Fri Aug 05, 2016 3:21 pm

retiredjg wrote:
Earl Lemongrab wrote:I question #4 there. Why can you only move 110k combination of after-tax and earnings? Are you sure that you aren't allowed to roll over the entire 110k of after-tax, in which case all of the earnings would come along as well?

I wondered about that as well. Different plans are allowed to have different rules, but this one seems odd to me. I did wonder if this was a misunderstanding.


Yeah, I agree. My understanding is that when this mega-backdoor thing works correctly, the after-tax contributions and the earnings on those contributions come out together. As I understand it, this always has to happen. I think the OP needs to verify this, and/or his(her) understanding of this.

Also, the OP needs to verify that a roll-in to the employer 401k is not allowed. I've heard some employer plans do not allow this, but this has never been the case for me. This would allow the backdoor Roth IRA, though I don't think this is much of a big deal considering access to the Mega-backdoor Roth.

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Re: taxes with megabackdoor roth

Postby celia » Fri Aug 05, 2016 3:26 pm

sg77 wrote:140k in value in after tax 401k, 110k of which is in contributions. company allows in plan conversion to roth 401k (up to value in AT account), or convert in to external roth ira. in the latter case, i can only convert up to the contributions (110k) pro-rated by ratio of earnings and conversion. my company lets me do these once or twice a year. My company does not allow me to move money from ira to 401k.

What is the difference between an after-tax 401k and a Roth 401k?
Does the after-tax account mean only the contributions are tax-free on withdrawal while in the Roth, the whole thing is tax-free on withdrawal?
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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Earl Lemongrab
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Re: taxes with megabackdoor roth

Postby Earl Lemongrab » Fri Aug 05, 2016 3:42 pm

celia wrote:What is the difference between an after-tax 401k and a Roth 401k?
Does the after-tax account mean only the contributions are tax-free on withdrawal while in the Roth, the whole thing is tax-free on withdrawal?

Yes. The important feature is that the after-tax contributions are not part of the 18k limit. So you can add these in addition to your regular deferrals or Roth contributions. And if the plan allows in-plan Roth conversion or rollovers out to a Roth IRA, it's a way to pump up your Roth savings. If you search on the phrase in the title, you'll find some long threads about it.

This is probably the single most important thing I read on this web site!

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Re: taxes with megabackdoor roth

Postby retiredjg » Fri Aug 05, 2016 4:08 pm

celia wrote:What is the difference between an after-tax 401k and a Roth 401k?
Does the after-tax account mean only the contributions are tax-free on withdrawal while in the Roth, the whole thing is tax-free on withdrawal?

To add Lemongrabs comment, the after tax sub account is in that space that is "above" the $18k elective deferral limit. In that space that currently goes up to $53k, there can be employer match, forfeitures, and the employee's after-tax contributions.

Not all plans offer this after-tax (aka "employee contribution") option. Many that do also allow in-service distributions of the after tax sub-account out to Roth IRA or Roth and tIRA (where the earnings would go because the earnings are pre-tax).

For those who have it who also have the ability to save that much, this is a way to get lot of money into Roth IRA instead of into taxable.

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Re: taxes with megabackdoor roth

Postby sg77 » Sat Aug 06, 2016 12:17 am

Thanks to all of you for replying to my post. I did verify that I cannot roll-over (or whatever the term is) an IRA in to my 401K. I have also checked with the 401k administrator that I can only withdraw up to the contribution amount to roll it over to an IRA (110k in my case).

panhead wrote:
retiredjg wrote:
Earl Lemongrab wrote:I question #4 there. Why can you only move 110k combination of after-tax and earnings? Are you sure that you aren't allowed to roll over the entire 110k of after-tax, in which case all of the earnings would come along as well?

I wondered about that as well. Different plans are allowed to have different rules, but this one seems odd to me. I did wonder if this was a misunderstanding.


Yeah, I agree. My understanding is that when this mega-backdoor thing works correctly, the after-tax contributions and the earnings on those contributions come out together. As I understand it, this always has to happen. I think the OP needs to verify this, and/or his(her) understanding of this.

Also, the OP needs to verify that a roll-in to the employer 401k is not allowed. I've heard some employer plans do not allow this, but this has never been the case for me. This would allow the backdoor Roth IRA, though I don't think this is much of a big deal considering access to the Mega-backdoor Roth.


All of your comments did get me to think about the trade-off between option #1 and #5. with #1 I have to pay ~10k upfront taxes but can invest 5500 in roth ira every year. with option #5, i can instead invest the 10k in a taxable account and $5500 in a taxable account every year.

assuming a growth rate of 7% annually, 15% LTCG, and a 20 yr horizon, it seems that the extra tax due to LTCG on the $5500 investment (vs Roth) is too small (~$2.3K) compared to the after tax value of the 10k investment in taxable account ($~34k). I will have to take the benefit of the Roth for 15 years to make the two match. #5 seems more attractive in that sense

So assuming i go with #5, here is a follow up question: i added non-deductible money to my tIRA for 2015 with the intent of using hte backdoor. that money has not been converted to Roth IRA. my plan was to do that conversion this year. if i do the backdoor today, and execute #5 later in the year, will I owe any taxes due to the backdoor. in other words, does the pro-rata rule on the tIRA->roth IRA conversion (for backdoor) apply at the moment of conversion, or based on some average across the year?

thanks in advance

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Re: taxes with megabackdoor roth

Postby retiredjg » Sat Aug 06, 2016 6:34 am

sg77 wrote:i added non-deductible money to my tIRA for 2015 with the intent of using hte backdoor. that money has not been converted to Roth IRA. my plan was to do that conversion this year. if i do the backdoor today, and execute #5 later in the year, will I owe any taxes due to the backdoor. in other words, does the pro-rata rule on the tIRA->roth IRA conversion (for backdoor) apply at the moment of conversion, or based on some average across the year?

Pro-rating occurs based on what is in your IRA accounts on 12/31 of the year in which you do a Roth conversion. If you finish your back door in 2016 by doing the Roth conversion and also execute #5 before the end of 2016, it will mess up the back door because pro-rating will occur. Legal, but a hassle that most people want to avoid.

You have several choices.

    Finish the back door in 2016 and execute #5 in 2017 or later.

    Withdraw your 2015 back door contribution (if that is still possible) and execute #5 any time you want.

    Leave the non-deductible contribution in tIRA and carry the basis forward on Form 8606 (this is not a very attractive idea).

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Re: taxes with megabackdoor roth

Postby cherijoh » Sat Aug 06, 2016 8:13 am

sg77 wrote:
options i have (as i understand)
1. in-plan rollover of all amount (140k) now: this is cleanest solution but has largest upfront taxes.
2. in-plan rollover, but wait until market dips to minimize taxes; obviously timing is uncertain; i may be in higher tax brackets next few years, so waiting has a risk
3. in-plan rollover in stages: i think this only makes sense (over #1 or #2) if the 30k earnings now will lead me to a different tax tranche, which i don’t believe is the case. not sure how AMT works though
4. convert to roth-ira; can only move up to 110k now. i can do these in multiple steps but it will take a while before all the money is converted. the longer it takes, the lower the benefit of converting to roth (less time for the money to grow tax free)
5. move earnings to t-ira, contributions to roth ira; messes up backdoor roth. if i want to continue to do backdoor roth, it seems this is no different than #3 from a tax perspective


The issue as I see it is that you have been making after-tax contributions without rolling them out to a Roth IRA. So now you have a backlog of contributions that have significant earnings. The longer you leave your after-tax contributions in the account, the longer the whole sum will have the potential to generate earnings!

Have you been maxing out both the Mega backdoor Roth and the standard back door Roth? If not, I would recommend option #5 and stopping the Back door Roth. Then you could deal with converting your traditional IRA gradually on your own time schedule - or wait until there is a dip in the market. You might want to do #5 even if you continue with the backdoor Roth.

You are right that it is probably a wash for THIS year, but IMO you are neglecting the impact in future years. The main advantage of option #5 over options #2, 3, or 4 is now you have a clean after-tax account. You can now start making contributions and then pulling them out in a timely fashion before they generate additional income. Earnings will be based on the new contributions only - not the previous x years of contributions plus the new contributions.

The main advantage of #5 over #1 (which also cleans out your after-tax account) is that you get to control when you pay the taxes on the earnings.

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Re: taxes with megabackdoor roth

Postby Earl Lemongrab » Sat Aug 06, 2016 9:32 am

sg77 wrote:Thanks to all of you for replying to my post. I did verify that I cannot roll-over (or whatever the term is) an IRA in to my 401K. I have also checked with the 401k administrator that I can only withdraw up to the contribution amount to roll it over to an IRA (110k in my case).

I suspect that they aren't explaining it correctly. I think you probably can withdraw all of the after-tax contributions (110k) which will also bring the appropriate share of earnings in addition. The actual rollover would be larger.

If you haven't already, ask for a Summary Plan Description. The rules should be explained in there. You might find that the people you are talking to don't actually know the rules.

Earl
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Re: taxes with megabackdoor roth

Postby panhead » Sat Aug 06, 2016 11:15 am

Earl Lemongrab wrote:
sg77 wrote:Thanks to all of you for replying to my post. I did verify that I cannot roll-over (or whatever the term is) an IRA in to my 401K. I have also checked with the 401k administrator that I can only withdraw up to the contribution amount to roll it over to an IRA (110k in my case).

I suspect that they aren't explaining it correctly. I think you probably can withdraw all of the after-tax contributions (110k) which will also bring the appropriate share of earnings in addition. The actual rollover would be larger.

If you haven't already, ask for a Summary Plan Description. The rules should be explained in there. You might find that the people you are talking to don't actually know the rules.

Earl


Yes, I have to believe this is true. As I understand it (I'm not an expert) when you withdraw the after-tax contributions from the sub-account, the earnings *must* come with it. There is the "IRS relents" thread where Alan S explains this in detail. The cool thing is after the IRS notice, your 401k administrator can issue 2 separate checks, 1 with just the contributions which goes to your Roth, and one with just the earnings that goes right to your rolllover tIRA.

As for the OPs non-deductible IRA, assuming its the only non-Roth IRA you have, I would likely do the conversion to a Roth and do the Mega-backdoor 401k in January of 2017. As retiredjg said, the pro-rata rule looks at your IRA balances as of 12/31, so if you do the mega after that, you should be good.

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Re: taxes with megabackdoor roth

Postby retiredjg » Sat Aug 06, 2016 11:27 am

I believe these plans are allowed to limit withdrawals as they see fit. It is entirely possible that the people who made the plan decided to not allow a full withdrawal.

I suppose a person could just put in a request to distribute the entire thing and see what happens. Reading the plan documents can be helpful when it is the clerk in HR making the mistake.

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Re: taxes with megabackdoor roth

Postby sg77 » Sat Aug 06, 2016 2:39 pm

Earl Lemongrab wrote:
sg77 wrote:Thanks to all of you for replying to my post. I did verify that I cannot roll-over (or whatever the term is) an IRA in to my 401K. I have also checked with the 401k administrator that I can only withdraw up to the contribution amount to roll it over to an IRA (110k in my case).

I suspect that they aren't explaining it correctly. I think you probably can withdraw all of the after-tax contributions (110k) which will also bring the appropriate share of earnings in addition. The actual rollover would be larger.

If you haven't already, ask for a Summary Plan Description. The rules should be explained in there. You might find that the people you are talking to don't actually know the rules.

Earl


I will check the SPD tonight and get back. but based on verbal communications, i understand that i can withdraw up to the contribution amount. the withdrawal will consist of pro-rated amount of contributions and earnings.

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Re: taxes with megabackdoor roth

Postby sg77 » Sat Aug 06, 2016 2:47 pm

panhead wrote:
Earl Lemongrab wrote:
sg77 wrote:Thanks to all of you for replying to my post. I did verify that I cannot roll-over (or whatever the term is) an IRA in to my 401K. I have also checked with the 401k administrator that I can only withdraw up to the contribution amount to roll it over to an IRA (110k in my case).

I suspect that they aren't explaining it correctly. I think you probably can withdraw all of the after-tax contributions (110k) which will also bring the appropriate share of earnings in addition. The actual rollover would be larger.

If you haven't already, ask for a Summary Plan Description. The rules should be explained in there. You might find that the people you are talking to don't actually know the rules.

Earl


Yes, I have to believe this is true. As I understand it (I'm not an expert) when you withdraw the after-tax contributions from the sub-account, the earnings *must* come with it. There is the "IRS relents" thread where Alan S explains this in detail. The cool thing is after the IRS notice, your 401k administrator can issue 2 separate checks, 1 with just the contributions which goes to your Roth, and one with just the earnings that goes right to your rolllover tIRA.

As for the OPs non-deductible IRA, assuming its the only non-Roth IRA you have, I would likely do the conversion to a Roth and do the Mega-backdoor 401k in January of 2017. As retiredjg said, the pro-rata rule looks at your IRA balances as of 12/31, so if you do the mega after that, you should be good.


Yes, based on these conversations I am inclined to go with #5 and execute in Jan 2017. In addition to the 5.5k non-deductible contribution for 2015 that i currently have in my tIRA, I intend to do the same for 2016 before year end, and convert all 11k to roth ira before year end. i assume that there will be not tax obligations as a result of this given that the megabackdoor will happen next year. right? i will have no earnings on my 11k non-deductible contributions by year end.
thanks

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Re: taxes with megabackdoor roth

Postby retiredjg » Sat Aug 06, 2016 7:50 pm

If there are no earnings and you don't have another IRA (including SEP IRA or SIMPLE IRA), there should be no tax due.

Getting in one last year, another $5,500, is a good idea.

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Re: taxes with megabackdoor roth

Postby sg77 » Mon Aug 08, 2016 9:17 pm

following up on the backdoor roth. so my Vanguard tIRA account now has my 2016 non-deductible (contributed Aug 2016) and 2015 non-deductible (contributed Feb 2016) contributions. i plan to convert all 11k to Roth IRA this year, and then do the megabackdoor Jan 2017. based on what i have heard on this thread, i shouldnt have any major tax implications due to the backdoor (i have ~10$ in earnings on the 2015 non-deductible contributions). right?

now a slightly different question: for reasons not mentioned here, i am considering (not sure yet) just going ahead and doing the megabackdoor this year. in that case, can i undo my 2015 and 2016 non-deductible contributions (before doing the megabackdoor) without paying any kind of penalty?
thanks
Last edited by sg77 on Mon Aug 08, 2016 10:09 pm, edited 1 time in total.

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Re: taxes with megabackdoor roth

Postby LadyGeek » Mon Aug 08, 2016 9:30 pm

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Re: taxes with megabackdoor roth

Postby sg77 » Mon Aug 08, 2016 10:09 pm

Understood. edited the post above.

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Re: taxes with megabackdoor roth

Postby retiredjg » Tue Aug 09, 2016 6:19 am

sg77 wrote:following up on the backdoor roth. so my Vanguard tIRA account now has my 2016 non-deductible (contributed Aug 2016) and 2015 non-deductible (contributed Feb 2016) contributions. i plan to convert all 11k to Roth IRA this year, and then do the megabackdoor Jan 2017. based on what i have heard on this thread, i shouldnt have any major tax implications due to the backdoor (i have ~10$ in earnings on the 2015 non-deductible contributions). right?

That appears to be correct.

now a slightly different question: for reasons not mentioned here, i am considering (not sure yet) just going ahead and doing the megabackdoor this year. in that case, can i undo my 2015 and 2016 non-deductible contributions (before doing the megabackdoor) without paying any kind of penalty?
thanks

You can undo the 2016 contribution. I am not sure what you can do about the 2015 contribution. I think it can be undone, but I'm not sure about the paperwork.

You do have the option of leaving those contributions in place and carrying the basis forward. This is what I described as a not very attractive option above. As an example, your tIRA contains about $11k basis right now (basis is money that has already been taxed) and about $10 earnings. Maybe if you execute the mega back door rollover distribution, it would contain the $11k basis and $9,010k in earnings and other untaxed money.

As long as you keep the paperwork that documents the basis (Form 8606 - you did do one for the 2015 contribution, right?) you won't pay tax on that money a second time as the money is withdrawn. Each withdrawal will be pro-rated - some taxed, some not.

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Re: taxes with megabackdoor roth

Postby sg77 » Sun Mar 19, 2017 10:46 pm

so i did execute my plan, though i did not convert the entire amount i am allowed to. since i was doing this for the first time, i converted a smaller amount (~20k which includes 25% earnings, 75% contributions). the earnings check went to my T-ira, and the contributions check went to my roth-ira.

i will do a similar conversion later in the year to convert whatever else (~100k) i can convert this year. i am wondering if i need to take any specific steps before i do that (e.g. do i need to do something to track basis)?

appreciate your help

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Re: taxes with megabackdoor roth

Postby retiredjg » Mon Mar 20, 2017 8:00 am

You do need to keep records on how money gets into your Roth IRA. Direct contributions, conversions (taxable part and non-taxable part), back door contributions, rollovers, etc. can received different treatment if you withdraw any money from the Roth IRA before age 59.5 and the Roth IRA itself is 5 tax years old. So those records need to be kept until probably your middle 60's.

I don't think it has to be very fancy. I'd probably do it with pencil and paper, keeping that list over the years with all the 1099's and Forms 5498 and at least the last Form 8606. Some people do it with a spreadsheet.

If you were asking if you track basis on an IRS form like people use Form 8606 when using the "back door"....no, not for the mega back door.

Glad to hear it went smoothly. :happy

panhead
Posts: 131
Joined: Fri Feb 22, 2013 10:53 am

Re: taxes with megabackdoor roth

Postby panhead » Mon Mar 20, 2017 12:19 pm

+1 to what retiredjg said, you need to keep track of how the money got into the Roth.

Congratulations and welcome to the Mega Backdoor Roth IRA, truly one of the cooler things I've learned on this forum, and I'll say thanks again to AlanS who walked many of us first timers through it in detail.


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