Backdoor Roth IRA conversion - is my technique allowed?

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nik
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Backdoor Roth IRA conversion - is my technique allowed?

Post by nik » Thu Mar 16, 2017 12:05 pm

Hello Bogleheads,

I am relatively new to the world of investing.
Our total household income last year was over $200K,
so I read about backdoor Roth IRA and followed Morningstar's recommended
technique for Traditional to Roth IRA conversion.

Last October I opened a Traditional IRA account at Vanguard with $1500.
I kept it for 2 months and on December 2016 I converted the $1500(plus the gains) to a Roth IRA.

This February 2017 I put in $4000 more into the Roth IRA for the maximum
permitted amount of $5500 for the tax year 2016.

I am concerned if my Backdoor conversion was allowed - would it have been correct to put in
the entire $5500 into a tradition IRA and convert the amount to Roth IRA, rather than partial
conversion to Roth IRA and then funding the account for maximum allowed contribution.

Thank you!

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FiveK
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by FiveK » Thu Mar 16, 2017 2:38 pm

nik wrote:Our total household income last year was over $200K...This February 2017 I put in $4000 more into the Roth IRA for the maximum
permitted amount of $5500 for the tax year 2016.
The $1500 backdoor appears fine, but unless you contributed enough pre-tax to get your MAGI below ~$186,000 you don't meet the IRS requirements for making "front door" Roth contributions.

See Amount of Roth IRA Contributions That You Can Make for 2016 for more.

See also IRA recharacterization - Bogleheads for how you might change the disallowed Roth contribution to a non-deductible traditional one, which you can then put into the Roth via the back door.

Might be worthwhile to call the brokerage firm where these are held. Unlikely you are the first to be in this situation with them....

Alan S.
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by Alan S. » Thu Mar 16, 2017 10:48 pm

If your MAGI for regular Roth IRA contribution purposes is too high for the 4,000 Roth contribution, you can still recharacterize that contribution as a non deductible TIRA contribution and convert back to Roth. While you can do this, it would have been easier to have just contributed the entire 5500 to a TIRA as that would have eliminated the recharacterization step.

You would have a 2016 8606 reporting 5500 in non deductible contributions (assuming you cannot or do not deduct it) and a 1500 conversion.
You would also need a 2017 8606 to report the 4000 conversion, since that conversion was done in a different year.

Note that "household income" is a general term and unlikely to reflect the actual amount of modified AGI for Roth contribution purposes. There is a worksheet in Pub 590A that allows you to arrive at your exact MAGI. It may turn out that you do not need to recharacterize after all if your MAGI drops under 184k.

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celia
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by celia » Fri Mar 17, 2017 12:24 am

With your higher income, it is probably better if you make all future contributions into a traditional IRA and report the contributions as non-deductible. (If you haven't done this for the two 2016 contributions, you need to fix it before doing further contributions that will make things messier.) This also assumes you don't own any other non-Roth IRAs (which would make conversions be partly taxable).

If the primary question is if you can do your backdoor contribution in pieces, say split into 2 or more times a year, the answer is YES. However, you should convert each non-deductible traditional IRA contribution within a few days of making the contribution. If it stays in the traditional IRA too long (such as if you were to wait until the whole $5,500 was contributed), there could be growth on the early contributions. The growth part will be taxed when you convert. It is better if you get the growth to happen in the Roth.

nik
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Joined: Thu Mar 16, 2017 11:02 am

Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by nik » Mon Mar 20, 2017 3:04 pm

FiveK wrote:
nik wrote:Our total household income last year was over $200K...This February 2017 I put in $4000 more into the Roth IRA for the maximum
permitted amount of $5500 for the tax year 2016.
The $1500 backdoor appears fine, but unless you contributed enough pre-tax to get your MAGI below ~$186,000 you don't meet the IRS requirements for making "front door" Roth contributions.

See Amount of Roth IRA Contributions That You Can Make for 2016 for more.

See also IRA recharacterization - Bogleheads for how you might change the disallowed Roth contribution to a non-deductible traditional one, which you can then put into the Roth via the back door.

Might be worthwhile to call the brokerage firm where these are held. Unlikely you are the first to be in this situation with them....


I will read up on the recharacterization, thank you for the link. I will call up Vanguard first to discuss my situation and see if they have any input.

nik
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Joined: Thu Mar 16, 2017 11:02 am

Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by nik » Mon Mar 20, 2017 3:08 pm

Alan S. wrote:If your MAGI for regular Roth IRA contribution purposes is too high for the 4,000 Roth contribution, you can still recharacterize that contribution as a non deductible TIRA contribution and convert back to Roth. While you can do this, it would have been easier to have just contributed the entire 5500 to a TIRA as that would have eliminated the recharacterization step.

You would have a 2016 8606 reporting 5500 in non deductible contributions (assuming you cannot or do not deduct it) and a 1500 conversion.
You would also need a 2017 8606 to report the 4000 conversion, since that conversion was done in a different year.

Note that "household income" is a general term and unlikely to reflect the actual amount of modified AGI for Roth contribution purposes. There is a worksheet in Pub 590A that allows you to arrive at your exact MAGI. It may turn out that you do not need to recharacterize after all if your MAGI drops under 184k.


Thank you for the worksheet, I took a look and since we don't have too many deductions and have capital gains from some stocks we sold last year, our MAGI might be above 184k. I will also make sure for the next tax year to make the full 5500 contribution and conversion in the same year.

nik
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by nik » Mon Mar 20, 2017 3:13 pm

celia wrote:With your higher income, it is probably better if you make all future contributions into a traditional IRA and report the contributions as non-deductible. (If you haven't done this for the two 2016 contributions, you need to fix it before doing further contributions that will make things messier.) This also assumes you don't own any other non-Roth IRAs (which would make conversions be partly taxable).

If the primary question is if you can do your backdoor contribution in pieces, say split into 2 or more times a year, the answer is YES. However, you should convert each non-deductible traditional IRA contribution within a few days of making the contribution. If it stays in the traditional IRA too long (such as if you were to wait until the whole $5,500 was contributed), there could be growth on the early contributions. The growth part will be taxed when you convert. It is better if you get the growth to happen in the Roth.


Thank you for your input. My understanding was that although Roth IRA is not tax deductible, the growth will be tax free and RMDs will not apply on Roth IRAs. What would be the value of having a Tradition IRA for higher income ? I was trying to follow Morningstar's recommendation- to keep Traditional IRA for a few months, pay tax on any gains so that it doesn't appear your intent was to immediately convert it into Roth IRA.

The Wizard
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by The Wizard » Mon Mar 20, 2017 3:25 pm

nik wrote: ...I was trying to follow Morningstar's recommendation- to keep Traditional IRA for a few months, pay tax on any gains so that it doesn't appear your intent was to immediately convert it into Roth IRA.

We've discussed this in other threads.
It's perfectly legal​ to contribute $5500 to your empty tIRA on Tuesday and then convert it to Roth on Wednesday.
No subterfuge is needed.

Now if you don't have the entire $5500 easily available at the start, then taking a few weeks or months to max your tIRA contribs is fine too...
Attempted new signature...

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FiveK
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by FiveK » Mon Mar 20, 2017 3:46 pm

The Wizard wrote:
nik wrote: ...I was trying to follow Morningstar's recommendation- to keep Traditional IRA for a few months, pay tax on any gains so that it doesn't appear your intent was to immediately convert it into Roth IRA.

We've discussed this in other threads.
It's perfectly legal​ to contribute $5500 to your empty tIRA on Tuesday and then convert it to Roth on Wednesday.
No subterfuge is needed.

Now if you don't have the entire $5500 easily available at the start, then taking a few weeks or months to max your tIRA contribs is fine too...
+1

For one recent thread, see More support for backdoor Roth? [Roth IRA Decision reversing Tax Court] - Bogleheads.org

nik
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by nik » Mon Mar 20, 2017 4:23 pm

The Wizard wrote:We've discussed this in other threads.
It's perfectly legal​ to contribute $5500 to your empty tIRA on Tuesday and then convert it to Roth on Wednesday.
No subterfuge is needed.

Now if you don't have the entire $5500 easily available at the start, then taking a few weeks or months to max your tIRA contribs is fine too...


Ah, glad to know I do not have to wait, thank you for the information!

nik
Posts: 12
Joined: Thu Mar 16, 2017 11:02 am

Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by nik » Mon Mar 20, 2017 4:24 pm

FiveK wrote:
The Wizard wrote:
nik wrote: ...I was trying to follow Morningstar's recommendation- to keep Traditional IRA for a few months, pay tax on any gains so that it doesn't appear your intent was to immediately convert it into Roth IRA.

We've discussed this in other threads.
It's perfectly legal​ to contribute $5500 to your empty tIRA on Tuesday and then convert it to Roth on Wednesday.
No subterfuge is needed.

Now if you don't have the entire $5500 easily available at the start, then taking a few weeks or months to max your tIRA contribs is fine too...
+1

For one recent thread, see More support for backdoor Roth? [Roth IRA Decision reversing Tax Court] - Bogleheads.org


Thank you for the link to the thread!

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celia
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by celia » Tue Mar 21, 2017 4:41 pm

nik wrote:What would be the value of having a Tradition IRA for higher income ? I was trying to follow Morningstar's recommendation- to keep Traditional IRA for a few months, pay tax on any gains so that it doesn't appear your intent was to immediately convert it into Roth IRA.

The value of contributing to a traditional IRA for higher income individuals, is that it is part of the method to get money into a Roth (when direct contributions start phasing out for Married Filing Jointly at taxable income of $184K and Singles at $117K (for 2016)).

Every wage earner is eligible to make a "backdoor Roth contribution" which is a 2-stage process in which you first make a non-deductible contribution to a traditional IRA, then convert it tax-free to Roth (but the growth will be taxed). Morningstar and others warn that the IRS could crack down on this since it "violates" the intent of who can contribute to a Roth directly. But since many, many people do this already and have been doing it for ages, I don't see how the IRS can stop it unless the law is changed. (Morningstar and others are suggesting to not make it so obvious that you are really putting money into a Roth. They think if you let the money "age" in the tIRA first, it won't be so obvious.)
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.

nik
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Re: Backdoor Roth IRA conversion - is my technique allowed?

Post by nik » Fri Mar 24, 2017 8:06 am

celia wrote:
nik wrote:What would be the value of having a Tradition IRA for higher income ? I was trying to follow Morningstar's recommendation- to keep Traditional IRA for a few months, pay tax on any gains so that it doesn't appear your intent was to immediately convert it into Roth IRA.
The value of contributing to a traditional IRA for higher income individuals, is that it is part of the method to get money into a Roth (when direct contributions start phasing out for Married Filing Jointly at taxable income of $184K and Singles at $117K (for 2016)).

Every wage earner is eligible to make a "backdoor Roth contribution" which is a 2-stage process in which you first make a non-deductible contribution to a traditional IRA, then convert it tax-free to Roth (but the growth will be taxed). Morningstar and others warn that the IRS could crack down on this since it "violates" the intent of who can contribute to a Roth directly. But since many, many people do this already and have been doing it for ages, I don't see how the IRS can stop it unless the law is changed. (Morningstar and others are suggesting to not make it so obvious that you are really putting money into a Roth. They think if you let the money "age" in the tIRA first, it won't be so obvious.)
Thank you for the clarifications!

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