Re-opening rollover IRA (after backdoor ROTH)

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Topic Author
gurusw
Posts: 208
Joined: Sun May 11, 2008 9:37 am

Re-opening rollover IRA (after backdoor ROTH)

Post by gurusw »

In the tax year 2018, I had done "Backdoor ROTH IRA" contributions. To do this procedure, I had followed advice from this wiki...
https://www.bogleheads.org/wiki/Backdoor_Roth
If you can transfer your pre-tax IRA funds to a solo 401(k), employer-sponsored 401k, or 403(b), then they will no longer be subject to taxation during the Roth conversion process.
and hence I had closed my existing traditional/rollover IRA accounts in that process. Since then I only have taxable, 401K and ROTH IRA accounts.

In the tax year 2019, my employer offered me choice of contributing to after-tax 401K, and hence it opened the choice of doing "Mega Backdoor ROTH IRA".
https://www.bogleheads.org/wiki/After-tax_401(k)
In Dec 2019, I did after-tax 401K to ROTH conversion. At the time of conversion, I had only $50 gains. I decided to pay taxes on the $50; and transferred all the after-tax 401K money to ROTH.

Now I am looking to repeat the same procedure for this year. However this time I have $2.5K of gains on the basis of $19.5K. I realized that my plan allows me to roll over the gains to rollover IRA account (and basis to ROTH). This will help me avoid taxes on $2.5K in this tax year.

Questions:
1. Given that I had closed my rollover IRA accounts in 2018 to do backdoor ROTH, is it ok to re-open them now? Or will it open a can of worms?
2. If (1) is ok to do, should I do it? Or is it better to pay taxes now; and have all the money grow tax-free in ROTH?

Thanks.
marcopolo
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by marcopolo »

gurusw wrote: Fri Nov 27, 2020 10:58 pm In the tax year 2018, I had done "Backdoor ROTH IRA" contributions. To do this procedure, I had followed advice from this wiki...
https://www.bogleheads.org/wiki/Backdoor_Roth
If you can transfer your pre-tax IRA funds to a solo 401(k), employer-sponsored 401k, or 403(b), then they will no longer be subject to taxation during the Roth conversion process.
and hence I had closed my existing traditional/rollover IRA accounts in that process. Since then I only have taxable, 401K and ROTH IRA accounts.

In the tax year 2019, my employer offered me choice of contributing to after-tax 401K, and hence it opened the choice of doing "Mega Backdoor ROTH IRA".
https://www.bogleheads.org/wiki/After-tax_401(k)
In Dec 2019, I did after-tax 401K to ROTH conversion. At the time of conversion, I had only $50 gains. I decided to pay taxes on the $50; and transferred all the after-tax 401K money to ROTH.

Now I am looking to repeat the same procedure for this year. However this time I have $2.5K of gains on the basis of $19.5K. I realized that my plan allows me to roll over the gains to rollover IRA account (and basis to ROTH). This will help me avoid taxes on $2.5K in this tax year.

Questions:
1. Given that I had closed my rollover IRA accounts in 2018 to do backdoor ROTH, is it ok to re-open them now? Or will it open a can of worms?
2. If (1) is ok to do, should I do it? Or is it better to pay taxes now; and have all the money grow tax-free in ROTH?

Thanks.
1) Account re-opening is probably specific to the brokerage, some may allow it others may not. The IRS does not care, they view all Trad IRA lumped together as a single entity, you can have lots of them, or just one, it is all treated as one aggregated account as far as the IRS is concerned.

2) Whether paying taxes on that part of the conversions is worth it or not depends on your current marginal tax rate and what you anticipate it to be when you would otherwise pull it out of the Trad IRA (presumably after you retire, or in low income year), If future marginal tax rates are likely to be the same or higher, then it may make sense to pre-pay the taxes now.


By the way, if you plan to do any backdoor Roth contributions in the future, having the $2.5k in the Trad (Rollover) IRA, will subject you to the pro-rata rules where a portion of your contributions will become taxable. If your plan allows it, one way to avoid this is to roll the Rollover IRA back into your 401k plan. This is a two step process:

1) Do a split rollover from 401k to Roth (Contributions) and Trad IRA (gains)
2) Roll the Trad IRA (gains) back into the 401k

This empties your Trad IRA, allowing you to avoid the pro-rata rules when doing backdoor Roth conversions in the future.
Once in a while you get shown the light, in the strangest of places if you look at it right.
HomeStretch
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by HomeStretch »

What is your marginal tax rate? It may be easier (and not too costly tax wise) to convert the $2,500 in earnings to a Roth IRA. This will allow you to continue doing backdoor Roths without being subject to pro-rated taxes.
MikeG62
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by MikeG62 »

gurusw wrote: Fri Nov 27, 2020 10:58 pm
...Given that I had closed my rollover IRA accounts in 2018 to do backdoor ROTH, is it ok to re-open them now? Or will it open a can of worms?
Opening another rollover IRA will not open a can of worms relative to your backdoor Roth's contributions you made in the past. Those are fine (assuming you followed the right procedures). Whether your broker will allow you to reopen the old rollover IRA's is a question for them. If not, just open a new one. It's really a six of one half dozen the other situation.
Real Knowledge Comes Only From Experience
Topic Author
gurusw
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by gurusw »

Thanks Mike, marcopolo and homestretch.

My RSU income has put me in 35% tax bracket this year. I am happy with all the money I am making, but the tax concerns are looming large in my mind. Since I never had this kinda income (aways in 22-24% bracket or its equivalent in previous years), I had not done any tax planning besides the general tips from this forum.

I will go with the rollover IRA for $2.5K. And yes, I will have to open a new TIRA I guess.
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anon_investor
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by anon_investor »

gurusw wrote: Sat Nov 28, 2020 6:50 pm Thanks Mike, marcopolo and homestretch.

My RSU income has put me in 35% tax bracket this year. I am happy with all the money I am making, but the tax concerns are looming large in my mind. Since I never had this kinda income (aways in 22-24% bracket or its equivalent in previous years), I had not done any tax planning besides the general tips from this forum.

I will go with the rollover IRA for $2.5K. And yes, I will have to open a new TIRA I guess.
You should just convert that $2.5k to Roth and make your life easier. If you are in the 35% tax bracket you make enough to afford the taxes to make your life easier.
teaman
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by teaman »

Yes, pay the taxes on $2500 now and keep it simple.
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celia
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by celia »

I would rather pay the taxes on $2,500 now than on $10,000 down the road, when it has grown or accumulated growth for multiple years.
marcopolo
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by marcopolo »

celia wrote: Mon Nov 30, 2020 12:30 am I would rather pay the taxes on $2,500 now than on $10,000 down the road, when it has grown or accumulated growth for multiple years.
Even if you were in the 35% tax bracket (as stated by OP), and might be in a significantly lower bracket next year, or multiple years down the road?
Once in a while you get shown the light, in the strangest of places if you look at it right.
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celia
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by celia »

marcopolo wrote: Mon Nov 30, 2020 2:46 am
celia wrote: Mon Nov 30, 2020 12:30 am I would rather pay the taxes on $2,500 now than on $10,000 down the road, when it has grown or accumulated growth for multiple years.
Even if you were in the 35% tax bracket (as stated by OP), and might be in a significantly lower bracket next year, or multiple years down the road?
Yes, because 35% of $2,500 is less than 22% (a low-ball tax rate for OP) of $10,000.
[ $875 < $2,200 ]

I doubt OP will ever be below a 8.75% tax rate.
marcopolo
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by marcopolo »

celia wrote: Mon Nov 30, 2020 6:18 pm
marcopolo wrote: Mon Nov 30, 2020 2:46 am
celia wrote: Mon Nov 30, 2020 12:30 am I would rather pay the taxes on $2,500 now than on $10,000 down the road, when it has grown or accumulated growth for multiple years.
Even if you were in the 35% tax bracket (as stated by OP), and might be in a significantly lower bracket next year, or multiple years down the road?
Yes, because 35% of $2,500 is less than 22% (a low-ball tax rate for OP) of $10,000.
[ $875 < $2,200 ]

I doubt OP will ever be below a 8.75% tax rate.
Oh boy, now i am starting to question all the (usually spot-on) Roth conversion advice you have posted in the past.
You do realize that this is not how to assess the benefit of doing a conversion, right?

Let's take a look:

Scenario 1: Do not convert, pay 22% tax in a number of years
Since you did not pay tax, you invest the entire $2500.
Let's say over a number of years, it grows to $10,000 (4x).
Now you withdraw, paying a 22% tax. So you pay $2200 in taxes. So, you are left with $7,800 after paying the taxes.

Scenario 2: Do the conversions, and pay taxes now at 35% tax rate.
After paying the $875 in taxes, you are left with $1625.
It grows by the same 4x, so you have $6,500.

I would rather have $7,800 after paying "more" taxes than to have $6,500 tax free.

You can improve the situation in Scenario #2 a little bit by paying the taxes out of your taxable account, but it will still not make up for the difference in tax rates.

Scenario 2a: Do the conversion, pay taxes out of a taxable account, so you can keep the full $2500 invested in the Roth.
Here you start with $2500, getting 4x return gives you $10,000 tax free, but you have to account for the money you took out of your taxable account to pay the taxes. That $875 would have grown to $3500, paying 15% cap gains, nets you $2,975. This is the money you gave up by paying the taxes out of taxable account. Subtracting that from the $10,000, you are left with a net of $7,025, still quite a bit less than the $7,800 you could get by NOT converting and paying taxes at lower rate later.

Roth Conversions definitely have their benefits in many situations, particularly when your future tax rates are likely to be equal or higher than they are when converting. They rarely make sense if you are in a high tax bracket and expect to be in a lower bracket later.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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celia
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by celia »

marcopolo wrote: Mon Nov 30, 2020 6:50 pm Oh boy, now i am starting to question all the (usually spot-on) Roth conversion advice you have posted in the past.
OK, Marco, I'll give you that one. But have you noticed any of my past comments saying that I think the dollar amount of the taxes paid is just as important as the marginal tax rate? In other words, if I have some available cash in taxable that is not earmarked for anything, I would just as soon spend it on Roth conversion taxes than anything else I might buy.

viewtopic.php?f=10&t=320645&p=5381956#p5381956
(see my comment under second quote box)

Along with this, I would want to be clearing out the rollover IRA each year in case I get the opportunity to do a backdoor Roth again.
marcopolo
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by marcopolo »

celia wrote: Mon Nov 30, 2020 7:08 pm
marcopolo wrote: Mon Nov 30, 2020 6:50 pm Oh boy, now i am starting to question all the (usually spot-on) Roth conversion advice you have posted in the past.
OK, Marco, I'll give you that one. But have you noticed any of my past comments saying that I think the dollar amount of the taxes paid is just as important as the marginal tax rate? In other words, if I have some available cash in taxable that is not earmarked for anything, I would just as soon spend it on Roth conversion taxes than anything else I might buy.

viewtopic.php?f=10&t=320645&p=5381956#p5381956
(see my comment under second quote box)

Along with this, I would want to be clearing out the rollover IRA each year in case I get the opportunity to do a backdoor Roth again.
I like the idea of clearing way for yearly backdoor, which is why I suggested rolling back the taxable dollars into the 401k, if allowed. I did that for a number of years to be able to do backdoor Roth. I was in a high tax bracket. I am now doing Roth conversions at a much lower tax rate.

I don't agree with your assessment of total dollars paid vs
tax rates. Unless one has some inate dislike of paying taxes, what should be more important is the after tax dollars one has available to spend. So, even if you end up paying more taxes in dollars (you are ignoring the time value of money), if you end up with more money in your pocket, I am OK with paying a higher dollar amount.

Reading you other response, I don't see the advantage of paying one's taxes earlier, especially if you are going to be paying more. Just like there are a number of things that could increase your taxes later, there are also many things that could lower them, especially if you are in a high tax bracket now.

I am doing some Roth Conversions now, would have never even considered doing them (pay taxes early as possible, as I think you are suggesting) while working because I was in a much higher tax bracket than I ever expect to be ever again. It would have just been throwing money away (giving it to the government for no good reason).
Once in a while you get shown the light, in the strangest of places if you look at it right.
Topic Author
gurusw
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Re: Re-opening rollover IRA (after backdoor ROTH)

Post by gurusw »

Marco, those were some eye-opening calculations for me. Thanks a lot for doing it.
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