Reasoning behind Backdoor Roth IRA

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PaulAtreides
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Reasoning behind Backdoor Roth IRA

Post by PaulAtreides » Fri Jan 12, 2018 5:07 pm

Hello,

I am trying to understand the reasoning behind not allowing high income earners contribute to a Roth IRA directly, even though they still can do a backdoor ROTH. Why the workaround in the first place?

High income earners can't deduct the traditional contributions anyway, so why can't they just contribute to a ROTH directly after tax instead of having to convert and jump through another process. Tax has already been paid on the contributions.

2 scenarios with same outcome:
Take $5,500 put into a Traditional, don't deduct, convert to ROTH right away. End up with ROTH.
Take $5,500 contribute to ROTH.

I guess this works better for brand new IRA accounts with not much gains and no deductions.

They are still getting a ROTH contribution in the end with conversion, which is allowed.

Maybe I am missing something.

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FiveK
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Re: Reasoning behind Backdoor Roth IRA

Post by FiveK » Fri Jan 12, 2018 5:17 pm

PaulAtreides wrote:
Fri Jan 12, 2018 5:07 pm
I am trying to understand the reasoning behind not allowing high income earners contribute to a Roth IRA directly, even though they still can do a backdoor ROTH. Why the workaround in the first place?
In short, politics and the wonders of the legislative process. See Roth IRA - Wikipedia for more.

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obafgkm
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Re: Reasoning behind Backdoor Roth IRA

Post by obafgkm » Fri Jan 12, 2018 5:22 pm

FiveK wrote:
Fri Jan 12, 2018 5:17 pm
In short, politics and the wonders of the legislative process. See Roth IRA - Wikipedia for more.
Could you give it to us in long? The Wikipedia article does not seem (to me) to tell why it is allowed.

TravelforFun
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Re: Reasoning behind Backdoor Roth IRA

Post by TravelforFun » Fri Jan 12, 2018 5:22 pm

PaulAtreides wrote:
Fri Jan 12, 2018 5:07 pm
Hello,

I am trying to understand the reasoning behind not allowing high income earners contribute to a Roth IRA directly, even though they still can do a backdoor ROTH. Why the workaround in the first place?

High income earners can't deduct the traditional contributions anyway, so why can't they just contribute to a ROTH directly after tax instead of having to convert and jump through another process. Tax has already been paid on the contributions.

2 scenarios with same outcome:
Take $5,500 put into a Traditional, don't deduct, convert to ROTH right away. End up with ROTH.
Take $5,500 contribute to ROTH.

I guess this works better for brand new IRA accounts with not much gains and no deductions.

They are still getting a ROTH contribution in the end with conversion, which is allowed.

Maybe I am missing something.
Yes it's ludicrous! The government ought to let high-income people contribute to Roth and pay the highest marginal tax rate.

TravelforFun

sailaway
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Re: Reasoning behind Backdoor Roth IRA

Post by sailaway » Fri Jan 12, 2018 5:26 pm

obafgkm wrote:
Fri Jan 12, 2018 5:22 pm
FiveK wrote:
Fri Jan 12, 2018 5:17 pm
In short, politics and the wonders of the legislative process. See Roth IRA - Wikipedia for more.
Could you give it to us in long? The Wikipedia article does not seem (to me) to tell why it is allowed.
Because it was not written as one coherent piece of legislation, mostly.

Katietsu
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Re: Reasoning behind Backdoor Roth IRA

Post by Katietsu » Fri Jan 12, 2018 5:34 pm

I am not suggesting that I have any insight into how the legislation ended up as is. However, at the time the law was changed most conversions resulted in a boost in income tax collections. There are still a lot of us affected by the pro rata rule who can not do the tax free backdoor Roth.

mhalley
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Re: Reasoning behind Backdoor Roth IRA

Post by mhalley » Fri Jan 12, 2018 5:34 pm

In 2010 I believe They removed the income limit on Roth IRA conversions but did not remove the limit on Roth contributions. If you are expecting for tax laws to make sense, then you have too high of an expectation. I imagine they did it to get some immediate tax revenue.

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FiveK
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Re: Reasoning behind Backdoor Roth IRA

Post by FiveK » Fri Jan 12, 2018 5:46 pm

obafgkm wrote:
Fri Jan 12, 2018 5:22 pm
FiveK wrote:
Fri Jan 12, 2018 5:17 pm
In short, politics and the wonders of the legislative process. See Roth IRA - Wikipedia for more.
Could you give it to us in long? The Wikipedia article does not seem (to me) to tell why it is allowed.
Here is a longer, but still short, history of the backdoor Roth.

The Wizard
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Re: Reasoning behind Backdoor Roth IRA

Post by The Wizard » Fri Jan 12, 2018 5:50 pm

One might also note that contributions to a tIRA are not allowed at age 70 or beyond, for people who still have earned income at that point.
Direct contributions to a Roth IRA are allowed at any age, provided one has earned income with AGI less than the limit.

This means that folks age 70 and beyond are ineligible for backdoor Roth contributions...
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Alan S.
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Re: Reasoning behind Backdoor Roth IRA

Post by Alan S. » Fri Jan 12, 2018 7:35 pm

Many of these provisions are affected by the 10 year budgeting process for tax related legislation. Since generated tax revenue over 10 years is used to "pay for" other provisions that reduce such revenue, budgeting often takes priority over sound tax policy.

FYI - Today's Morningstar article by IRA guru Natalie Choate indicates that she considers the conference committee's comments on the back door Roth to be an official blessing of the practice.
More good news: Though not part of the law itself, the conference committee's explanatory statement of the law explicitly blesses a popular technique that some had questioned, namely, the "back-door Roth contribution." An individual who is younger than 70 1/2 and who has compensation income, but whose adjusted gross income is too high to permit her to make an annual-type contribution to a Roth IRA, can instead make her annual contribution to a traditional IRA, then convert that traditional IRA to a Roth (because there is no income limit applicable to conversions). Some had questioned the legality of such an indirect Roth IRA contribution, saying it might be illegal under the "step transaction doctrine." The conference committee definitively answers that question: Back-door Roth contributions are legal. The explanatory statement states (four times!) that an individual who is legally permitted to contribute to a traditional IRA can contribute to a traditional IRA then convert the account to a Roth--under the prior law and the new one. This should put an end to skepticism about back-door Roth contributions.
Therefore, the step transaction concern can be put to rest and there is no reason for ANY waiting period before the conversion is done. However, you should still have a mental waiting period to make darn sure that you will NOT have a pre tax TIRA balance at the end of the year that will make the conversion taxable - since such conversions can no longer be recharacterized. This does not apply to those who actually SHOULD be converting some pre tax money because they are able to do so at a rate less than they expect to pay in retirement on RMDs if they don't convert prior to RMDs.

DarkHelmetII
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Re: Reasoning behind Backdoor Roth IRA

Post by DarkHelmetII » Fri Jan 12, 2018 7:43 pm

Cynic in me says - more complicated the process, the more taxes we can collect. I am biased because based on numerous mistakes I have made in past few years (funding Roth IRA when I earned too much + not doing back door ever year and hence having to deal with pro-rata rule though I am about to clear the platform on that).

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Re: Reasoning behind Backdoor Roth IRA

Post by LadyGeek » Fri Jan 12, 2018 7:47 pm

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