IRA worth it given salary / income dynamics?

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Topic Author
Nupey03
Posts: 17
Joined: Tue Dec 03, 2019 5:12 pm

IRA worth it given salary / income dynamics?

Post by Nupey03 » Mon Jan 13, 2020 10:42 am

Hello All - I am curious as to whether or not it is most beneficial for me to contribute the $6k limit towards my existing Traditional IRA (or $12k in-aggregate for 2019 and 2020). My current salary is just under $400k, so the amount would not be tax deductible (i.e., making it a non-deductible IRA) — is it more beneficial to simply put those post-tax dollars towards my brokerage on an annual basis? Is there anything else that I need to consider (aware that there are no capital gains or dividend taxes with the IRA on an annual basis, but withdrawals are considered taxable income)? Currently, my taxable brokerage account makes up ~55% of my total investable assets (~45% in 401k and this IRA). I know that IRA dynamics are covered ad nauseam on the forum, and I don’t know why this is so hard for me to understand, but I just want to ensure that I am making the correct decision by forgoing IRA contributions (in-lieu of it simply going into my taxable account). Thanks!
Last edited by Nupey03 on Mon Jan 13, 2020 11:41 am, edited 1 time in total.

Bully3000
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Joined: Mon Jan 07, 2019 4:23 pm

Re: IRA worth it given salary / income dynamics?

Post by Bully3000 » Mon Jan 13, 2020 10:47 am

yes, you can add $6000 at the end of each year and then convert immediately to a ROTH IRA and all gains are Tax free

Silk McCue
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Joined: Thu Feb 25, 2016 7:11 pm

Re: IRA worth it given salary / income dynamics?

Post by Silk McCue » Mon Jan 13, 2020 10:51 am

Bully3000 wrote:
Mon Jan 13, 2020 10:47 am
yes, you can add $6000 at the end of each year and then convert immediately to a ROTH IRA and all gains are Tax free
Sorry but the OP said that they have an existing IRA. They would be subject to the pro rata rule and would be required to pay taxes. Please take a look at the Wiki.

https://www.bogleheads.org/wiki/Backdoor_Roth

The OP would have to convert their entire IRA in order to do Backdoor Roths going forward without the pro rata rule coming into play.

Cheers

Topic Author
Nupey03
Posts: 17
Joined: Tue Dec 03, 2019 5:12 pm

Re: IRA worth it given salary / income dynamics?

Post by Nupey03 » Mon Jan 13, 2020 10:54 am

Silk McCue wrote:
Mon Jan 13, 2020 10:51 am
Bully3000 wrote:
Mon Jan 13, 2020 10:47 am
yes, you can add $6000 at the end of each year and then convert immediately to a ROTH IRA and all gains are Tax free
Sorry but the OP said that they have an existing IRA. They would be subject to the pro rata rule and would be required to pay taxes. Please take a look at the Wiki.

https://www.bogleheads.org/wiki/Backdoor_Roth

The OP would have to convert their entire IRA in order to do Backdoor Roths going forward without the pro rata rule coming into play.

Cheers
That is correct. Fortunately, the one existing Traditional IRA is a very small amount ($11k) — and I am looking to understand whether or not I should look to contribute the $12k for 2019 + 2020 (to that same existing IRA) and then potentially convert to a Roth IRA. Apologies for the novice question.

Silk McCue
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Re: IRA worth it given salary / income dynamics?

Post by Silk McCue » Mon Jan 13, 2020 11:10 am

Nupey03 wrote:
Mon Jan 13, 2020 10:54 am

That is correct. Fortunately, the one existing Traditional IRA is a very small amount ($11k) — and I am looking to understand whether or not I should look to contribute the $12k for 2019 + 2020 (to that same existing IRA) and then potentially convert to a Roth IRA. Apologies for the novice question.
I believe it would be worth paying the taxes to convert the $11k in order to allow you to begin doing Backdoor Roths. To be clear you can't have any form of an IRA anywhere (Traditional, Simple, SEP) without being hit with the pro rata rule.

You should perform the Roth conversion of the existing IRA first in order to make a clean break as that it is a distinct taxable event. Then you can contribute $6k x 2 for 2019 and 2020 into a money market fund. As soon as you are able, perform the conversion. You many need to come back at the beginning of the next month to clean up some pennies that will show up in the account. You will just convert those like you did the initial $12k.

Cheers
Last edited by Silk McCue on Mon Jan 13, 2020 11:12 am, edited 2 times in total.

Spirit Rider
Posts: 12198
Joined: Fri Mar 02, 2007 2:39 pm

Re: IRA worth it given salary / income dynamics?

Post by Spirit Rider » Mon Jan 13, 2020 11:10 am

Nupey03 wrote:
Mon Jan 13, 2020 10:54 am
Silk McCue wrote:
Mon Jan 13, 2020 10:51 am
Bully3000 wrote:
Mon Jan 13, 2020 10:47 am
yes, you can add $6000 at the end of each year and then convert immediately to a ROTH IRA and all gains are Tax free
Sorry but the OP said that they have an existing IRA. They would be subject to the pro rata rule and would be required to pay taxes. Please take a look at the Wiki.

https://www.bogleheads.org/wiki/Backdoor_Roth

The OP would have to convert their entire IRA in order to do Backdoor Roths going forward without the pro rata rule coming into play.
That is correct. Fortunately, the one existing Traditional IRA is a very small amount ($11k) — and I am looking to understand whether or not I should look to contribute the $12k for 2019 + 2020 (to that same existing IRA) and then potentially convert to a Roth IRA. Apologies for the novice question.
You can rollover all pre-tax balances in all traditional, SEP and SIMPLE IRA accounts to any 401a, 401k, 403b and governmental 457b plan that accepts such rollovers. Only pre-tax balances in any of the above IRA accounts on 12/31 of the year you do a Roth conversion is subject to pro-rata taxation.

MichCPA
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Re: IRA worth it given salary / income dynamics?

Post by MichCPA » Mon Jan 13, 2020 11:13 am

IMO, if the traditional IRAs are only at 11k, OP should bite the bullet and pay the few grand in taxes and go do the backdoor setup moving forward.

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hand
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Re: IRA worth it given salary / income dynamics?

Post by hand » Mon Jan 13, 2020 11:45 am

MichCPA wrote:
Mon Jan 13, 2020 11:13 am
IMO, if the traditional IRAs are only at 11k, OP should bite the bullet and pay the few grand in taxes and go do the backdoor setup moving forward.
Agreed 100%.

One-time tax hit on the $11k allows $6k/yr (after-tax) into Roth which is unquestionably better than the same $6k/yr (after-tax) into taxable.

Spirit Rider
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Re: IRA worth it given salary / income dynamics?

Post by Spirit Rider » Mon Jan 13, 2020 12:14 pm

hand wrote:
Mon Jan 13, 2020 11:45 am
MichCPA wrote:
Mon Jan 13, 2020 11:13 am
IMO, if the traditional IRAs are only at 11k, OP should bite the bullet and pay the few grand in taxes and go do the backdoor setup moving forward.
Agreed 100%. One-time tax hit on the $11k allows $6k/yr (after-tax) into Roth which is unquestionably better than the same $6k/yr (after-tax) into taxable.
Why, when it is highly likely that the OP can roll the pre-tax traditional IRA assets over to an employer plan. The whole point of tax deferral is to not pay taxes when you are in your highest marginal tax brackets.

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hand
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Re: IRA worth it given salary / income dynamics?

Post by hand » Mon Jan 13, 2020 1:44 pm

Spirit Rider wrote:
Mon Jan 13, 2020 12:14 pm
hand wrote:
Mon Jan 13, 2020 11:45 am
MichCPA wrote:
Mon Jan 13, 2020 11:13 am
IMO, if the traditional IRAs are only at 11k, OP should bite the bullet and pay the few grand in taxes and go do the backdoor setup moving forward.
Agreed 100%. One-time tax hit on the $11k allows $6k/yr (after-tax) into Roth which is unquestionably better than the same $6k/yr (after-tax) into taxable.
Why, when it is highly likely that the OP can roll the pre-tax traditional IRA assets over to an employer plan. The whole point of tax deferral is to not pay taxes when you are in your highest marginal tax brackets.
Agreed, rolling the IRA into an employer plan if available is best course of action.

Topic Author
Nupey03
Posts: 17
Joined: Tue Dec 03, 2019 5:12 pm

Re: IRA worth it given salary / income dynamics?

Post by Nupey03 » Mon Jan 13, 2020 8:36 pm

hand wrote:
Mon Jan 13, 2020 1:44 pm
Spirit Rider wrote:
Mon Jan 13, 2020 12:14 pm
hand wrote:
Mon Jan 13, 2020 11:45 am
MichCPA wrote:
Mon Jan 13, 2020 11:13 am
IMO, if the traditional IRAs are only at 11k, OP should bite the bullet and pay the few grand in taxes and go do the backdoor setup moving forward.
Agreed 100%. One-time tax hit on the $11k allows $6k/yr (after-tax) into Roth which is unquestionably better than the same $6k/yr (after-tax) into taxable.
Why, when it is highly likely that the OP can roll the pre-tax traditional IRA assets over to an employer plan. The whole point of tax deferral is to not pay taxes when you are in your highest marginal tax brackets.
Agreed, rolling the IRA into an employer plan if available is best course of action.
OK; it looks as though I can in-fact rollover the Traditional IRA into my 401k plan. Is sounds like the best course of action is rolling that into the 401k plan... and then separately opening a Roth IRA to begin max contributions going forward (i.e., beginning with $12k ahead of Tax Day 2020). Is that correct? Thank you, all!

Silk McCue
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Joined: Thu Feb 25, 2016 7:11 pm

Re: IRA worth it given salary / income dynamics?

Post by Silk McCue » Tue Jan 14, 2020 7:36 am

Nupey03 wrote:
Mon Jan 13, 2020 8:36 pm

OK; it looks as though I can in-fact rollover the Traditional IRA into my 401k plan. Is sounds like the best course of action is rolling that into the 401k plan... and then separately opening a Roth IRA to begin max contributions going forward (i.e., beginning with $12k ahead of Tax Day 2020). Is that correct? Thank you, all!
That is good to hear. You will want to start the rollover immediately to allow time for any hiccups along the way. Once that is done you will follow the steps described in the Backdoor Roth wiki that I shared a link to earlier.

To be perfectly clear, you are not making a Roth IRA contribution period. If you use those words with your broker you are going to create a mess. You are going to make a non-deductible contribution to an IRA and then immediately convert it to Roth for both 2019 and 2020.

Cheers

ryman554
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Re: IRA worth it given salary / income dynamics?

Post by ryman554 » Tue Jan 14, 2020 9:49 am

To tack on to summarize what the OP should do:

1. Roll the existing tIRA into the workplace 401(k).
1a: Make sure there is no non-deductible stuff currently in the tIRA. If there is, you need to leave the non-deductible contributions behind as part of the rollover.
2. Once the rollover has happened, contribute $6k ($7k if you are 50+) to the IRA.
3. Once that money gets in there and clears (for me, this is 5 business days, YMMV), convert the entire tIRA into a ROTH IRA.
4. Enjoy tax free growth on your money, learn about withdrawal rules in case you need to within 5 years.
5. You may have to do it a second time the following month because of accrued interest. No worries.
6. Keep the tIRA account open. The balance should be $0 as of Dec 31, 2020. This is the only key requirement to make tax reporting simpler. You could do steps 1-3 in any order you wanted, as long at the balance is $0 at the end of the year. This order makes it simpler for you to bookkeep and unravel any issues that may arise.
7. Practice filling out tax form 8606 (use 2019 version) by hand, so you can see that the amount of tax should be 0 (maybe $1 if you have interest), as long as you only have the post-tax stuff in there. Now you know what to look for in tax software in 2021.
8. Repeat exercise in 2021. Enjoy!

Spirit Rider
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Re: IRA worth it given salary / income dynamics?

Post by Spirit Rider » Tue Jan 14, 2020 10:16 am

If you have the funds, it may be better to make contributions for both 2019 and 2020 and do a single Roth conversion. The 2019 contribution will be reported on a 2019 Form 8606 with your 2019 tax return. The 2020 contribution and 2020 Roth conversion will be reported on a 2020 Form 8606 with and on your 2020 tax return.

You really should rollover the IRA to the 401k and verify completion before doing any Roth conversion. As of 1/1/2018, you can no longer recharacterize Roth conversions.

Katietsu
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Joined: Sun Sep 22, 2013 1:48 am

Re: IRA worth it given salary / income dynamics?

Post by Katietsu » Tue Jan 14, 2020 10:18 am

Everything has been covered.

Follow the process described as long as previous contributions to the traditional IRA were deductible contributions.

finite_difference
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Re: IRA worth it given salary / income dynamics?

Post by finite_difference » Tue Jan 14, 2020 10:36 am

If you are planning to leave this money to heirs, is it worth using a Roth IRA to purchase VTSAX over simply using a taxable account (VTSAX), given the new rules about limiting stretch IRAs?

For your own retirement, and that of your spouse’s, I agree the Roth IRA always wins. But may be something to think about if you are high income with heirs.
The most precious gift we can offer anyone is our attention. - Thich Nhat Hanh

MichCPA
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Re: IRA worth it given salary / income dynamics?

Post by MichCPA » Tue Jan 14, 2020 11:54 am

Spirit Rider wrote:
Mon Jan 13, 2020 12:14 pm
hand wrote:
Mon Jan 13, 2020 11:45 am
MichCPA wrote:
Mon Jan 13, 2020 11:13 am
IMO, if the traditional IRAs are only at 11k, OP should bite the bullet and pay the few grand in taxes and go do the backdoor setup moving forward.
Agreed 100%. One-time tax hit on the $11k allows $6k/yr (after-tax) into Roth which is unquestionably better than the same $6k/yr (after-tax) into taxable.
Why, when it is highly likely that the OP can roll the pre-tax traditional IRA assets over to an employer plan. The whole point of tax deferral is to not pay taxes when you are in your highest marginal tax brackets.
I am glad that worked out in this case and it was a good catch by you. It's not a typical feature of a 401k though.

Spirit Rider
Posts: 12198
Joined: Fri Mar 02, 2007 2:39 pm

Re: IRA worth it given salary / income dynamics?

Post by Spirit Rider » Tue Jan 14, 2020 12:32 pm

MichCPA wrote:
Tue Jan 14, 2020 11:54 am
Spirit Rider wrote:
Mon Jan 13, 2020 12:14 pm
hand wrote:
Mon Jan 13, 2020 11:45 am
MichCPA wrote:
Mon Jan 13, 2020 11:13 am
IMO, if the traditional IRAs are only at 11k, OP should bite the bullet and pay the few grand in taxes and go do the backdoor setup moving forward.
Agreed 100%. One-time tax hit on the $11k allows $6k/yr (after-tax) into Roth which is unquestionably better than the same $6k/yr (after-tax) into taxable.
Why, when it is highly likely that the OP can roll the pre-tax traditional IRA assets over to an employer plan. The whole point of tax deferral is to not pay taxes when you are in your highest marginal tax brackets.
I am glad that worked out in this case and it was a good catch by you. It's not a typical feature of a 401k though.
Define typical.

With Revenue Ruling 2014-9, the IRS provided a safe harbor for simplified due diligence of the qualification status of IRA rollover contributions. Many, many more 401k plans now accept IRA rollover contributions. While I don't have concrete statistical evidence. The overwhelming anecdotal evidence of myself, family, friends and acquaintances as well as here on Bogleheads and other forums. Indicates it is now atypical for a 401k plan to not accept IRA rollover contributions.

fyre4ce
Posts: 441
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Re: IRA worth it given salary / income dynamics?

Post by fyre4ce » Tue Jan 14, 2020 1:39 pm

Nupey03 wrote:
Mon Jan 13, 2020 10:42 am
Hello All - I am curious as to whether or not it is most beneficial for me to contribute the $6k limit towards my existing Traditional IRA (or $12k in-aggregate for 2019 and 2020). My current salary is just under $400k, so the amount would not be tax deductible (i.e., making it a non-deductible IRA) — is it more beneficial to simply put those post-tax dollars towards my brokerage on an annual basis? Is there anything else that I need to consider (aware that there are no capital gains or dividend taxes with the IRA on an annual basis, but withdrawals are considered taxable income)? Currently, my taxable brokerage account makes up ~55% of my total investable assets (~45% in 401k and this IRA). I know that IRA dynamics are covered ad nauseam on the forum, and I don’t know why this is so hard for me to understand, but I just want to ensure that I am making the correct decision by forgoing IRA contributions (in-lieu of it simply going into my taxable account). Thanks!
It's hard for me to tell from your post, but I want to make sure you understand how IRAs work. Here's the (somewhat simplified) primer, and apologies if you already know it.

There are two types of IRAs: Traditional and Roth. They share a combined annual contribution limit of $6,000 ($7,000 age >=50). Traditional IRAs can be funded with pre-tax (deductible) or after-tax (non-deductible) dollars, at the option of the investor. In fact, the institution holding the IRA doesn't know/care about the mix of pre-tax and after-tax dollars in the account; you are responsible for tracking the basis yourself and reporting it to the IRS with your income tax return on Form 8606. Your basis increases when ever you make non-deducted (possibly non-deductible) contributions. Growth is necessarily pre-tax, so your account value increases from growth but the basis stays the same. The basis decreases when you withdraw money, and the IRS requires withdrawals to be "pro-rata" between pre-tax and after-tax money. For example, if you have a $15,000 IRA with a $12,000 basis and you withdraw $1,000, $800 will be after-tax and $200 will be pre-tax and thus taxable. After the withdrawal the balance would be $14,000 and your basis would be $11,200. This calculation is done for the aggregate of all your Traditional, SEP, and SIMPLE IRAs. There is no income limit on non-deductible contributions, but deductible contributions have relatively low income limits: $65k MAGI single, $104k MFJ, $196k for non-working spouses.

Roth IRAs are funded only after-tax but all future withdrawals of basis and growth are tax-free. A Roth IRA is strictly better than a fully non-deductible Traditional IRA; both are made with after-tax contributions, but a percentage of Traditional withdrawals are taxable whereas 100% of Roth IRA withdrawals are tax-free. High earners would probably prefer deductible Traditional IRA contributions to Roth contributions, but the income limits get in the way. Income limits for direct Roth IRA contributions are $124k MAGI single, and $196k MFJ.

As has already been pointed out, the Backdoor Roth IRA is a two-step process that allows Roth IRA contributions for those above the limit to contribute directly: make a non-deductible Traditional IRA contribution, then immediately convert the balance to a Roth IRA. There is no income limit for either step, so the process is available to everyone. The net result is the same as a direct Roth IRA contribution, except that any growth that happens between the two steps becomes taxable at the conversion. It doesn't work if you have any other Traditional, SEP, or SIMPLE IRA pre-tax balances, because that pre-tax money gets mixed into the conversion pro-rata and becomes taxable.

You say you have a $11k Traditional IRA. What is the basis? If the basis is high ($9-10k or more), I would probably just make a non-deductible contribution for 2019 (if you haven't already) and 2020 and convert the entire thing to Roth. It will result in only $1-2k of taxable income, will be straightforward, and will give you some tax diversification. If the basis is low, I would roll out the pre-tax portion into your employer's 401k, then make non-deductible contributions for (2019+)2020 and again convert the entire thing, in this case with no tax liability.

Your original question was whether IRA contributions in general are worth it relative to a taxable account. Deductible traditional contributions would be nice but are ruled out by your income, as are direct Roth IRA contributions. Non-deductible traditional contributions are probably inferior to taxable, but with the Backdoor Roth IRA you don't have to make this choice. I strongly recommend you do Backdoor Roths rather than just keeping your money in taxable. The Roth IRA is a great account - growth is tax-free (so no tax drag, which is significant in your tax bracket), contributions can be withdrawn any time penalty-free, growth can be withdrawn prior to age 59.5 for a whole list of hardships, and the SECURE Act made Roth IRA's even more desirable for estate planning, relative to pre-tax accounts. Clean up your Traditional IRAs by one of the two options I gave above, and do Backdoor Roths every year, for you and your spouse (if you have one). You won't regret it.

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