IRAs to ROTH IRA conversion

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Topic Author
mavenleek
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IRAs to ROTH IRA conversion

Post by mavenleek »

Hi!

I've been contributing to IRAs for many years by mostly not getting any tax deduction because my income is above the limit. My goal is to have growth tax free account. At retirement, I will get the money out of the IRA and will pay income tax on the withdrawals.

Today, I'm looking a bit closely at using the backdoor ROTH Ira by converting my IRA(s) to a ROTH IRA. To my understanding, the benefit of doing this would be that the growth would be tax free and when I get the money at retirement, I will not pay income tax on the withdrawals. Is this correct? :?:

Now, looking at my options to perform the backdoor conversion, I need to manage 2 IRAs:
IRA 1: For this one, I know for sure that I did not get any tax deduction when I contributed (because my income was too high). Can I deduct the full amount (about $40k) into a ROTH IRA using the backdoor? What are the things I need to consider when doing the conversion?

IRA 2: For this one, some early contributions were tax deductible (because my income was below the limit) and some contributions done later were not (because my income was too Hugh). I'm not sure how to proceed with this one... any tips or recommendations?

Thanks! :sharebeer
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David Jay
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Re: IRAs to ROTH IRA conversion

Post by David Jay »

mavenleek wrote: Sun Nov 21, 2021 3:47 pmToday, I'm looking a bit closely at using the backdoor ROTH Ira by converting my IRA(s) to a ROTH IRA. To my understanding, the benefit of doing this would be that the growth would be tax free and when I get the money at retirement, I will not pay income tax on the withdrawals. Is this correct? :?:
This is correct. Also, your heirs do not pay tax on the distributions form a Roth.
mavenleek wrote: Sun Nov 21, 2021 3:47 pmNow, looking at my options to perform the backdoor conversion, I need to manage 2 IRAs:
The IRS does not look at your situation as IRA 1 and IRA 2. They only consider the total of (IRA 1 + IRA 2). All decisions about conversion flow from that premise.

For specifics, you will only pay taxes at the ratio of ((IRA balance - after-tax contributions) / IRA balance)) so if the majority of your total balance is after-tax then your taxable percentage will be low. Unfortunately, per this calculation all growth is taxable, which is why folks here try to do Roth conversions of after-tax contributions promptly.

You also need to make sure that all past 8606 forms have been filed, accurately recording your after-tax contributions.
Last edited by David Jay on Sun Nov 21, 2021 4:21 pm, edited 2 times in total.
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FiveK
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Re: IRAs to ROTH IRA conversion

Post by FiveK »

David Jay wrote: Sun Nov 21, 2021 4:17 pm You also need to make sure that all past 8606 forms have been filed, accurately recording your after-tax contributions.
+1

mavenleek, you would then use the 2021 version of Form 8606 to calculate how much of the conversion amount is taxable. See the Backdoor Roth wiki article for more.
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Eagle33
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Re: IRAs to ROTH IRA conversion

Post by Eagle33 »

Do you have a 401k at your current employer? If so, check to see if the 401k allows rollovers of pre-tax dollars from an IRA. If it does, you can rollover the pre-tax portion of your IRAs leaving you only the post-tax basis (non-deductible contributions) in them. Then you can convert the basis to your Roth IRA.
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mavenleek
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Re: IRAs to ROTH IRA conversion

Post by mavenleek »

Thanks for your answers.

I don't think my 401k allows rollovers of pre-tax dollars from an IRA but I will check with HR.

Regarding the timing of using the backdoor, does it matter if I do it in 2021 or can I wait next year?
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FiveK
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Re: IRAs to ROTH IRA conversion

Post by FiveK »

mavenleek wrote: Mon Nov 22, 2021 11:23 pm Thanks for your answers.

I don't think my 401k allows rollovers of pre-tax dollars from an IRA but I will check with HR.

Regarding the timing of using the backdoor, does it matter if I do it in 2021 or can I wait next year?
You may convert from traditional to Roth any amount at any time.

You will be subject to tax for whatever taxable amount you convert in the same tax year as the calendar year in which you do the conversion. In other words, if you convert in December 2021 you include that in the taxes you file by April 15, 2022. If you convert in January 2022, you include that in taxes you file by April 15, 2023.
Topic Author
mavenleek
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Re: IRAs to ROTH IRA conversion

Post by mavenleek »

Total IRAs for myself and wife are $119500 splitted in 3 accounts.
The larger one is a rollover from a 401k to an IRA.

I checked my tax return for the previous years and found the following information:
2012, 2013, 2014 - no ira contribution
2015 - $5500 tax deductible contribution reported to tax return
2016 - $11000 tax deductible contribution reported to tax return
2017 - no tax deductible ira contribution reported, no form 8606 filled (haven't found any contributions to the account so I must have forgotten... :| )
2018 - Form 8606 filled (non deductible contribution) with 11k amount
2019 - Form 8606 filled (non deductible contribution) with 12k amount
2020 - Form 8606 filled (non deductible contribution) with 12k amount

To calculate the tax I would do as follow:
Total IRA balance: $119500
Total after tax contribution reported: 35k
Rollover 401k to IRA: 15k
Last edited by mavenleek on Wed Nov 24, 2021 1:40 am, edited 3 times in total.
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FiveK
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Re: IRAs to ROTH IRA conversion

Post by FiveK »

If I understand your numbers correctly, and you make another $12K non-deductible contribution in 2021 and convert that along with the $119500, your 2021 form 8606 would look something like

Code: Select all

+────+───────────────────────────────+────────+
| 1  | Nondeduct. Contrib.           | 12000  |
| 2  | tIRA basis                    | 35000  |
| 3  | Add lines 1 and 2             | 47000  |
| 4  | Contributed next year         | 0      |
| 5  | Line 3 minus Line 4           | 47000  |
| 6  | EOY tIRA balance              | 0      |
| 7  | non-conversion tIRA distrib.  | 0      |
| 8  | t->R conversion               | 131500 |
| 9  | Add lines 6, 7, and 8         | 131500 |
| 10 | Divide line 5 by line 9       | 0.3574 |
| 11 | Line 8 * line 10              | 47000  |
| 12 | Line 7 * line 10              | 0      |
| 13 | Add lines 11 and 12           | 47000  |
| 14 | Subtract line 13 from line 3  | 0      |
| 15 | Taxable amount                | 0      |
| 16 | t->R conversion               | 131500 |
| 17 | Basis in t->R conversion      | 47000  |
| 18 | Taxable amount                | 84500  |
+────+───────────────────────────────+────────+
The good news is you don't have to worry about capital gains in the IRAs at all. The bad news is all your deductible contributions and all gains within the IRAs are taxed as ordinary income when you withdraw.

After looking at Form 8606 and its instructions, does the table above make sense?
Topic Author
mavenleek
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Re: IRAs to ROTH IRA conversion

Post by mavenleek »

Thanks for your help!

I found additional information that helps clarify my situation.

Rollover 401k to IRA: 15k I understand this amount is a "deductible contribution"
Unrealized gains in IRAs: 25k
Total deductible contribution reported to IRS: 16500
Total non deductible contribution reported to IRA (from 8606), 35k
Total non deductible contribution done but not reported to IRA for 2021 tax year: 12k

+────+───────────────────────────────+────────+
| 1 | Nondeduct. Contrib. | 12000 |
| 2 | tIRA basis | 35000 |
| 3 | Add lines 1 and 2 | 47000 |
| 4 | Contributed next year | 0 |
| 5 | Line 3 minus Line 4 | 47000 |
| 6 | EOY tIRA balance | 0 |
| 7 | non-conversion tIRA distrib. | 0 |
| 8 | t->R conversion | 119500 |
| 9 | Add lines 6, 7, and 8 | 119500 |
| 10 | Divide line 5 by line 9 | 0.3933 |
| 11 | Line 8 * line 10 | 47000 |
| 12 | Line 7 * line 10 | 0 |
| 13 | Add lines 11 and 12 | 47000 |
| 14 | Subtract line 13 from line 3 | 0 |
| 15 | Taxable amount | 0 |
| 16 | t->R conversion | 119500 |
| 17 | Basis in t->R conversion | 47000 |
| 18 | Taxable amount | 72500 |
+────+───────────────────────────────+────────+

So I would add $72500 to my income for 2021. I will pay 35% Fed + 10% CA = $32625 of additional taxes.

//edit: removed the 25k of unrealized gains.

Hefty tax bill but does the conversion makes sense?

Assuming the IRA stop growing, I would pay 25%+7% = $38k to withdraw the money when I retire.
Assuming the IRA grows 6% per year for 20 years ($384'000), I would pay 25%+7% = $122'000 to withdraw the money.
Last edited by mavenleek on Wed Nov 24, 2021 2:29 am, edited 1 time in total.
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FiveK
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Re: IRAs to ROTH IRA conversion

Post by FiveK »

If you add another $12K this year (line 1), you have to withdraw that in addition to the $119500 already there to have nothing left (line 6).

Why do you think you need to add $25000 of unrealized capital gains?

Don't look at the tax paid to determine if a conversion makes sense now vs. later. Look at the amount remaining after tax. See the Calculations section of that wiki.
todaysBob
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Re: IRAs to ROTH IRA conversion

Post by todaysBob »

Out of curiosity, why did you contribute to after tax but didn't convert to backdoor Roth right away?
Topic Author
mavenleek
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Re: IRAs to ROTH IRA conversion

Post by mavenleek »

FiveK wrote: Wed Nov 24, 2021 1:48 am If you add another $12K this year (line 1), you have to withdraw that in addition to the $119500 already there to have nothing left (line 6).

Why do you think you need to add $25000 of unrealized capital gains?

Don't look at the tax paid to determine if a conversion makes sense now vs. later. Look at the amount remaining after tax. See the Calculations section of that wiki.
Regarding the 12k they are already included in the balance of $119500. So I think my table is correct?

Not sure why I added the 25k but it's now removed. So my total tax bill would be about $33k

For the calculation, I found that this calculator seems to provide a good indication: https://www.schwab.com/ira/understand-i ... conversion

What do you think?
Topic Author
mavenleek
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Re: IRAs to ROTH IRA conversion

Post by mavenleek »

todaysBob wrote: Wed Nov 24, 2021 2:25 am Out of curiosity, why did you contribute to after tax but didn't convert to backdoor Roth right away?
Because I didn't know what I didn't know :happy

I knew about the Roth IRA and the backdoor Roth IRA but it never occurred to me that because I was doing non deductible contributions, I should have done the conversion to Roth IRA right away.... :?
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FiveK
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Re: IRAs to ROTH IRA conversion

Post by FiveK »

mavenleek wrote: Wed Nov 24, 2021 2:33 am Regarding the 12k they are already included in the balance of $119500. So I think my table is correct?
Yes, looks good.
For the calculation, I found that this calculator seems to provide a good indication: https://www.schwab.com/ira/understand-i ... conversion
What do you think?
It's close either way.
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celia
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Re: IRAs to ROTH IRA conversion

Post by celia »

OP, Let’s back up a bit. When talking about IRAs, we need to keep in mind they are Individual Retirement Accounts, meaning you need to keep your accounts (and calculations) separate from your spouses’s. So put all the contributions for SPOUSE1 on a separate page from SPOUSE2. It is only on the last step when your software transfers your numbers from both your and your spouse’s Forms 8606 to the Form 1040 that your numbers are merged when they appear on the 1040.

So the earlier question as to if you have an employer retirement plan that accepts rollovers from IRAs actually applies to you and your spouse. You will have to do separate calculations from each other. But if only one of you has an employer plan that accepts IRA rollovers, you should start with that person’s accounts. Maybe it makes sense to convert the IRA for one of you in one year and the other person to convert theirs in a different year.

And there’s nothing that says you have to do your conversions all in one year. Maybe you want to take a year to rollover half of one person’s IRA, then the following year do 1/3 of the other person’s, and in the third year, finish the second half of the first persons. Then use the 4th and 5th years to finish the second person’s conversions. Note that if anyone takes more than one year, the pro rata rule will apply, as described in the above-referenced wiki page. Just know that every dollar was/ will be taxed just once: when contributed (and not deducted on your taxes) or when withdrawn or when converted.

So, start by making a list for each person showing the year FOR WHICH a contribution was made, how much was contributed to an IRA and if the contribution was deducted on the taxes for that year (or not). Also be aware that it is possible to contribute FOR any year up until April 15 of the following year.

Then check that a Form 8606 was generated as part of the tax return whenever one of you made a non-deductble contribution and that contribution was added to previous non-deductible contributions and shows up on line 14 of Form 8606, which is the cumulative ‘basis’ for each of you.
Last edited by celia on Wed Nov 24, 2021 5:07 am, edited 1 time in total.
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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celia
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Re: IRAs to ROTH IRA conversion

Post by celia »

mavenleek wrote: Mon Nov 22, 2021 11:23 pm I don't think my 401k allows rollovers of pre-tax dollars from an IRA but I will check with HR.
Check with each of your 401K custodians instead.
Regarding the timing of using the backdoor, does it matter if I do it in 2021 or can I wait next year?
You probably should convert over a few years to keep a lid on your taxes. For example, you might want to convert to the top of your current tax bracket each year until the conversions are done.
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.
Topic Author
mavenleek
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Re: IRAs to ROTH IRA conversion

Post by mavenleek »

celia wrote: Wed Nov 24, 2021 4:43 am OP, Let’s back up a bit. When talking about IRAs, we need to keep in mind they are Individual Retirement Accounts, meaning you need to keep your accounts (and calculations) separate from your spouses’s. So put all the contributions for SPOUSE1 on a separate page from SPOUSE2. It is only on the last step when your software transfers your numbers from both your and your spouse’s Forms 8606 to the Form 1040 that your numbers are merged when they appear on the 1040.
Understood.
celia wrote: Wed Nov 24, 2021 4:43 am So the earlier question as to if you have an employer retirement plan that accepts rollovers from IRAs actually applies to you and your spouse. You will have to do separate calculations from each other. But if only one of you has an employer plan that accepts IRA rollovers, you should start with that person’s accounts. Maybe it makes sense to convert the IRA for one of you in one year and the other person to convert theirs in a different year.
I need to check this. If I understand correctly, the goal is to rollover the contributions that were deductible right? For my wife it would be 62k and for me 22.5k If I manage to do this, then the backdoor from IRA to Roth IRA would not be taxed because all the contributions (minus capital gains) would have not been tax deductible, right?

celia wrote: Wed Nov 24, 2021 4:43 am
And there’s nothing that says you have to do your conversions all in one year. Maybe you want to take a year to rollover half of one person’s IRA, then the following year do 1/3 of the other person’s, and in the third year, finish the second half of the first persons. Then use the 4th and 5th years to finish the second person’s conversions. Note that if anyone takes more than one year, the pro rata rule will apply, as described in the above-referenced wiki page. Just know that every dollar was/ will be taxed just once: when contributed (and not deducted on your taxes) or when withdrawn or when converted.
If we are already in the highest tax brackets, there are no upsides of doing the rollover over couple of years right?
celia wrote: Wed Nov 24, 2021 4:43 am So, start by making a list for each person showing the year FOR WHICH a contribution was made, how much was contributed to an IRA and if the contribution was deducted on the taxes for that year (or not). Also be aware that it is possible to contribute FOR any year up until April 15 of the following year.

Then check that a Form 8606 was generated as part of the tax return whenever one of you made a non-deductble contribution and that contribution was added to previous non-deductible contributions and shows up on line 14 of Form 8606, which is the cumulative ‘basis’ for each of you.
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nerdymarketer
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Re: IRAs to ROTH IRA conversion

Post by nerdymarketer »

Also, time may be of the essence here.

We can't discuss pending legislation on this forum, but all you need to do is Google it to see why there's a chance you may need to do this backdoor conversion before Jan 1.

Since you already are looking at doing the backdoor, I'd just jump on it to be sure you complete it in the current tax year as it completely removes the risk the laws may change what's allowed.

This is all assuming that you're able to find a way to split out the pretax from after tax contribution to avoid the pro rata issue discussed above.
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David Jay
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Re: IRAs to ROTH IRA conversion

Post by David Jay »

It depends how much tax you want to pay, but I would at least convert "He" and pay the taxes on the $16,500. This clears out his account for future backdoor contributions.
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celia
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Re: IRAs to ROTH IRA conversion

Post by celia »

mavenleek wrote: Thu Nov 25, 2021 12:36 am If I understand correctly, the goal is to rollover the contributions that were deductible right? For my wife it would be 62k and for me 22.5k If I manage to do this, then the backdoor from IRA to Roth IRA would not be taxed because all the contributions (minus capital gains) would have not been tax deductible, right?
The goal is to roll over all pre-tax dollars (deductible contributions and growth) leaving only the basis (non-deductible contributions). But since assets change value daily, you probably want to liquidate things first. Even then, after you move out a chunk of money, you may get overnight interest for the money that was removed. Then you would convert everything left, paying taxes only on that interest.

Another option is to leave behind any other money you want to convert and pay taxes on. That could even be the whole account!

BTW, there are no “capital gains” in IRAs, because that term refers to gains in Taxable accounts. IRAs have “gains” (or “growth”) or possible “losses” instead.
If we are already in the highest tax brackets, there are no upsides of doing the rollover over couple of years right?
Correct, unless you planning some change that will put you in a lower tax bracket (like retirement, sabbatical, or unpaid family leave).
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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