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Method for Backdoor Roth with multiple contributions

Posted: Thu Jan 26, 2023 11:58 am
by MDDO
This is my first year planning to contribute to a Roth IRA via a backdoor method and I am hoping you all could answer some questions. We are contributing to a Backdoor Roth because we plan to MFS for student loan purposes (see my post history for more details), so we cannot contribute directly to a Roth.

Our financial plan calls for contributing $1,100 a month into myself and my spouse's IRAs to max them out by the year's end. We usually finish early via some extra contributions if able. This makes the backdoor option a little more tricky. I have seem multiple theories about how to attempt this.

1. Contribute one lump sum by pulling from other sources. We are growing our emergency fund so this is not an option for us.
2. Contribute $1,100 to our trad IRA monthly and invest according to our financial plan. Convert to a Roth once we reached $6,500 each. This would incur a loss or gain. If there is a gain we will eat the taxes as a price to pay for convenience. If there is a loss we can carry basis forward.
3. Contribute $1,100 to our trad IRA and convert to a Roth after each contribution. From what I am reading, this can cause a tax preparation headache. Having never done this before, I am unaware of what exactly this means. It seems to me that the smaller contributions would add up to $6,500 on form 8606 and again we would pay taxes or carry losses forward. Where does the complication come in?

Option 3 seems to be the best for us but I could be wrong.

What do you all think would be the best approach? Is there something I am missing? Thank you in advance!

Re: Method for Backdoor Roth with multiple contributions

Posted: Thu Jan 26, 2023 1:02 pm
by newacct
I don't think converting multiple times has more complications than converting once. What matters are the total amount you contributed, the total amount you converted, and the amount in the Traditional IRAs at the end of the year. Converting soon after contributing has the advantage of reducing the gains you have to pay tax on.

Re: Method for Backdoor Roth with multiple contributions

Posted: Thu Jan 26, 2023 1:07 pm
by exodusNH
MDDO wrote: Thu Jan 26, 2023 11:58 am This is my first year planning to contribute to a Roth IRA via a backdoor method and I am hoping you all could answer some questions. We are contributing to a Backdoor Roth because we plan to MFS for student loan purposes (see my post history for more details), so we cannot contribute directly to a Roth.

Our financial plan calls for contributing $1,100 a month into myself and my spouse's IRAs to max them out by the year's end. We usually finish early via some extra contributions if able. This makes the backdoor option a little more tricky. I have seem multiple theories about how to attempt this.

1. Contribute one lump sum by pulling from other sources. We are growing our emergency fund so this is not an option for us.
2. Contribute $1,100 to our trad IRA monthly and invest according to our financial plan. Convert to a Roth once we reached $6,500 each. This would incur a loss or gain. If there is a gain we will eat the taxes as a price to pay for convenience. If there is a loss we can carry basis forward.
3. Contribute $1,100 to our trad IRA and convert to a Roth after each contribution. From what I am reading, this can cause a tax preparation headache. Having never done this before, I am unaware of what exactly this means. It seems to me that the smaller contributions would add up to $6,500 on form 8606 and again we would pay taxes or carry losses forward. Where does the complication come in?

Option 3 seems to be the best for us but I could be wrong.

What do you all think would be the best approach? Is there something I am missing? Thank you in advance!
Option 3 isn't really a headache. If you let it each contribution sit around for a few weeks, you'd earn a bit of taxable interest that would add to your income.

But if you contribute to the tIRA, wait for it to settle, and convert as soon as your broker allows you, the amount of interest you'll earn probably rounds to $0.

Re: Method for Backdoor Roth with multiple contributions

Posted: Thu Jan 26, 2023 2:04 pm
by mega317
newacct wrote: Thu Jan 26, 2023 1:02 pm I don't think converting multiple times has more complications than converting once. What matters are the total amount you contributed, the total amount you converted, and the amount in the Traditional IRAs at the end of the year. Converting soon after contributing has the advantage of reducing the gains you have to pay tax on.
+1

There is no basis to carry forward on your IRA.

Re: Method for Backdoor Roth with multiple contributions

Posted: Thu Jan 26, 2023 3:06 pm
by tashnewbie
If you do #2, I'd probably put the contributions in a money market fund if you're worried about value fluctuation. But if there are gains, you just owe ordinary income tax on the gains (not a big deal but can be avoided via #3). FYI, there are no loss carryforwards in an IRA.

#3 creates no tax paperwork headache because your IRA custodian will aggregate all of your contributions and conversions in your 1099s.

Re: Method for Backdoor Roth with multiple contributions

Posted: Thu Jan 26, 2023 5:43 pm
by retiredjg
MDDO wrote: Thu Jan 26, 2023 11:58 am 3. Contribute $1,100 to our trad IRA and convert to a Roth after each contribution. From what I am reading, this can cause a tax preparation headache. Having never done this before, I am unaware of what exactly this means. It seems to me that the smaller contributions would add up to $6,500 on form 8606 and again we would pay taxes or carry losses forward. Where does the complication come in?
I'm not sure what the headache is other than making sure you keep the total contribution correct.

All contributions will be reported in one lump sum. And the conversions are all reported in one lump sum.

Well, I take part of that back. It seems it can take several transactions on your part to contribute, wait, convert, wait, then invest....but this is not a tax preparation headache. It's a brokerage headache.

Re: Method for Backdoor Roth with multiple contributions

Posted: Thu Jan 26, 2023 5:48 pm
by DonIce
4. Put the contributions into a savings account at a bank. Once the savings account reaches $6500, contribute it to a trad IRA and convert.

Re: Method for Backdoor Roth with multiple contributions

Posted: Fri Jan 27, 2023 12:23 pm
by MDDO
Thank you everyone for the feedback so far. I am glad to hear that many smaller contributions and conversions is not the headache that many of the articles made it out to be. This will allow us to follow our plan and continue with our contributions and conversions monthly. We will stick with plan 3.

My comment about carrying basis forward comes from the WCI post on Backdoor Roth IRAs. See the quote below:

"What happens if you LOSE money in between the contribution and conversion step? This problem is easily avoided by using an investment like a money market fund that does not go down in value for that time period, but some people fail to do so and end up losing money. When they work their way through their IRS Form 8606, they discover they have basis left over that they can then carry forward indefinitely for years! No big deal, it just makes your paperwork more complicated. Perhaps at some point in the future you'll do a Roth conversion of tax-deferred money and this carry forward basis will reduce the tax on that event."

@DonIce, I think your suggestion is exactly what our plan tries to avoid. Ideally we would have the money to max out the accounts at the beginning of the year but that just isn't an option. I would rather be in the market as soon as possible rather than keeping it tied up in cash.