IRA for spouse
I am still employed despite my age. My wife is not employed. My income level is too high to open a deductible TIRA. I plan to open a $6k TIRA on nondeductible basis. Then I plan to convert it immediately to a Roth IRA. I understand I can do this beginning 2010. Question: Can I do the same thing for my wife: open a nondeductible TIRA and then immediately convert it to a Roth IRA?
Permalink Submitted by Alan Spross on Fri, 2011-12-16 19:16
Your income may also be too high to make a regular Roth contribution.
If so, as long as you do not reach 70.5 for the year of the contribution you can make a 6k non deductible TIRA contribution and also fund from your earnings a spousal contribution for your wife if she will not be 70.5 either.
When you convert the TIRA, the pro rate rules apply per Form 8606. If these were your only TIRA accounts, the conversion would be tax free. However, if you or your spouse (separately) have any other TIRA, SEP or SIMPLE IRA accounts, your non deductible contributions must be pro rated over all these accounts. That would cause your conversion to be mostly taxable even if you only converted the recent new contributions.
This strategy of converting non deductible TIRA contributions is informally known as a “back door Roth” contribution. The tax impact depends on whether you have other TIRA accounts or not.
Permalink Submitted by Douglas Broome on Sat, 2011-12-17 13:20
Thank you. (1) My wife is already over 70.5, so I conclude from your answer that I am not able to to do a “back door Roth” for her in 2011 or any future year (unless the law changes). Is this correct?
(2) I shall be 70.5 in 2012. That means 2011 (this year) is the final year in which I am eligible to do a “back door Roth.” Is this correct?
(3) I currently have funds in two TIRAs (totaling maybe $130k) and one Roth (totaling $12k). Until I read your answer, I had been thinking of simply opening a new nondeductible-contribution TIRA for $6k and then immediately converting that to a new Roth. I do not understand how the pro rata thing works per your mention. Will a dummy Form 8606 walk me through it easily? Is there a likelihood that my $6k that I plan to use will be substantially taxed in 2011? If so, that vastly undermines the point of the “back door Roth” maneuver in my circumstances, it seems. Or am I misunderstanding things?
Permalink Submitted by Alan Spross on Sat, 2011-12-17 18:29
1) Correct. Starting in the year she reaches 70.5, TIRA contributions cannot be made. A regular Roth contribution could be made if your joint MAGI is not too high, as there are no age limits for regular Roth contributions.
2) Right. You can make a 2011 regular TIRA contribution up to 4/17/2012, but you would need to do it by 12/31/11 to have it included in the pro rate rules.
3) The pro rate rules in your situation would work like this, assuming that the 130k TIRA is fully pre tax, ie you did not make any prior non deductible contributions:
a) You make the 6k contribution
b) Convert prior to year end
c) The adjusted year end value is now 136k of which only 6k is from non deductible contributions. 130k/136k = .956 taxable per Form 8606. Taxable amount of conversion is 5736.
So your understanding is correct. All the contribution does for you is that you have 6k more in your retirement accounts. You would get the 6k back tax free only gradually over your remaining life expectancy, so the full benefit of a back door Roth is not possible.
If you plan to work for awhile and participate in a qualified plan, it might be possible to roll over your 130k TIRA into the plan. This would eliminate the pro rating issue for you and it will also eliminate your TIRA RMDs until after you retire and roll the plan back into a TIRA. There is not much time left this year, but if you did it next year, you would have to take out your 2012 RMD first and then roll over what was left. You can then make the 2011 non deductible contribution and convert it tax free, but it would be the last TIRA contribution you could make. It probably is not worth it to all this for just a one year opportunity for 6k, but that would be up to you if the rollover possibility exists.
Permalink Submitted by Douglas Broome on Mon, 2011-12-19 20:18
Thank you for your informative reply. It will prevent me from making a mistake. My current TIRAs will obviously make my plan to open a new Roth for $6k this year unviable.
It seems I screwed myself. In 2010 I converted all of my wife’s and my own TIRAs to Roths. Paid tax on my wife’s conversion in 2010 and split the conversions for my TIRAs over 2011 and 2012 to pay the taxes in those years. Then, because of the stock market I recharacterized these Roth conversions back to TIRAs before October 17, 2010. Now I am presently with all TIRAs. That renders the “back door Roth” for 2011 uneconomic for me based on the scenario outlined in the reply.
Am I missing something?
Permalink Submitted by Alan Spross on Mon, 2011-12-19 20:43
You are correct, having the TIRAs makes the conversion mostly taxable. But it is still better to have recharacterized the conversion if the value dropped more than just a few %s.
If you work less in the future, you may have some years when your income reduces enough to make regular Roth contributions.
Permalink Submitted by Douglas Broome on Thu, 2011-12-22 14:42
Thank you, Alan, for your information and help. It saves me a serious mistake.
As mentioned above, I am still working, and I don’t know when I shall decide to retire the second time. I shall be 70.5 in 2012. I have been contributing to a traditional 401(k) with my employer. For 2012, however, this employer has finally decided to add a Roth 401(k) plan in addition to its on-going traditional 401(k). In light of the fact that, after the IRA recharactrizations discussed above, I now have multiple TIRAs, as well as the traditional 401(k) for the past many years, can I now start contributing to the employer’s Roth IRA and cease contributing to the traditional 4501(k)–up to the 401(k) limit for 2012?
Permalink Submitted by Alan Spross on Thu, 2011-12-22 17:36
Yes, you should be able to split your 401k contributions any way you wish between the pre tax and the Roth options, or put 100% in either as well. Any company match must go to the pre tax account. That said, while still working and probably both of you collecting SS as well, you may be in a higher tax bracket now than after you retire. If that is the case, you would probably pass on Roth contributions until you retire, and then start converting incremental amounts after you retire to a Roth IRA. Of course, you must take out your RMDs each year before converting any additional amounts.
If you are NOT in a higher bracket in 2012 than after you retire, then you might consider making Roth 401k contributions. A Roth 401k cannot be qualified until you have held it 5 years, but if you roll it over to a Roth IRA when you retire and have held the Roth IRA for at least 5 years, the Roth 401k money will be instantly qualified along with your Roth IRA. The key is the marginal tax rate now vrs after you retire in determining if you should make the Roth 401k contributions now or not. Your taxable income will go up with Roth 401k deferrals since they are obviously not pre tax like your regular 401k contributions.
Note that most employer plans follow the IRS RMD rule. You do not have to start RMDs from the current 401k until after you have retired.
Also, I think you are aware that neither of you can make TIRA contributions starting with the year you reach 70.5, but you could still make one for 2011 if you wanted to. Not sure that it is worth it to make just one non deductible contribution to a TIRA, as then you would be stuck with Form 8606 every year from now on as each RMD would have a small portion tax free as calculated on the 8606.