Just go through the Backdoor (Roth) first?

Submitted by Amar Patel on Sat, 2014-01-18 05:28

Every year, my wife and I bump right up against the income limits of what is allowed in order to make full Roth IRA contributions. Every year, we wait until all of our tax forms are in, and we run our tax calculations first as Married Filing Jointly and then each of us filing separately. Then we determine the best route in contributing to our Roth IRA for the prior calendar year, and we don’t mind paying a “little more” in taxes if it saves us the headache of running a backdoor Roth maneuver to get funds over into our Roth IRAs.

But this approach is not without its drawbacks either, like having to wait until just a few weeks before the deadline when all of the tax papers are in before running our calculations (which can be a problem if we have questions or need corrected forms, etc.). And of course who wants to pay a higher tax bill if not necessary? And then this time, my wife needs to roll a Roth 401(k) over too, creating a need for a traditional IRA in the process (because the 401(k) has both her post-tax contributions and pre-tax employer contributions).

And so, I wondered… if the traditional IRA is going to be there anyway because of the rollover, why not make use of it in January to go ahead and make a nondeductible contribution now for last year, and then convert that over to the existing Roth IRA immediately thereafter? Could this be done instead of waiting for tax forms and needing to run three sets of Form 1040 just to get contributions over to a Roth IRA?



Submitted by Alan - IRA critic on Sat, 2014-01-18 19:35

It is too late now to convert her TIRA tax free if the pre tax 401k balance will be rolled over this year. This will make her conversion mostly taxable, but if you do not have a pre tax non Roth IRA balance, you can convert your ND contribution tax free. Accordingly, you will save on taxes if you max her regular Roth contributions (but you must file jointly), and if you run that math you could do the same as both of you will have the same regular Roth contribution max. If her pre tax IRA balance from the rollover can be rolled into a new plan if she has one, it will eliminate the tax problem on her conversions, and you both could just do the back door every year without worrying about either your filing status or your MAGI.



Submitted by Amar Patel on Sun, 2014-01-19 03:27

The last line of the previous post seems to imply that we *can* go the backdoor Roth route every year without messing with multiple filing scenarios.  But, I’m not clearly following the post up to that last statement, so let I’ll attempt to provide more details to see if I can get another response to help me understand.The situation is currently as follows:- My wife has multiple 401(k)s right now, but only one of which we are interested in moving to Schwab- The 401(k) we’re interested in moving has her post-tax contributions plus her previous employer’s pre-tax matching contributions- My wife has an IRA with only post-tax contributions (a Roth IRA) at Schwab- She does *not* currently have pre-tax IRA (a traditional IRA) at Schwab or anywhere else- Schwab recommended that we open her a traditional IRA now and roll the pre-tax matching contributions from the 401(k) there while moving the post-tax contributions directly to the existing Roth IRA- Then Schwab would help us immediately convert the traditional IRA to a Roth (our goal is to have all retirement balances in Roth accounts for the tax-free distributions in retirement)- Schwab told us that the entire balance of the traditional IRA could be converted without withholding and that the taxes owed on this portion can be paid from a checking or savings account when taxes eventually are due- As a result of all of the above, my wife would still have a traditional IRA account open at Schwab, although it would be empty- Seeing that we’d both still want to put the $5500 into the IRA that we’re allowed, we figure we could avoid the hassle of waiting on all the forms and running all the various calculations of contribution limits and phased deductions, etc. and just put $5500 into traditional IRAs at Schwab and immediately convert those too into Roths- The goal, getting an additional $5500 each into our Roth IRAs, would be accomplished without the headache of running multiple calculations/scenarios.  Instead, we’d be able to file taxes before April without this “extra homework”, probably as a Married Filing Jointly return for the smallest tax bill That’s what I recall being told by Schwab anyway.  But I didn’t fully understand Alan’s post, so I’m still not sure where to go from here.



Submitted by Amar Patel on Tue, 2014-01-21 00:36

I thought that maybe a second day of studying Alan’s response would help, but I’m still not getting it…



Submitted by Alan - IRA critic on Tue, 2014-01-21 00:53

  • While it is not clear whether you should do so, if you are willing to pay the taxes on converting her pre tax assets to a Roth IRA, then she can do the back door Roths every year and convert them tax free. Everything Schwab indicates is correct, and the tax bill for converting her 401k pre tax amount after rolling it to the IRA of course depends on what that pre tax balance is.
  • And what will be done with all her other 401k accounts?


Submitted by Amar Patel on Wed, 2014-01-22 02:36

So it does seem as if some of the info Schwab threw at me landed.  Thanks Chuck!  🙂  Sounds like we do the following:1) Open a traditional IRA at Schwab in addition to the Roth IRA that already exists there2) Contribute a nondeductible $5500 now for 2013, without having to wait for all W-2s and 1099s in order to determine the best filing status (filing jointly, filing separately) and MAGI and phaseouts and deductible limts… just make it a nondeductible traditional IRA contribution from the beginning and convert immediately3) Convert that contribution immediately to a Roth, paying the tax from savings and not from the IRA balance itself4) Roll her 401(k) over to Schwab, into the traditional and Roth as appropriate5) Convert that traditional IRA balance immediately to a Roth, paying the tax from savings and not from the IRA balance itselfIs that it?  How do I make and report a nondeductible traditional contribution anyway?And what’s not clear about the taxes on the conversion?  I didn’t know *not paying* taxes was an option?  I’m not trying to run afoul of the IRS in any way here… all on the up and up for us.And the other 401(k)s… one is with her current employer, and the other is with her most prior employer.  We can’t roll that one yet it seems because she technically still works there part time (and we were told she can’t typically rollover while still employed).



Submitted by Alan - IRA critic on Wed, 2014-01-22 04:28

  • Generally correct. It’s the 401k rollover to a TIRA that makes the Roth conversions taxable. If the 401k was left in place so that you did not have ANY non Roth IRA balance other than your current non deductible contributions, the conversions would be tax free. If you roll the 401k accounts over and convert them, your taxable income on the conversions will be the amount converted less the non deductible contributions you make.
  • Step 4 has some risk involved because it isolates the after tax contributions in the plan to the Roth IRA. That is not what the IRS wants, but people have been doing these successfully anyway and the IRS has not objected. So if Schwab will do those direct rollovers, go ahead and do it.
  • The back door Roth process can be done while filing either separately or jointly so you still have that flexibility. It’s the regular Roth contributions that cannot be done when filing separately.
  • Report the non deductible contributions on a separate Form 8606 for each spouse. This form also is used to report the conversions and it calculates how much of the conversion is taxable.
  • Remember that you do not have to convert those 401k accounts and you can still do the back door Roths if you leave the 401k accounts where they are. But if you are convinced you want to convert them, at least I would not convert them all in the same year as that will increase your tax bracket. Of course I have no idea how big these accounts are. If they are small, then conversion is not a big deal.

 



Submitted by Amar Patel on Sat, 2014-01-25 18:02

… that said something like “if you cannot explain a thing, then you do not understand that thing.”  I’ve been trying to explain this stuff to my wife… and I’ve not been doing a good job so I studied this thread in more detail and have the following discussion to attempt.

  • Post by Alan on 18-Jan-2014 at 2:35 PM
  • “It is too late now to convert her TIRA tax free if the pre tax 401k balance will be rolled over this year”
  • Can this statement be explained again?  Does this mean some option to avoid taxes existed?  What was that, because I’d like to keep an eye on that option for the future?
  • Or is this a reference to some “order of operations”?  Meaning, the statement assumes that at some point in the near future one TIRA balance will be converted (instead of two smaller conversions) and that this balance would be a mixture of nondeductible contributions made by my wife AND the pre-tax contributions made by her employer in the 401(k) being rolled over, and therefore all that pro-rata math must be done?
  • “This will make her conversion mostly taxable, but if you do not have a pre tax non Roth IRA balance, you can convert your ND contribution tax free.”
    • “Pre tax non Roth IRA” seems to imply “Post tax non Roth IRA” is a real thing… does this refer to nondeductible contributions in a traditional IRA, and that “pre tax non Roth IRA” is otherwise just a “regular”/traditional IRA?  If so, then note that she presently has none in either category (only has a Roth IRA and no other IRAs of any kind anywhere else).
    • But, in addition to the backdoor Roth maneuver, we’re thinking of rolling over a Roth 401(k) that includes pre-tax employer contributions, and these employer monies will first likely end up in a traditional IRA before any conversion of those employer monies is made to a Roth IRA.
    • I would have expected taxes to be incurred in converting that set of employer monies from pre-tax to post-tax (ideally taxes that are paid from checking to avoid dinging the IRA itself and incurring penalties in the process).
    • I would not have expected taxes incurred (unless gains were seen) on the nondeductible portion of the traditional IRA as that is converted to a Roth in the backdoor maneuver.  In this case, the math can supposedly get complicated while pro-rating this or that.  I’d hope to avoid that.
  • “you will save on taxes if you max her regular Roth contributions (but you must file jointly)”.
    • Can this statement be explained again?  I don’t understand this statement because I thought Roth contributions were nondeductible and thus I cannot reduce MAGI based on Roth contributions.
  • “If her pre tax IRA balance from the rollover can be rolled into a new plan if she has one, it will eliminate the tax problem on her conversions.”
    • What problem is being referred to here?  Again, I expected to pay tax in going from pre-tax IRA to Roth IRA.  The pre-tax balance shouldn’t be too huge, and thus I’d be surprised if it bumped us into those stratospheric tax brackets.
    • Or is this a reference to the pro-rata math noted above?  Something else?
    • And aren’t 401(k)s inherently “problematic” in the sense that they offer fewer investment fund choices and typically higher fees than IRAs?  That’s another reason to get things over to IRAs when possible, no?
  • Post by Alan on 20-Jan-2014 at 7:53 PM
    • “While it is not clear whether you should do so, if you are willing to pay the taxes on converting her pre tax assets to a Roth IRA, then she can do the back door Roths every year and convert them tax free.”
    • This statement of “while it is not clear” seems to suggest some possible downside I’ve overlooked, other than paying taxes?
  • Post by me on 21-Jan-2014 at 9:36 PM
    • I seem to imply in “to do” items 2 and 3 that a nondeductible contribution to a traditional IRA would be taxed upon a conversion.  That’s wrong, right?

    I know that’s a ton of detail and questions.  I just need to understand this so that my wife doesn’t feel uncomfortable about any of the options we’re about to take.



    Submitted by Amar Patel on Sun, 2014-01-26 05:25

    I’ve spent several hours today, on and off, trying to study this topic across the internet.  I still don’t quite understand everything in this thread as noted above.  But I think I’m beginning to see through the fog… if I think of these as two separate operations:

    1. A backdoor Roth operation (nondeductible contribution to TIRA, then convert this to Roth relatively free of tax because we have no other pre-tax TIRA balances anywhere)
    2. A relatively standard Roth 401(k) rollover to Roth IRA, where the pre-tax employer monies make a pass through of a pre-tax IRA before ending up in a Roth IRA

    So, in addition the questions asked in the prior post today, I guess I wonder if the IRS will think of these are “clean and separate” operations, leaving me with a clean-slate for the next tax year?  Or does something linger the accounting from year to year such that it won’t be as clean as I hope to avoid the pro-rata stuff?



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