How best to open up Backdoor Roth

[pulmdoc]

I am trying to help a physician friend get his investing house in order (He bought WCI’s book at least!).  He is already doing a lot of things right on a macro level (no debt, lives below means etc) but there’s also room for improvement.  One area I think he could possibly benefit is that he does not have a ROTH account and was unaware of the ability to do Backdoor ROTH contributions.  The challenge is that he has multiple retirement accounts that may affect his ability to do backdoor conversions without tax penalties.

 

The scenario:

 

MFJ, age 43, his income ~$400k W-2, $50k 1099. Wife ~$60k W-2, no benefits bc part time so not eligible for 401k contributions

Accounts: Employer 403(b), contributes max yearly.  SEP-IRA funded with his IC income, ~$200k balance.  Traditional IRA opened as a resident, ~$40k balance (unknown how much of that is growth vs contributions, assume contributions were deductible).

Assuming he opens a SOLO401(k) for 2018, rolls over the SEP IRA balance into that and only contributes to the SOLO 401(k) going forward, what is the best way to deal with his TIRA?  It looks like it’s not possible to convert his TIRA without paying taxes because there are deductible contributions.  Does he need to wait until 2019 to do a Roth conversion on the TIRA to avoid paying pro-rata on the SEP balance as well, or if he converts the SEP before 4/15/18 will he be able to claim that conversion happened in 2017, allowing him to do a Roth conversion in 2018?  Help is much appreciated.

 

[DMFA]

pulmdoc wrote:

Assuming he opens a SOLO401(k) for 2018, rolls over the SEP IRA balance into that and only contributes to the SOLO 401(k) going forward, what is the best way to deal with his TIRA?  It looks like it’s not possible to convert his TIRA without paying taxes because there are deductible contributions.  Does he need to wait until 2019 to do a Roth conversion on the TIRA to avoid paying pro-rata on the SEP balance as well, or if he converts the SEP before 4/15/18 will he be able to claim that conversion happened in 2017, allowing him to do a Roth conversion in 2018?  Help is much appreciated.

Click to expand...

1. Make 2017 contribution of $5,500 before 4/17/2018


2. Do 2017 taxes; form 8606 will show the $5,500 non-deductible contribution and basis.  (these don't have to be done prior to converting or doing 2018 contribution)


3. Make 2018 contribution of $5,500 whenever (same day, or before, even...doesn't matter)


4. Open Roth IRA (if not already done)


5. Convert $11,000 from Traditional IRA to Roth any time in 2018 (amount equal to non-deductible basis)


6. Rollover all other pretax IRA money (Traditional, SEP) to qualified plan like 401(k) prior to 12/31/2018


7. Do 2018 taxes; form 8606 will show $5,500 contrib, $5,500 prior basis, $0 pretax on 12/31/2018, $11,000 conversion, $0 taxable, and $0 residual basis

...none of the above should result in taxes on the conversion.  When converting the non-deductible contributions, it does not matter for what year the converted funds were contributed; all that matters is the calendar year of the conversion, and the pretax IRA balance on 12/31 of the year of conversion.

Clear as mud?

[spiritrider]

First, when you say he contributes the max yearly. Are you just referring to the maximum employee deferral (2017 = $18K, 2018 = $18.5K). Or are you also referring to additional employer and/or employee after-tax contributions. The reason is there is a unique rule with regards to a 403b. The annual additions (employee + employer contributions) of a 403b must be aggregated with the annual additions of employer plan(s) of business(es) > 50% owned by the 403b participant.

Assuming that there is no problem with the annual addition limit. Your friend can do the following:

1. Make his 2017 SEP IRA contribution as he always has.


2. Adopt a one-participant 401k plan for 2018 with the effective date 01/01/18. Make sure this is a provider that accepts rollover contributions if required. Vanguard's Individual 401k does not.


3. Find out if the 403b plan accepts rollover contributions or not.


4. Determine if it is better to rollover the pre-tax IRA assets to the 403b or the one-participant 401k. Some considerations:
   
   
   
   • What are the relative expense ratios of the two plans.
   
   
   • One-participant 401k plans require a yearly 401k plan filing of Form 5500-EZ when the plan assets on 12/31 > $250K.
   
   
   
   


5. Rollover both the SEP IRA assets and the pre-tax traditional IRA assets to the selected non-IRA employer plan.


6. Then make the non-deductible traditional IRA contribution and Roth conversion.


7. Like the SEP IRA he will have until the tax filing deadline including extensions the following year to make one-participant 401k contributions.

Note: It is very important that steps 5 and 6 are now in this order. The tax reform removed the ability to recharacterize Roth conversions. So it is important now to verify that the rollovers are successful before doing the Backdoor Roth.

P.S. I see that DMFA and I were both composing our replies at the same time. Which is actually good, because while a lot of the information is duplicate. There is complmentary information in both posts.

[DMFA]

Yeah, I left out the 2017 SEP contrib.  Thanks for catching that.

[pulmdoc]

Thanks for the replies. I just meant he contributes the employee max to the 403b.

403b does not accept rollovers, so it's a solo 401k or nothing.

Good to know it can all be accomplished this year, as long as the SEP IRA and TIRA rollovers happen first. I will let him know.