Need *simple* instructions for Backdoor Roth IRA

[Slav4ikMD]

I've been meaning to explore the Backdoor Roth IRA thing for a couple of years now and am determined to do it this year!  Can someone explain the step by step instructions to me, on say 5th grade level as I find all this stuff to be rather complicated?

Also want to make sure I am eligible to do this (not sure who isn't...):  in short, I am employed with a maxed out 457 plan and self-employed with max contributions to the solo 401k.  I use Vanguard for the solo 401k.

Would love to hear some simple instructions, info on deadlines, limits for contribution and whatever else you think might be help to a simple person.

Thanks!

[conniebird]

WCI wrote one

https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/

Would also read these articles to get you started:

https://www.whitecoatinvestor.com/category/classics/

[PhysicianOnFIRE]

Slav4ikMD wrote:

I’ve been meaning to explore the Backdoor Roth IRA thing for a couple of years now and am determined to do it this year!  Can someone explain the step by step instructions to me, on say 5th grade level as I find all this stuff to be rather complicated?

Also want to make sure I am eligible to do this (not sure who isn’t…):  in short, I am employed with a maxed out 457 plan and self-employed with max contributions to the solo 401k.  I use Vanguard for the solo 401k.

Would love to hear some simple instructions, info on deadlines, limits for contribution and whatever else you think might be help to a simple person.

Thanks!

Click to expand...

You should be fine. WCI's instructions should suffice, and the 401(k) and 457(b) are not subject to the Pro-Rata rule.

If you had a SEP-IRA or traditional IRA in your name, you wouldn't be able to do the backdoor Roth covnersion tax-free. Those can sometimes be rolled over into a 401(k), which is what I did to enable the Back Door.

 

[Slav4ikMD]

Thanks!  Will read the WCI tutorial, just started!

I do have a SEP from 2014 - is that a problem?  Should I roll it over into the IRA?  Can I still do that with Vangaurd?

WCI says "Vanguard’s Individual 401K doesn’t accept IRA rollovers"...

[Hatton]

You need to convert the sep Ira to a Roth IRA.  You will have to pay tax on it.  If your sep is large you might want to wait until you have a year with little income for some reason or as you approach retirement. Converting a sep to a Roth is easy at vanguard.  There is a little button that says Roth conversion.  I did it a few weeks ago.

[Slav4ikMD]

My SEP is tiny, around $8000 - I did it my first year of self-employment, not even sure why, should have done a solo 401k but my incompetent former accountant told me that it is "very expensive to open" and I should do a SEP.  Lesson learned.

Anyway, ok so what's the advantage of converting it to a roth IRA now?  That I would be able to do Backdoor, or something else as well?

My concern is this:  in a couple of years my self-employed income will (hopefully) grow (and possible replace all W2 income), so it would in fact make more sense for me to do a sep rather than solo 401k (with a goal of maximizing my pre-tax retirement savings).  If I did that, then can't do backdoor?  Thoughts?

[RetiredERdoc]

If you have an existing traditional Ira, it complicates taxes when doing a backdoor Roth due to th pro rata rule, so if you do backdoor roths it is better to get rid of them.  This bed Roth guide discusses the rule:

http://www.goodfinancialcents.com/roth-ira-conversion-tax-rules/

this guide includes firm 8606 examples

http://thefinancebuff.com/the-backdoor-roth-ira-a-complete-how-to.html

[jfoxcpacfp]

Slav4ikMD wrote:

My SEP is tiny, around $8000 – I did it my first year of self-employment, not even sure why, should have done a solo 401k but my incompetent former accountant told me that it is “very expensive to open” and I should do a SEP.  Lesson learned.

Anyway, ok so what’s the advantage of converting it to a roth IRA now?  That I would be able to do Backdoor, or something else as well?

My concern is this:  in a couple of years my self-employed income will (hopefully) grow (and possible replace all W2 income), so it would in fact make more sense for me to do a sep rather than solo 401k (with a goal of maximizing my pre-tax retirement savings).  If I did that, then can’t do backdoor?  Thoughts?

Click to expand...

There are 3 major differences between the SEP and the SOLO-k:

1. The SEP is calculated totally on a % of income basis but a 401k allows an $18k discretionary contribution (among ALL 401k accounts) before calculating a % of net income you can contribute.


2. The SEP is a personal IRA which would preclude you from making a tax-free backdoor Roth contribution. The SOLO-k is a business retirement plan and will not preclude the backdoor Roth.


3. However, the SEP can be set up and funded after the close of the year, which makes it useful if you need to make a contribution for the prior year after year-end.

Otherwise, there is no reason to use a SEP instead of a SOLO-k - the annual contribution limits are the same. Just roll any and all pre-tax IRA balances to your SOLO-k. When your SE income grows to the point that a SOLO-k isn't enough, you might be a good candidate for a combo plan (a defined benefit plan combined with the SOLO-k).

[litovskyassetmanagement]

Slav4ikMD wrote:

My SEP is tiny, around $8000 – I did it my first year of self-employment, not even sure why, should have done a solo 401k but my incompetent former accountant told me that it is “very expensive to open” and I should do a SEP.  Lesson learned.

Anyway, ok so what’s the advantage of converting it to a roth IRA now?  That I would be able to do Backdoor, or something else as well?

My concern is this:  in a couple of years my self-employed income will (hopefully) grow (and possible replace all W2 income), so it would in fact make more sense for me to do a sep rather than solo 401k (with a goal of maximizing my pre-tax retirement savings).  If I did that, then can’t do backdoor?  Thoughts?

Click to expand...

You might want to convert that SEP to Roth because Vanguard solo 401k does not accept incoming withdrawals. This is how you turn your Vanguard solo 401k into a 401k that accepts incoming withdrawals and allows in-plan Roth conversions (and after-tax contributions as well):

https://www.whitecoatinvestor.com/improving-the-vanguard-individual-401k-with-a-customized-plan

Once your 1099 income increases, you will definitely want to customize your solo 401k for the following reasons:

1) Roll your other retirement plans into it once you become fully self-employed (and allow many of the features that are great to have for your personal retirement plan listed above)

2) Potentially add a defined benefit plan to your solo 401k to increase your contribution beyond $53k allowed by the solo 401k, provided that this plan makes sense for you:

http://quantiamd.com/player/ygvmhdmbm?cid=1467

 

 

[Slav4ikMD]

Thanks guys.  This looks a little complicated for DIY, so I will either have to spend some time learning this a bit or talking to my CPA/CFP.  Don't want to waste your time on free advice, but help me quickly gauge whether it is time for me to start customizing and thinking of other more complex strategies:  I am fairly early in my career, have a W2 job with a 457 plan that I max out at 18k, and currently have a self-employed income of around 150k - for the next two years self-employment will likely grow slightly and W2 will stay (hard to predict what I will do later).  Time to "customize" or not yet?  Is 53k currently my limit for all plans or there are more creative paths to explore?  Thanks!

[litovskyassetmanagement]

Slav4ikMD wrote:

Thanks guys.  This looks a little complicated for DIY, so I will either have to spend some time learning this a bit or talking to my CPA/CFP.  Don’t want to waste your time on free advice, but help me quickly gauge whether it is time for me to start customizing and thinking of other more complex strategies:  I am fairly early in my career, have a W2 job with a 457 plan that I max out at 18k, and currently have a self-employed income of around 150k – for the next two years self-employment will likely grow slightly and W2 will stay (hard to predict what I will do later).  Time to “customize” or not yet?  Is 53k currently my limit for all plans or there are more creative paths to explore?  Thanks!

Click to expand...

There are many different strategies that can be employed depending on many factors, and all of them have to be customized to your specific situation (especially if you have significant self-employment income).  Whoever your adviser is, they should be able to help you with tax planning as well as with retirement plan set up and management, and they should put together a plan to address your entire financial situation and help you implement it. This stuff is definitely not DIY for most doctors, though some might have the time and the inclination to do things themselves.  However, there are too many moving parts when you are self-employed, so there is also a possibility to add significant value with good advice.

[Slav4ikMD]

Guys, I spoke to my accountant and he said that having a sepIRA does not in any way preclude me from setting up a backdoor Roth and there would not be any additional taxation on anything.  Is he wrong?  Honestly I am beyond confused.  If I keep the sepIRA and do the backdoor Roth, what exactly gets taxed extra?  Please use very simple language

I found this:  https://www.bogleheads.org/wiki/Backdoor_Roth_IRA   So if I put say 20k into a sep and 5500 backdoor, then the 14500 is taxes and I lose the benefit of the sep, is that right?  Thanks!

[litovskyassetmanagement]

Yes, you can have a backdoor Roth with a SEP IRA, but you will have to pay pro-rata taxes on any conversions you make to Roth.

http://www.forbes.com/sites/ashleaebeling/2012/01/23/the-backdoor-roth-ira-advanced-version/#48a16b805556

So you will owe taxes on the conversion:

"The barrier to the backdoor Roth—in many folks’ minds—is the pro rata rule. The rule says that you have to aggregate all your IRAs to determine how much income tax you owe when you convert. If you have no other IRAs and you open a $5,000 nondeductible IRA and then convert it, you only owe tax on the earnings, if any. By contrast, if you have a $95,000 traditional IRA (pre-tax contributions), and you convert a $5,000 nondeductible contribution to a new IRA, the conversion would be 95% taxable."

[Slav4ikMD]

Ok here is what I am confused about:  "if you have a $95,000 traditional IRA (pre-tax contributions), and you convert a $5,000 nondeductible contribution to a new IRA, the conversion would be 95% taxable.” - the $5000 that I put in is post-tax money, isn't it?  So say I have 95k in a sep from before, now I put in 5k into an IRA and convert to Roth immediately, what actually physically happens in terms of what extra I may owe in taxes?

(sorry if I am asking really dumb questions)

[litovskyassetmanagement]

Good question. This is money that goes into a non-deductible Traditional IRA.  You are converting this to Roth, this is not 'after-tax' money.  IRS rules might not make sense sometimes, but this is what it is - a rule that has to be followed.  So you can show this to your CPA who most likely should know about this.  After all, if you do this, your CPA would have to calculate pro-rata taxes on the conversion.