Backdoor Roth

[jfoxcpacfp]

1. All of the growth in the post-tax contributions to your TIRA will be taxable at your marginal (highest) tax bracket. The only way to get tax-free growth is to move the money to an IRA. You'll still pay taxes on the pre-move growth, but all future growth will be tax free.


2. Yes, having $$ in a pre-tax TIRA will subject you to the pro-rata rule should you convert to a Roth IRA. You have a few choices, though:\
   
   
   
   • roll the pre-tax TIRA over to your current 401k/403b if it accepts roll-ins
   
   
   • convert it to a Roth IRA
   
   
   • find a way to earn some IC income, set up a SOLO-k, and roll the pre-tax TIRA balance over to that.
   
   
   
   

[jfoxcpacfp]

(duplicate post deleted)

[jfoxcpacfp]

Cl3333 wrote:

Would you recommend rolling this back to a 403b so that I don’t have to pay taxes on it yet and I can start a backside Roth IRA?

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Yes, if you want to do tax-free back-door Roth IRA conversions and your current employer plan will accept rollovers (most do). Check your SPD (Summary Plan Description) or with your HR department.

[ENT Doc]

Thank you for your reply.  I am a little confused about your comments but maybe I should help clarify some of mine first.  I put about $53K in pre-tax money into a traditional IRA after I finished residency.  Over the last 3 years I have contributed $5,500 of post-tax money into that same traditional IRA.  At the time I didn't know anything about pro rata or what the implications would be of combining the accounts.  Regardless, my intention of putting the post-tax money in there is that it will grow without any tax effect (no tax on dividends or capital gains when the funds have turnover).  Now I'm looking to get that money into a 401K (which I can presumably create because I do locums on the side) and then do the back-door Roth conversion.

"The only way to get tax-free growth is to move the money to an IRA."

Do you mean into a Roth IRA?

"You’ll still pay taxes on the pre-move growth, but all future growth will be tax free."

I'm assuming you're talking about a conversion of the traditional to the Roth, right?

I've never heard of a SOLO-k but I've heard of an individual 401K.  I should be able to set one of those up because I do locums work, right?  This isn't my standard income and is private income/work.

Thanks so much for your help!

[DMFA]

ENT Doc wrote:

Thank you for your reply.  I am a little confused about your comments but maybe I should help clarify some of mine first.  I put about $53K in pre-tax money into a traditional IRA after I finished residency.  Over the last 3 years I have contributed $5,500 of post-tax money into that same traditional IRA.  At the time I didn’t know anything about pro rata or what the implications would be of combining the accounts.  Regardless, my intention of putting the post-tax money in there is that it will grow without any tax effect (no tax on dividends or capital gains when the funds have turnover).  Now I’m looking to get that money into a 401K (which I can presumably create because I do locums on the side) and then do the back-door Roth conversion.

“The only way to get tax-free growth is to move the money to an IRA.”

Do you mean into a Roth IRA?

“You’ll still pay taxes on the pre-move growth, but all future growth will be tax free.”

I’m assuming you’re talking about a conversion of the traditional to the Roth, right?

I’ve never heard of a SOLO-k but I’ve heard of an individual 401K.  I should be able to set one of those up because I do locums work, right?  This isn’t my standard income and is private income/work.

Thanks so much for your help!

Click to expand...

1. “The only way to get tax-free growth is to move the money to an IRA.” Do you mean into a Roth IRA?
   Yes, otherwise the growth is tax-deferred, meaning you'll pay it when you withdraw it at the highest marginal rate.


2. “You’ll still pay taxes on the pre-move growth, but all future growth will be tax free.” I’m assuming you’re talking about a conversion of the traditional to the Roth, right?
   Yes.  Once you pay taxes on the conversion (since it was deducted or untaxed before) and on the growth, once it's in the Roth, it's done being taxed and grows tax-free.


3. I’ve never heard of a SOLO-k but I’ve heard of an individual 401K.  I should be able to set one of those up because I do locums work, right?  This isn’t my standard income and is private income/work.
   
   
   
   • Same thing with a different name.  Here's the IRS website: [Link]
   
   
   • Yes, you should be able to set one of those up.  Your contribution limit is 20% of your net 1099 profits.
   
   
   
   

[ENT Doc]

Awesome.  Thanks so much.  Looks like I have some more work cut out for me.   

[jfoxcpacfp]

ENT Doc wrote:

Thank you for your reply.  I am a little confused about your comments but maybe I should help clarify some of mine first.  I put about $53K in pre-tax money into a traditional IRA after I finished residency.  Over the last 3 years I have contributed $5,500 of post-tax money into that same traditional IRA.  At the time I didn’t know anything about pro rata or what the implications would be of combining the accounts.  Regardless, my intention of putting the post-tax money in there is that it will grow without any tax effect (no tax on dividends or capital gains when the funds have turnover).  Now I’m looking to get that money into a 401K (which I can presumably create because I do locums on the side) and then do the back-door Roth conversion.

“The only way to get tax-free growth is to move the money to an IRA.”

Do you mean into a Roth IRA?

“You’ll still pay taxes on the pre-move growth, but all future growth will be tax free.”

I’m assuming you’re talking about a conversion of the traditional to the Roth, right?

I’ve never heard of a SOLO-k but I’ve heard of an individual 401K.  I should be able to set one of those up because I do locums work, right?  This isn’t my standard income and is private income/work.

Thanks so much for your help!

Click to expand...

DMFA has answered your questions correctly but I would like to comment on your plan to roll your TIRA into a SOLO-k. Your TIRA has 2 components: the pre-tax and the post-tax. iow, you have "basis" in the post-tax, which means it will not be taxed when withdrawn. Lumping the whole TIRA into a rollover into your SOLO-k would create an unnecessarily complicated situation, as you would have to track the post-tax basis separately from the pre-tax. Better to go ahead and convert the post-tax contributions to a back-door Roth to grow tax free and roll the pre-tax balance along with growth to the SOLO-k.

[ENT Doc]

I was just thinking about that actually.  Would they just put the 3 contributions I made in post-tax dollars to the Roth, or would this involve some sort of pro-rata analysis to determine taxation on growth as well (I'm assuming the latter is accurate)?  I agree that I'd prefer to keep the 401K money pure and make it all pre-tax.  Just curious about the tax effects of doing the conversion from those 3 $5,500 payments over the last 3 calendar years.  Also, my understanding is that the contribution limit per year is still $5500 but there is no conversion limit.  This should mean that if I get all this taken care of in the next few months I should be able to contribute $5500 to my traditional (after the 401K is created) and then do a back-door conversion to the Roth for the 2017 calendar year, right?  Thanks so much for your valuable guidance.

[jfoxcpacfp]

ENT Doc wrote:

I was just thinking about that actually.  Would they just put the 3 contributions I made in post-tax dollars to the Roth, or would this involve some sort of pro-rata analysis to determine taxation on growth as well (I’m assuming the latter is accurate)?  I agree that I’d prefer to keep the 401K money pure and make it all pre-tax.  Just curious about the tax effects of doing the conversion from those 3 $5,500 payments over the last 3 calendar years.

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The IRS has a special rule for this situation, articulated in Pub 590. See the last paragraph on page 23 which is continued on page 24. As long as you leave an amount equal to your basis behind in your IRA, you can roll the pre-tax amount, including all earnings into your qualified plan, as long as the qualified plan will accept such a rollover. You can then convert the basis left behind into a Roth IRA.

ENT Doc wrote:

Also, my understanding is that the contribution limit per year is still $5500 but there is no conversion limit.  This should mean that if I get all this taken care of in the next few months I should be able to contribute $5500 to my traditional (after the 401K is created) and then do a back-door conversion to the Roth for the 2017 calendar year, right?  Thanks so much for your valuable guidance.

Click to expand...

That is correct.

[ENT Doc]

Thank you for the advice and the publication.  Definitely a good document to have on file.  So after I do this, can the amount that is left behind in the traditional (original post-tax contributions) be converted to a Roth with no tax implications?  This is of course aside from the money I mentioned before for 2017.  The IRS document seems to imply that this must be done within 60 days of putting the money in the traditional IRA.  I just don't want the $16500 (3 years contributions) being added to my taxable income in any way.  Thanks!

[jfoxcpacfp]

ENT Doc wrote:

So after I do this, can the amount that is left behind in the traditional (original post-tax contributions) be converted to a Roth with no tax implications?

Click to expand...

Yes, that is correct.

ENT Doc wrote:

The IRS document seems to imply that this must be done within 60 days of putting the money in the traditional IRA.

Click to expand...

The 60-day rule is for a situation where you remove the funds into your own name first and then roll into a Roth. You can do this only once per year and you must re-deposit the money w/i 60 days. A custodian-to-custodian transfer is what you want to do.

[ENT Doc]

Ahh, I see.  Thanks so much for your help with this!

[PenguinMD]

@Ent Doc -- did something similar last year.

The steps I did:
1) I opened a 2nd TIRA and moved the amount of the non-deductible over
2) This gives you two accounts: TIRA-PRE (amount equal to your pre-tax contribution + growth) and TIRA-POST (amount equal to your post-tax contribution)
3) TIRA-PRE I rolled INTO my employer 401k plan since in theory this is money that has not been paid taxes on
4) Once three is done then I convert the TIRA-POST to a ROTH IRA (open a separate account if for whatever reason you need to reverse/recharacterize later it's easy to do)
5) Now you should be "clean" to do a backdoor roth moving forward without subject to pro-rato rule since you have 0 TIRA anymore.

So in theory this makes sense but in reality there are some bumps.
1) You don't need to split the TIRA, I did it cause when youblter convert it's easier to just say take everything in the account vs specifying a specific number. Wanted to make the transactions as dead simple as possible.
2) Not all plans allow roll-ins so you need to check. Think you mentioned setting up your own solo-401k, you want to check which ones allow you to roll-in as I recall Vanguard does not but Fidelity may should verify before embarking on this journey.
3) Per IRS rules you're suppose to do the roll-in FIRST.
4) Because of the sequencing when you eventually convert your TIRA-POST to ROTH you may still pay a little taxes as that account could have gone UP above your cost basis. Now if your account went DOWN in value then your cost basis is higher then the amount your converting so you will pay NO TAX, however you could have rolled LESS into your 401k. I ended up giving myself a buffer of a few hundred dollars. I rather pay a little bit of tax then accidentally rolling more into my 401k then I needed to.
5) I open multiple accounts when I convert (no extra cost). The reason is if I need to roll back like the converted Roth lost value and I paid tax on gains I no longer have then you may want to reverse. Of course when you eventually do a "clean" backdoor ROTH you won't have this issue since you have zero tax since it's all post tax with no gains.

It's a bit of gymnastics but it makes things much easier later.

Also the counter argument is if you're in a low income year (low tax bracket), just take the tax hit and move on .

Good luck!