Backdoor Roth IRA Question

[shish18]

Hi all,

 

I am just starting out as an attending and am thinking that I need to to a backdoor Roth IRA. I would prefer to make contributions to all my investments monthly. It seems that when doing a backdoor Roth IRA, most people do a lump sum at the end of the year then convert it the next day and invest everything. I feel like the problem with this is that I have certain assets allocated in my Backdoor Roth and different ones in my individual 401k and HSA accounts. So doing my HSA and Solo 401K contributions monthly and my Backdoor Roth yearly would mess up my asset allocation throughout the year. I suppose I could just do lump investments in my HSA and 401K with the Backdoor Roth but I would lose out on a years worth of compounding if I did that each year. I've always read that its better to invest when you have the money and not let it sit in a savings account with low interest.

So my question is, does anyone use the traditional IRA and make monthly contributions to certain investment funds and let it grow throughout the year then convert the sum at the end of the year to a Roth? I understand I would probably pay tax on my earnings but wouldn't it be worth it if that money were in investments and growing throughout the year and not sitting in a money market? Is it even possible to do the backdoor IRA this way? Or would this completely screw things up? Does anyone do multiple conversions throughout the year so that they are making monthly contributions? Any info would help. Thanks.

[jfoxcpacfp]

shish18 wrote:

So my question is, does anyone use the traditional IRA and make monthly contributions to certain investment funds and let it grow throughout the year then convert the sum at the end of the year to a Roth? I understand I would probably pay tax on my earnings but wouldn’t it be worth it if that money were in investments and growing throughout the year and not sitting in a money market? Is it even possible to do the backdoor IRA this way? Or would this completely screw things up? Does anyone do multiple conversions throughout the year so that they are making monthly contributions? Any info would help. Thanks.

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Since you are willing to pay the tax if your money grows, there is no problem with this method. Understand, however, that you are making an assumption that your IRA will constantly and consistently grow. That is not how the stock market works in the short term. You have no guarantee of growth over the short term (< 5 years) and you may be converting less, not more. You especially have no guarantee of growth of you do not invest in a properly diversified portfolio.

shish18 wrote:

I’ve always read that its better to invest when you have the money and not let it sit in a savings account with low interest.

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Clarification: it is better to invest when you have money available to invest that you will not need to tap in the next 5 years. If you will need it in the next 5 years, it is better to "let it sit in a savings account with low interest" and focus on liquidity and safety rather than growth. Of course, the only way to know this is with a financial plan.

[shish18]

Thanks for the reply. Yea I currently have about 6 months salary in savings right now and want to start investing. I will still be putting a percentage into a savings account by want to get into the market. I understand that there is no guarantee in a positive return, but I was just using a hypothetical situation so that my question was more specific. I just want to make sure that the asset allocation for my portfolio will be able to be carried out and not altered significantly throughout the year and the only way to assure that is if I can make monthly contributions to the traditional IRA and make a one time conversion at the end of the year, regardless of whether I had a positive or negative return. I can then rebalance my investments accordingly once a year at the time of the conversion. Thank you again for the response.

[hightower]

You can do monthly contributions and monthly conversions if you want.  I did that for awhile when I first opened my Roth a few years ago.  But, don't try investing that money in the traditional IRA.

Your plan to contribute to a traditional IRA all year and invest in that account doesn't make sense.  Why not just use a taxable brokerage account to do the same thing and then you don't have to worry about the pro rata rules at the end of the year?  You can just take $5500 out of your brokerage account in December each year, transfer it to your traditional, then convert it to a Roth.  That way you're not missing out on potential gains all year like you are worried about and you don't have to worry about the tax issues surrounding a traditional IRA.

[shish18]

hightower wrote:

You can do monthly contributions and monthly conversions if you want.  I did that for awhile when I first opened my Roth a few years ago.  But, don’t try investing that money in the traditional IRA.

Your plan to contribute to a traditional IRA all year and invest in that account doesn’t make sense.  Why not just use a taxable brokerage account to do the same thing and then you don’t have to worry about the pro rata rules at the end of the year?  You can just take $5500 out of your brokerage account in December each year, transfer it to your traditional, then convert it to a Roth.  That way you’re not missing out on potential gains all year like you are worried about and you don’t have to worry about the tax issues surrounding a traditional IRA.

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I guess that makes sense. No need to invest in the traditional IRA if my gains are going to be taxed anyway. But, the traditional IRA is the only IRA that I have that would count towards the pro rata rule and all my contributions will be post-tax so I guess a brokerage or traditional IRA is equivalent in my case? I suppose using a brokerage account could make the taxes simpler. Regardless I'll be paying taxes. Thanks for your point of view.

[hightower]

Maybe someone else could answer this, because I don't know the answer, but if you put $5500 in a traditional IRA and it earned even a small gain or distribution, would the entire $5500+ be taxed when you convert it to a roth?  In other words, would the $5500 be actually taxed twice (once when you earn it from your paycheck and again when you convert it to a roth?)?

Whereas with the taxable brokerage account, only the gains/distributions would be taxed?

[PhysicianOnFIRE]

hightower wrote:

Maybe someone else could answer this, because I don’t know the answer, but if you put $5500 in a traditional IRA and it earned even a small gain or distribution, would the entire $5500+ be taxed when you convert it to a roth?  In other words, would the $5500 be actually taxed twice (once when you earn it from your paycheck and again when you convert it to a roth?)?

Whereas with the taxable brokerage account, only the gains/distributions would be taxed?

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No, you would only pay tax on the amount of the conversion that exceeds $5,500.

It's true that you're using after-tax money in the first place. It's true with standard and "backdoor" Roth conversions.

[jfoxcpacfp]

hightower wrote:

Maybe someone else could answer this, because I don’t know the answer, but if you put $5500 in a traditional IRA and it earned even a small gain or distribution, would the entire $5500+ be taxed when you convert it to a roth?  In other words, would the $5500 be actually taxed twice (once when you earn it from your paycheck and again when you convert it to a roth?)?

Whereas with the taxable brokerage account, only the gains/distributions would be taxed?

Click to expand...

Are you talking about a non-deductible TIRA? If so...

1. The conversion would be fully or partially taxed (at your highest marginal tax bracket rate) under the pro-rata rule if you have any pre-tax TIRAs in your name.


2. Only the growth would be taxed if you have no pre-tax TIRAs in your name.

Yes, with a taxable brokerage account, not only is only the growth in the account subject to tax but you are also paying tax at favorable rates for dividends and LTCG's.

[DMFA]

Ideally you should lump-sum $5,500 in early January each year. Where you build up the money in the interim, whether cash savings, taxable investments, or something else, is less important. We just put $1000/mo into savings and contribute from there (leaving $1000 extra at year-end, no biggie).

[hightower]

jfoxcpacfp wrote:

hightower wrote:

Maybe someone else could answer this, because I don’t know the answer, but if you put $5500 in a traditional IRA and it earned even a small gain or distribution, would the entire $5500+ be taxed when you convert it to a roth?  In other words, would the $5500 be actually taxed twice (once when you earn it from your paycheck and again when you convert it to a roth?)?

Whereas with the taxable brokerage account, only the gains/distributions would be taxed?

Click to expand…

Are you talking about a non-deductible TIRA? If so…

1. The conversion would be fully or partially taxed (at your highest marginal tax bracket rate) under the pro-rata rule if you have any pre-tax TIRAs in your name.


2. Only the growth would be taxed if you have no pre-tax TIRAs in your name.

Yes, with a taxable brokerage account, not only is only the growth in the account subject to tax but you are also paying tax at favorable rates for dividends and LTCG’s.

Click to expand...

Yes I was talking about non-deductible Trad IRAs.  So you would pay more in taxes under the pro-rata rule because you'd be taxed at your highest marginal tax bracket rate?  So, it makes more sense to use a taxable brokerage account because those earnings would be taxed at the lower dividend/LTCG rates.  That makes sense

[shish18]

hightower wrote:

jfoxcpacfp wrote:

hightower wrote:

Maybe someone else could answer this, because I don’t know the answer, but if you put $5500 in a traditional IRA and it earned even a small gain or distribution, would the entire $5500+ be taxed when you convert it to a roth?  In other words, would the $5500 be actually taxed twice (once when you earn it from your paycheck and again when you convert it to a roth?)?

Whereas with the taxable brokerage account, only the gains/distributions would be taxed?

Click to expand…

Are you talking about a non-deductible TIRA? If so…

1. The conversion would be fully or partially taxed (at your highest marginal tax bracket rate) under the pro-rata rule if you have any pre-tax TIRAs in your name.


2. Only the growth would be taxed if you have no pre-tax TIRAs in your name.

Yes, with a taxable brokerage account, not only is only the growth in the account subject to tax but you are also paying tax at favorable rates for dividends and LTCG’s.

Click to expand…

Yes I was talking about non-deductible Trad IRAs.  So you would pay more in taxes under the pro-rata rule because you’d be taxed at your highest marginal tax bracket rate?  So, it makes more sense to use a taxable brokerage account because those earnings would be taxed at the lower dividend/LTCG rates.  That makes sense

Click to expand...

So based on what I am hearing. It seems like the best way to avoid taxes on any gains and to be able to contribute monthly is to do a conversion monthly like hightower mentioned he/she used to do. 2nd best if you want to make one conversion per year is to keep in a taxable brokerage account and have lower capital gains tax rate. 3rd would be to keep it in a TIRA where the growth would be taxed at marginal tax rate. Got it. Thanks all for the clarification.

[jfoxcpacfp]

hightower wrote:

Yes I was talking about non-deductible Trad IRAs.  So you would pay more in taxes under the pro-rata rule because you’d be taxed at your highest marginal tax bracket rate?  So, it makes more sense to use a taxable brokerage account because those earnings would be taxed at the lower dividend/LTCG rates.  That makes sense

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You would pay more under the pro-rata rule only if you have a pre-tax TIRA. Otherwise, it is better to convert from the nondeductible TIRA to the Roth ("back-door").

[VinGizzi]

Hi,

I'm going to ask this question here because I don't want to ask a question that may have already been answered on a new thread.

Can I convert twice in a year?

I converted earlier this year without maxing out my Roth IRA. I misunderstood some information I was told. I had about 13k in a Trad IRA and didn't realize that it wasn't tax deductible because I opened up an employee sponsored 401k.

I contributed $5,500 in 2015 when I did not have the 401k and took the deduction.

I contributed $5,500 in 2016 when I did have the 401k and could not take the traditional IRA deduction because I did not realized I was unable to take a deduction because I was contributing to an employee sponsored 401k.

I contributed about $1000 in 2017 to Traditional IRA which leaves me with about 13k after some growth. Then I did a Roth conversion for the first time in 2017.

Can I convert again? Am I allowed to do 2 conversions in 1 year? Will I get hit with any extra taxes given that I have converted pre- and post-tax money? I understand that when I fill out the 8608b that I will basically payback the deduction I took for 2015.

Thank You

[jfoxcpacfp]

VinGizzi wrote:

Can I convert again? Am I allowed to do 2 conversions in 1 year? Will I get hit with any extra taxes given that I have converted pre- and post-tax money? I understand that when I fill out the 8608b that I will basically payback the deduction I took for 2015.

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You can make as many Roth IRA conversions in a year as you want. The one-per-year rule applies only to IRA-to-IRA rollovers.

[Dreamgiver]

I personally lump sum everything can be lump-summed at the beginning of the year. Roth IRA, 529, etc..., they all get maxed out first week of january. Just plan on doing that for the future.