Backdoor Roth IRA minutiae

[jfoxcpacfp]

FamilyFirst wrote:

I know I am jumping into this conversation late, but wouldn’t it make more sense to leave 403b money where it is as a high income earner. Then during the early years of retirement when your income is probably lower, you could begin converting however much you wanted each year into a Roth IRA. Therefore you would save even more on taxes in the long run. During those early years of retirement, you may be able to live off whatever Roth money you (and possibly your spouse) have already accrued. Your only taxable income would be the conversion if you were able to make it for 5 years on Roth income while you established the conversion ladder. This is my understanding of how that would work.

A little bit tangential to this thread topic, but I feel like I have heard of this strategy before.

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Maybe, maybe not. And, yes, this strategy has been discussed multiple times on this and other forums.

First of all, remember that you're not going to be converting the same amount of money years into the future as you are today. Hopefully, you are going to invest and manage your account to grow 8 - 10%/year between now and retirement, so you'll be converting a much higher balance. You're also assuming that you will have the same great choices inside your 403b as outside on your own.

That said, I don't recommend non-strategic conversions of pre-tax retirement accounts at peak earnings. The strategy should be to project grow and the tax impact of conversion in the future and to choose optimal conversion years. An optimal conversion year is one in which:

• Your earnings are down (spouse quits working, you go on sabbatical, you leave employment to start your own practice, etc.) and


• The market is down - bear markets (sustained drop of 20%) and corrections (temporary drops of between 10% and 20%) are the ideal times to convert even when you are at the top of your career.
  
  
  
  • Convert as much as you can afford in a bear market.
  
  
  • Make partial conversions in corrections.
  
  
  
  

[q-school]

FamilyFirst wrote:

I know I am jumping into this conversation late, but wouldn’t it make more sense to leave 403b money where it is as a high income earner. Then during the early years of retirement when your income is probably lower, you could begin converting however much you wanted each year into a Roth IRA. Therefore you would save even more on taxes in the long run. During those early years of retirement, you may be able to live off whatever Roth money you (and possibly your spouse) have already accrued. Your only taxable income would be the conversion if you were able to make it for 5 years on Roth income while you established the conversion ladder. This is my understanding of how that would work.

A little bit tangential to this thread topic, but I feel like I have heard of this strategy before.

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eh.  it could work that way.  it could go many different ways.  hard to know for sure.

tax laws may change.  you may work a long time (unimaginable on this site) and work into rmd years.  you may find that you are in a high tax bracket in retirement and can't do much to get out (i'm told this is a good problem to have).  you may want to leave roth for your heirs and be reluctant to tap that asset.  lots of different things can happen between now and retirement.

 

[FamilyFirst]

I know I am jumping into this conversation late, but wouldn't it make more sense to leave 403b money where it is as a high income earner. Then during the early years of retirement when your income is probably lower, you could begin converting however much you wanted each year into a Roth IRA. Therefore you would save even more on taxes in the long run. During those early years of retirement, you may be able to live off whatever Roth money you (and possibly your spouse) have already accrued. Your only taxable income would be the conversion if you were able to make it for 5 years on Roth income while you established the conversion ladder. This is my understanding of how that would work.

A little bit tangential to this thread topic, but I feel like I have heard of this strategy before.

[RogueOne]

I agree with DMFA. While I may be too young to understand the value of mitigating the tax hit of conversion(s) later, I can say that pro rata rule stinks. As the CFP Pointed out above, if your plan is backdoor Roth IRA's then it is ideal to keep your traditional IRA at $0 to avoid paying taxes at the time of conversion.

(Complex to explain, but if there is $1000 in your TIRA, when you put in the $5500 and convert it, the IRS treats at as you moving $5500/$6500 so you pay tax on the ratio (55/65) applied to $5500. (You can't say you're just moving the $5500 intended for the backdoor Roth)).

I came here looking for a better description of the pro rata rule...any one see a WCI post on it?

Personally, I'm hoping to move my TIRA funds to a solo 401k when it's set up so I can maximize the benefit of the backdoor Roth. I think there's little benefit in doing the "backdoor Roth" if you're just paying taxes at the time of conversion from TIRA to RIRA. Thoughts?

A taxable investment account would be better with the hope that you get to pay capital gains taxes as opposed to income tax rates due at conversion. But looking for input from others...I realize compounding helps out the Roth, but it's a big difference in tax rates.

[DMFA]

urologyisgreat wrote:

My income (58k averaged during residency years) enables me to contribute directly to Roth IRA, and I do at maximal level.

My general line of thought here is: I have savings laying around (no debt, of any kind), and an un-used 403b (unused as of yet because my institution doesn’t match my contribution). The options, as I see them, include (all after maxxing out Roth): fund a taxable account vs fund the 403b with plan to roll into TIRA upon termination (I checked with my institution and they will deposit the funds wherever you designate) and backdoor before attending salary kicks in. Maybe both?

My last question about converting periodically vs at once stems from reading in many places that people with a TIRA (and no other types of IRA so as to avoid pro rata rule) will convert into Roth IRA periodically, rather than a lump sum. Aside from being able to pay the taxes on that conversion (if any of the money in the TIRA is pre-tax), is there a reason to convert periodically?

Another question – is funding a TIRA directly treated the same as having funds roll over into the account from a 403b, for instance?

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You do not seem to understand the use of "backdoor" and appear to be confusing it with a simple conversion. Backdoor specifically refers to making a non-deductible TIRA contribution and then converting it to Roth without taxes being due. You are talking about converting pretax money to Roth and hence owing taxes on it. The pro rata rule does not apply when what you are converting is either completely pretax or completely non-deducted.

People with large pretax TIRAs will convert in a piecemeal fashion year-by-year usually to fill up the current tax bracket so as to mitigate the tax hit of doing it all at once. In this instance, making non-deductible TIRA contributions is ill-advised since that already-taxed amount will trigger tax again on conversion since it will be factored in with the pretax amount due to the pro rata rule.

You are trying to make this way too complicated. Take the tax advantage and contribute to your 403b. The current deduction might not be great due to your low income, but the tax-deferred growth will be very useful. Also, you do not need to roll it over when you leave; if you choose to do so, then you can roll it into another employer account (401k or 403b) instead of an IRA and save yourself the headache.

Thing is, though, you can't put already-earned cash into a 403b, only elective salary deferrals. So if you want to invest it, you could put it in taxable, or just hold it as an emergency fund and use it for next year's IRA contribution.

[spiritrider]

Caligirl wrote:

For this year’s backdoor Roth, I’d like to open it with Vanguard instead (because I liked their Index fund options better–I think they’re lower fee).

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Open it at Vanguard if you prefer, but your basic premise is wrong. Vanguard does have more asset classes as index funds than Fidelity. However, for the asset classes they have, Fidelity's expense ratios are <= Vanguard's expense ratios.

 

 

[jfoxcpacfp]

Caligirl wrote:

Thanks! I thought that in order to do a Backdoor RothIRA  we couldn’t have any TIRAs with a balance so I was wondering if it was the same for the Backdoor RothIRA. It sounds like not. THanks again!

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You will be taxed if you have a balance in a pre-tax TIRA. Nondeductible TIRAs are fine because they have "basis". Be sure to file your form 8606 every year.

[Caligirl]

Thanks! I thought that in order to do a Backdoor RothIRA  we couldn't have any TIRAs with a balance so I was wondering if it was the same for the Backdoor RothIRA. It sounds like not. THanks again!

 

 

[jfoxcpacfp]

Caligirl wrote:

Piggybacking another question about Backdoor Roth IRAs onto this post. I opened a backdoor RothIRA with Fidelity for the first time last tax year after learning about it here. For this year’s backdoor Roth, I’d like to open it with Vanguard instead (because I liked their Index fund options better–I think they’re lower fee). So I’m just wondering if I can do this while keeping my old Backdoor Roth IRA open at Fidelity? Or would I have to convert it over to avoid any taxes? For example, right now I kept the TIRA at Fidelity open with 0 balance after the conversion. Thanks.

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You can have as many IRA accounts as you want to keep up with. For simplicity's sake, you might want to eventually combine them by rolling the Fidelity account into the Vanguard. There are no tax implications either way.

[Caligirl]

Piggybacking another question about Backdoor Roth IRAs onto this post. I opened a backdoor RothIRA with Fidelity for the first time last tax year after learning about it here. For this year's backdoor Roth, I'd like to open it with Vanguard instead (because I liked their Index fund options better--I think they're lower fee). So I'm just wondering if I can do this while keeping my old Backdoor Roth IRA open at Fidelity? Or would I have to convert it over to avoid any taxes? For example, right now I kept the TIRA at Fidelity open with 0 balance after the conversion. Thanks.

[jfoxcpacfp]

@DMFA has answered most of your questions. Your income will (probably) never be lower than it is right now, so you are at the optimal point to contribute to a Roth IRA and convert at least some of your pre-tax IRA account(s). You'll need a tax projection to help determine how much to convert.

A backdoor Roth is only used if your income is too high to make a traditional Roth contribution impossible. If you convert enough $$ this year, you may have to go the backdoor route.

Periodic TIRA conversions are strategic, based upon your goals, tax bracket, market conditions, and so forth.

I don't really understand your last question. Funding a TIRA directly is either a deductible or nondeductible transaction. Rolling funds over from a 403b to a TIRA is a transfer from one pre-tax account to another. There are no tax consequences. If you chose to r/o to a Roth IRA instead of a TIRA, you would owe taxes at that point.

Explaining Backdoor Roth IRAs

[urologyisgreat]

My income (58k averaged during residency years) enables me to contribute directly to Roth IRA, and I do at maximal level.

My general line of thought here is: I have savings laying around (no debt, of any kind), and an un-used 403b (unused as of yet because my institution doesn't match my contribution). The options, as I see them, include (all after maxxing out Roth): fund a taxable account vs fund the 403b with plan to roll into TIRA upon termination (I checked with my institution and they will deposit the funds wherever you designate) and backdoor before attending salary kicks in. Maybe both?

My last question about converting periodically vs at once stems from reading in many places that people with a TIRA (and no other types of IRA so as to avoid pro rata rule) will convert into Roth IRA periodically, rather than a lump sum. Aside from being able to pay the taxes on that conversion (if any of the money in the TIRA is pre-tax), is there a reason to convert periodically?

Another question - is funding a TIRA directly treated the same as having funds roll over into the account from a 403b, for instance?

[DMFA]

urologyisgreat wrote:

A few questions regarding back door Roth IRA. I have a Roth IRA (maxed out) at Vanguard currently. No other IRAs, and an unexercised option to invest in 403b where I work.

1. Are Roth IRA direct contributions and conversions mutually exclusive processes? Can I contribute usual 5500 AND convert any amount I wish in the same tax year?

2. When converting from a tax-deffered account, you pay tax – is this your marginal tax rate? effective fed income tax rate?

3. If it is marginal tax rate, would it be wise to max out 403b at 18k, throw in some HSA funding that year, and convert so my marginal tax rate is as low as can be? I would have savings helping me get through that year.

3. Would it be smarter to take my current post-tax dollars and put into TIRA, and eventually convert? OR, pursue the 403b? My institution does not match.

4. Keep open a TIRA at vanguard just for the heck of it? Upsides or downsides?

5. Why convert periodically and not at once?

Thank you everyeone!

 

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1. You can convert any amount, but you can only contribute $5,500 to all Traditional and Roth IRAs combined for a tax year.

2. Marginal. It adds to your income on your 1040. Everything is taxed at the marginal rate when it adds onto your income.

3. Conversions should be made at the lowest tax bracket possible. You should generally be maxing tax-advantaged accounts (probably pretax) anyway, as well as backdoor Roth.

3 again. If they're going to end up in Roth anyway, there's no sense in waiting to convert. I doubt you can move your 403b into a Roth IRA, though. Most plans don't allow in-service rollovers, and if you can contribute directly to Roth IRA, you should just do that...and, if you make too much to contribute directly to Roth IRA, you should be making enough to max 403b and backdoor Roth IRA.

4. It helps to leave the $0 account open just to save the trouble of opening a new one each year. Again, if you can contribute directly to Roth, a TIRA is p much pointless.

5. What? You can only contribute $5,500/yr. Are you saying you would convert several years' contributions together, paying taxes on the earnings, when all those earnings could have been tax-free?

I'm not following your line of reasoning, here. Can you tell us:

• Why you're not finding your 403b, and


• Whether you can make direct Roth contributions based on income?

[urologyisgreat]

A few questions regarding back door Roth IRA. I have a Roth IRA (maxed out) at Vanguard currently. No other IRAs, and an unexercised option to invest in 403b where I work.

1. Are Roth IRA direct contributions and conversions mutually exclusive processes? Can I contribute usual 5500 AND convert any amount I wish in the same tax year?

2. When converting from a tax-deffered account, you pay tax - is this your marginal tax rate? effective fed income tax rate?

3. If it is marginal tax rate, would it be wise to max out 403b at 18k, throw in some HSA funding that year, and convert so my marginal tax rate is as low as can be? I would have savings helping me get through that year.

3. Would it be smarter to take my current post-tax dollars and put into TIRA, and eventually convert? OR, pursue the 403b? My institution does not match.

4. Keep open a TIRA at vanguard just for the heck of it? Upsides or downsides?

5. Why convert periodically and not at once?

Thank you everyeone!