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  • SIMPLE IRA converting to backdoor Roth IRA

    I am an owner of a small practice and currently offer a SIMPLE IRA for myself and my employees. Every year I contribute the maximum that I can ($12,500).  I would love to do a backdoor Roth IRA and know that I need to "zero" my SIMPLE IRA. Currently I have $84,000 in my SIMPLE and know that I will need to pay taxes on it. But what is the best way to go about doing this? Do I just need to make sure everything is transferred to a traditional IRA first, then to a Roth IRA? Or can I go straight from the SIMPLE IRA to a Roth IRA? I want to make sure I do this correctly so I'm not hit with additional taxes.

  • #2
    The only taxable event is distributing from a pretax IRA, including converting to Roth. However, if you have any other pretax retirement account, such as a 401(k), you can do a rollover (pretax to pretax) which has no tax consequence.

    If you are self employed and can start an individual (one-participant aka solo) 401(k) which accepts incoming rollovers, then you can just rollover your SEP into it. That enables you to do backdoor Roth without pro rata taxation. You can do this with any amount of self-employed (1099) income from stuff as simple as taking online surveys, for instance.

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    • #3
      You will pay taxes on the conversion of the SIMPLE to a Roth, which you should be able to do in one step. You have a couple of options and I recommend some tax planning before converting it all in one fell swoop. You may want to convert over a period of 2 or 3 years, iow, depending upon how much space you have at the top of your tax bracket. Of course, there may be positive or negative growth during that period, which will affect the rollover amount.

      If you choose to go the extended route for converting, you can still contribute the maximum annually ($5,500 or $6,500 if age 50+) to a non-deductible IRA and wait to convert the total amount until you have finished moving the SIMPLE to a Roth. That way, you don't miss a year of IRA space and you will owe taxes only on the growth when you convert. You can also contribute to a spousal IRA if applicable.

      The only caveat is not to convert in the two years since starting the SIMPLE or you will owe a 25% penalty. I don't believe that is the case, given that you stated "every year", but I am adding this for the benefit of other readers.

      This is one of the rare times I disagree with DMFA. While a SOLO-k is good for most of these situations, in yours, it won't work. Because you already have employees and would be 100% owner of both businesses, they would be considered eligible for benefits under any 401k you establish. Otherwise, anyone with a business could just start a side business and use that to exclude employees from their retirement plans. (DMFA , I am positive you know better and just had a period of temporary forgetfulness   )
      Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

      Comment


      • #4
        Why would you want to convert and pay the taxes?  Is it just so you can do a backdoor Roth in future years?

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        • #5
          @ jfoxcpacfp, Yes, the SIMPLE has been open longer than 2 year. The first deposit was made in November of 2014. So I can roll it over without the 25% penalty. So are you saying if I open a solo 401K for a separate job (AKA online surveys like WCI stated), then I would be subject to a match for my current employees...even if they aren't a part of the separate job? I would not be the sole owner of the online survey income, just the sole owner of my practice.

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          • #6
            @ Donnie, Ideally I would like to not have to pay taxes if I can avoid it. However, over the long term, having my account grow tax free would be a huge benefit and in my mind, outweigh the costs of converting if needed. I am currently 33 years old, so it would be growing for around 30 years tax free.

            Comment


            • #7




              @ Donnie, Ideally I would like to not have to pay taxes if I can avoid it. However, over the long term, having my account grow tax free would be a huge benefit and in my mind, outweigh the costs of converting if needed. I am currently 33 years old, so it would be growing for around 30 years tax free.
              Click to expand...


              I would definitely run the numbers to make sure it is worth it before signing up for a $25k tax bill.

              Comment


              • #8


                So are you saying if I open a solo 401K for a separate job (AKA online surveys like WCI stated), then I would be subject to a match for my current employees…even if they aren’t a part of the separate job? I would not be the sole owner of the online survey income, just the sole owner of my practice.
                Click to expand...


                Who would be the other owner of the online survey income? You mean you're setting up a business for this with other partners?
                Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

                Comment


                • #9
                  Though you only mention one Simple IRA, if you have additional Simple IRA, the IRS will look at the total Simple IRA amount with respect to a Roth IRA conversion.  This is an issue for my wife who has two separate Simple IRA's which extends the Roth IRA conversion time based on value and a desire not eat a higher marginal tax rate.  As other have stated for the conversion from Simple to Roth, you will have pay taxes (i.e. recognize income).  As such you will need to determine (based on your marginal tax rate) the amount of conversion (income) you can recognize without going into a higher marginal tax rate.  As an example:

                  Simple IRA value (eligible for conversion): 60k

                  2017 taxable Income (estimate): $385K (33% marginal tax bracket)

                  In order to stay within the 33% marginal tax bracket limit of $418.4k (reference: tax policy institute), you could recognize up to 33.4k (418.4k - 385k) of Simple IRA conversion value to a Roth.  This translates into about 11k of additional federal income tax paid (state will also get additional tax revenue, unless you live in a state without income tax) to convert 33.4 (56% of the Simple IRA).

                  Comment


                  • #10
                    @jfoxcpacfp, This could be through another company such as SurveySavvy. So I would have no ownership in the business.

                    Comment


                    • #11
                      @ajm184, I agree I will have to run the numbers before I convert everything. The good (and bad) news is that I will most likely be in the 39.6% tax bracket for the foreseen future. That is where I have been for the last 3 years and am on target for this year as well.

                      Comment


                      • #12




                        @ajm184, I agree I will have to run the numbers before I convert everything. The good (and bad) news is that I will most likely be in the 39.6% tax bracket for the foreseen future. That is where I have been for the last 3 years and am on target for this year as well.
                        Click to expand...


                        At the highest marginal tax rate, I would have a discussion with your accountant/tax/financial planner person around converting.  An upfront decision in conversion of taxable to non-taxable is your expected tax rate in retirement.  Unless there is a strong expectation of either remaining in the top tax bracket in retirement or an increase in the top marginal tax rate, the conversion decision becomes more difficult from financial standpoint.  There are addition differences in the two type of retirement accounts also that maybe a consideration to you (required minimum distributions for example).

                        I realize you are young and can pay the tax.  The tax amount you would potentially pay (at the highest marginal tax rate) also represents an opportunity cost that would need to be calculated/modeled with the the growth of a Simple IRA versus growth of a non-taxable Roth IRA.

                        Comment


                        • #13




                          @jfoxcpacfp, This could be through another company such as SurveySavvy. So I would have no ownership in the business.
                          Click to expand...


                          Any 1099 income makes you 100% owner of your own 'business' even if it is just a sole proprietorship.  Therefore, this creates a controlled group so you can't use this income for opening a separate plan that does not include the employees of the main practice.
                          Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

                          Comment


                          • #14




                            You will pay taxes on the conversion of the SIMPLE to a Roth, which you should be able to do in one step. You have a couple of options and I recommend some tax planning before converting it all in one fell swoop. You may want to convert over a period of 2 or 3 years, iow, depending upon how much space you have at the top of your tax bracket. Of course, there may be positive or negative growth during that period, which will affect the rollover amount.

                            If you choose to go the extended route for converting, you can still contribute the maximum annually ($5,500 or $6,500 if age 50+) to a non-deductible IRA and wait to convert the total amount until you have finished moving the SIMPLE to a Roth. That way, you don’t miss a year of IRA space and you will owe taxes only on the growth when you convert. You can also contribute to a spousal IRA if applicable.

                            The only caveat is not to convert in the two years since starting the SIMPLE or you will owe a 25% penalty. I don’t believe that is the case, given that you stated “every year”, but I am adding this for the benefit of other readers.

                            This is one of the rare times I disagree with DMFA. While a SOLO-k is good for most of these situations, in yours, it won’t work. Because you already have employees and would be 100% owner of both businesses, they would be considered eligible for benefits under any 401k you establish. Otherwise, anyone with a business could just start a side business and use that to exclude employees from their retirement plans. (DMFA , I am positive you know better and just had a period of temporary forgetfulness   )
                            Click to expand...


                            I still fail to see how converting parts of SIMPLE to Roth avoids pro-rata taxation given the rest of the money is still invested in a SIMPLE.  Yes, you can move SIMPLE money to an IRA after 2 years, but it becomes a giant mess of pro-rata taxation in my opinion.  Not only that but you have to track the 2 years accurately, and initiate annual transactions/transfers, which is paperwork.  I would much prefer to wait until one can set up a 401k plan, and then move the SIMPLE money into the 401k, and do the backdoor Roth contributions thereafter.  One can also make non-deductible Traditional IRA contributions in the meanwhile, but any gains will be taxable on conversion, though this might be fine if the 401k option is something that will be viable in the near future.
                            Kon Litovsky, Principal, Litovsky Asset Management | [email protected] | 401k and Cash Balance plans for solo and group practices, fixed/flat fee, no AUM fees

                            Comment


                            • #15







                              You will pay taxes on the conversion of the SIMPLE to a Roth, which you should be able to do in one step. You have a couple of options and I recommend some tax planning before converting it all in one fell swoop. You may want to convert over a period of 2 or 3 years, iow, depending upon how much space you have at the top of your tax bracket. Of course, there may be positive or negative growth during that period, which will affect the rollover amount.

                              If you choose to go the extended route for converting, you can still contribute the maximum annually ($5,500 or $6,500 if age 50+) to a non-deductible IRA and wait to convert the total amount until you have finished moving the SIMPLE to a Roth. That way, you don’t miss a year of IRA space and you will owe taxes only on the growth when you convert. You can also contribute to a spousal IRA if applicable.

                              The only caveat is not to convert in the two years since starting the SIMPLE or you will owe a 25% penalty. I don’t believe that is the case, given that you stated “every year”, but I am adding this for the benefit of other readers.

                              This is one of the rare times I disagree with DMFA. While a SOLO-k is good for most of these situations, in yours, it won’t work. Because you already have employees and would be 100% owner of both businesses, they would be considered eligible for benefits under any 401k you establish. Otherwise, anyone with a business could just start a side business and use that to exclude employees from their retirement plans. (DMFA , I am positive you know better and just had a period of temporary forgetfulness   )
                              Click to expand…


                              I still fail to see how converting parts of SIMPLE to Roth avoids pro-rata taxation given the rest of the money is still invested in a SIMPLE.  Yes, you can move SIMPLE money to an IRA after 2 years, but it becomes a giant mess of pro-rata taxation in my opinion.  Not only that but you have to track the 2 years accurately, and initiate annual transactions/transfers, which is paperwork.  I would much prefer to wait until one can set up a 401k plan, and then move the SIMPLE money into the 401k, and do the backdoor Roth contributions thereafter.  One can also make non-deductible Traditional IRA contributions in the meanwhile, but any gains will be taxable on conversion, though this might be fine if the 401k option is something that will be viable in the near future.
                              Click to expand...


                              As I said...


                              you can still contribute the maximum annually ($5,500 or $6,500 if age 50+) to a non-deductible IRA and wait to convert the total amount until you have finished moving the SIMPLE to a Roth. That way, you don’t miss a year of IRA space and you will owe taxes only on the growth when you convert. You can also contribute to a spousal IRA if applicable.
                              Click to expand...


                              No pro-rata taxation. I said nothing about converting parts of the SIMPLE to a Roth in the context of a backdoor Roth IRA conversion.
                              Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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