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Back door Roth conversion question

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  • Back door Roth conversion question

    Hello! A questions regarding Roth IRA conversions:

    * why is a Roth IRA better than a traditional IRA? I expect my income to decline with time, so why is paying interest up front in my high income bracket better? I cannot seem to grasp the advantage.

    Thank you


  • #2
    A Roth IRA isn't always better. In the general case a traditional IRA is better than a Roth IRA when your current contribution marginal tax rate is higher than your future withdrawal marginal tax rate. A Roth IRA can be better for other circumstances. You might need to access some of the funds earlier than 59 1/2. Two common reasons for this are college expenses and early retirement. With a Roth you can always withdraw contributions tax and penalty free. Even if you might be better off with a traditional IRA, there is a very low MAGI limit for deducting traditional IRA contributions. There is a higher MAGI limit for Roth IRA contributions. Then above this limit only a backdoor Roth is possible.

    Higher income earners with higher current contribution marginal tax rates choose a Roth IRA not because it is better, but because they have no other option for additional tax-advantaged contribution space. You should generally max out an HSA if you have one and pre-tax deferrals to employer plans before a Roth IRA.

    Then there is the benefit of tax diversification. jfoxcpacfp one of our noted CPA/CFP forum members, advocates for a financial plan that will result in significant assets in three buckets. Those buckets are pre-tax, taxable and tax-free. The pre-tax bucket will be subject to ordinary income tax rates on withdrawal and RMDs for the year you turn 70 1/2, the taxable bucket will be subject to the lower capital gains tax rates on sale and well... tax-free are not subject to any taxes. This allows great flexibility to manage your AGI/MAGI in early retirement, post medicare retirement and post SS retirement.


    • #3
      To tag onto spiritrider's excellent advice, another important reason for a Roth is that no RMDs (Required Minimum Distributions) are required at any point in your lifetime. TIRAs, 401k's and 403b's require owners to begin taking RMDs at age 70-1/2 over a schedule designed to empty the account over the owners' lifetimes. Because this is not required of Roth IRA owners, Roth IRAs make a great estate planning tool.

      For example, if you believe your children will be in a higher tax bracket, you might want to take taxable distributions from your TIRAs/401k's/403b's in the lower tax brackets of retirement and pass the Roth IRA accounts along to your children - tax free. Of course, if you are not in the lower tax bracket you think you'll be in during retirement (which I think is highly possible for the folks saving madly in pre-tax accounts), then you can supplement taxable withdrawals with tax-free withdrawals.

      Just be sure to recognize that all speculation about future tax brackets is just that, so, the more flexibility you can have to control your taxable income in retirement, the better.
      My passion is protecting clients and others from predatory and ignorant advisors 270-247-6087 for CPA clients (we are Flat Fee for both CPA & Fee-Only Financial Planning)
      Johanna Fox, CPA, CFP is affiliated with Wrenne Financial for financial planning clients


      • #4

        Hello! A questions regarding Roth IRA conversions: * why is a Roth IRA better than a traditional IRA? I expect my income to decline with time, so why is paying interest up front in my high income bracket better? I cannot seem to grasp the advantage.
        Click to expand...

        Your question does not apply to the Backdoor Roth, which is an investment made in lieu of additional taxable investments.

        The advantage is that the money will grow tax free without tax drag. If that $5,500 ($11,00 for a couple) were invested in a taxable account instead, you'd pay capital gains and state income taxes on dividends and capital gains distributed from the investments. The disadvantage is that you cannot access the growth of that money in the Roth, only the contribution, until you're 59.5 at which point you can access both.

        The question of Roth vs. Traditional investments in your retirement accounts (401(k) and similar) depends on factors mentioned above, namely your current marginal tax bracket and your best prediction of your future marginal tax bracket. I take every deduction possible. The only Roth contributions I make are via the Backdoor.





        • #5
          You had two different questions as POF pointed out.

          The Roth vs Traditional question has many flavors as pointed out above.  The biggest as one's portfolio grows over the years is retirement and estate planning.  More often than not, many here will be challenged with how to be most efficient with their dollars.

          Roth IRA has no RMD and tax free to future generation.

          In our situation, we have a lot of tax deferred 401k/403b/457 amounts that will generate high amounts of RMD to add to the pensions; so the Roth makes a valuable asset to bring in as needed/if needed.



          • #6
            WCICON24 EarlyBird
            Anyone can contribute to traditional IRA. Most of us *can't* deduct traditional IRA contributions because we make too much money and have employer accounts.

            Anyone can convert traditional to Roth IRA. Most of us also *can't* make Roth IRA contributions because we make too much. If any of that traditional IRA money hasn't had taxes paid on it, such as if it was deducted or if it was earned from the investment, then it gets taxed on conversion to Roth.

            Therefore, the only way to get a tax-advantaged IRA is to make a traditional IRA contribution, don't deduct it, and convert it to Roth prior to its earning anything. Hence the "backdoor Roth."

            Roth is always preferable to taxable since why pay any taxes is you can pay none ever? Roth is probably not preferable to Traditional for high earners for whom the deduction is worth 40% now to be taxed at 25% in retirement. So if your only option is Roth or taxable, then Roth all the way, but if it's Roth vs Traditional, that's a slightly more complex and individualized decision.

            If you have any money in pretax IRAs that's not converted at the end of the year, then the conversion is taxed as a percentage of the whole, meaning it can basically be double-taxed. So if you have a high traditional or SEP IRA balance that you're not converting (and paying taxes on) or rolling into a 401(k), then the conversion is cost-prohibitive.

            I promise this isn't as complicated as some of us might make this seem.