Backdoor Roth IRA options and questions

[spartywrx]

Hello WCI forum! First post. Fan of the book and the blog. I evangelize for WCI with all of my medical friends whenever they ask about money.

I am in an orthopedic fellowship this year. The fellowship ends in August. We (wife and I) currently max out our Roth IRAs, her Roth 401k, my 403b, HSA, and we save in a 529 for our children (we are blessed that she is still able to be working!). In 2017, our income level was qualified to contribute to a Roth IRA. This year after signing a contract (probably in March) and starting a real job in September, I anticipate we will be over the Roth income limit for 2018 by the end of the year. In attempting to do the backdoor Roth for 2018, we don't have the $11000 up front to do it all at once.  Usually we contribute a little per month up to the Roth limit as income comes in through the year and by the end of the year it is fully funded.

I’m thinking of 3 options:

1.) Store the money in my bank account as it comes in, earning 0.25% interest until it reaches 5500, then proceed with the backdoor Roth for my wife and then repeating for myself. Safest yet not in the market for a longer period.

2.) Contribute non-deductible contributions monthly to our T-IRA (buying index funds) until they hit 5500 and then backdoor convert to a Roth. This would get money into the market, but short term capital gains would be taxed and I’m not sure what would happen. I have the feeling calculating taxes owed on this would be messy with monthly contributions.

3.) Contribute monthly to my brokerage account and buy similar commission free ETFs to what I would have in my IRA. Once this hits $5500, sell and do the backdoor Roth. Short term capital gains would be owed on any gains. I anticipate that I would make more than 0.25% in my checking account and I would also be able to beat inflation, but if the bubble pops then I have some tax loss harvesting to do.

Any thoughts on which method would be the best balance between getting money into the market sooner and the least headache when doing the backdoor Roth at the end of 2018? Or am I worrying too much about this and just need to do option 1 and relax a little?

Thanks for all comments and replies.

[DMFA]

spartywrx wrote:

2.) Contribute non-deductible contributions monthly to our T-IRA (buying index funds) until they hit 5500 and then backdoor convert to a Roth. This would get money into the market, but short term capital gains would be taxed and I’m not sure what would happen. I have the feeling calculating taxes owed on this would be messy with monthly contributions.

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It wouldn't be STCGs, it would be growth added to your taxable income...so basically the same, but not quite.  Calculating the taxes owed would actually be very easy; amount converted - amount contributed = amount to add to taxable income, p much.  So if you gained $200 by the time you finally hit $5,500, you'd convert the whole thing and pay taxes on your $200 gain.  (Minutiae alert: technically it's not just subtracted but is the total minus the proportion of non-deducted to total rounded to 3 decimal places, but whatever).

Literally any of these is good enough.  Be aware that if you lose what you put into a taxable you can "tax-loss harvest" by selling it and buying a different-enough fund, which you can't do in an IRA...however, that's more risk than leaving it sitting at savings-account rates.

I've never tried it, but I don't see why you couldn't contribute some, convert it, contribute some more, convert it again, etc until you end up at $5,500 of contributions.  Might just be a bit tedious.  I'm not aware of any specific regulations on frequency of conversions allowed.

[ENT Doc]

I'm not saying that I favor the 2nd option but you'd pay at your marginal tax rate on the earnings whether short or long term, in the year of the conversion. What is your marginal rate expected to be this year? Also, you don't have to pay tax at all this year if you roll the earnings into a 401k, assuming your 401k's accept rollovers. Future tax rates on that 401k withdrawal will assuredly be higher so might be better paying the tax now. If markets go up or sideways you still win out compared to the other options.

Any possibility you're in the old taxable brackets to have LT CG taxed at 0? You could sell certain lots in taxable and fund the backdoor Roth immediately and then fill taxable up as the year goes on.

[spartywrx]

ENT Doc wrote:

I’m not saying that I favor the 2nd option but you’d pay at your marginal tax rate on the earnings whether short or long term, in the year of the conversion. What is your marginal rate expected to be this year? Also, you don’t have to pay tax at all this year if you roll the earnings into a 401k, assuming your 401k’s accept rollovers. Future tax rates on that 401k withdrawal will assuredly be higher so might be better paying the tax now. If markets go up or sideways you still win out compared to the other options.

Any possibility you’re in the old taxable brackets to have LT CG taxed at 0? You could sell certain lots in taxable and fund the backdoor Roth immediately and then fill taxable up as the year goes on.

Click to expand...

So right now our top rate is 25% for 2017, and for 2018 I'm guessing it will be in the 32% or if we're lucky 35%. For LTCG we would be in 15%. I took the first step of the backdoor Roth and everything in my T-IRA has been rolled into our 401k/403b. Could I roll the earnings on the money in the nondeductible into the 401k/403b pre tax and convert the 5500 each into our Roths? Not sure about that.

DMFA wrote:

spartywrx wrote:

2.) Contribute non-deductible contributions monthly to our T-IRA (buying index funds) until they hit 5500 and then backdoor convert to a Roth. This would get money into the market, but short term capital gains would be taxed and I’m not sure what would happen. I have the feeling calculating taxes owed on this would be messy with monthly contributions. 

Click to expand…

It wouldn’t be STCGs, it would be growth added to your taxable income…so basically the same, but not quite.  Calculating the taxes owed would actually be very easy; amount converted – amount contributed = amount to add to taxable income, p much.  So if you gained $200 by the time you finally hit $5,500, you’d convert the whole thing and pay taxes on your $200 gain.  (Minutiae alert: technically it’s not just subtracted but is the total minus the proportion of non-deducted to total rounded to 3 decimal places, but whatever).

Literally any of these is good enough.  Be aware that if you lose what you put into a taxable you can “tax-loss harvest” by selling it and buying a different-enough fund, which you can’t do in an IRA…however, that’s more risk than leaving it sitting at savings-account rates.

I’ve never tried it, but I don’t see why you couldn’t contribute some, convert it, contribute some more, convert it again, etc until you end up at $5,500 of contributions.  Might just be a bit tedious.  I’m not aware of any specific regulations on frequency of conversions allowed.

Click to expand...

It doesn't sound so complicated doing #2 but it sounds like a lot of work always converting it. It does sound possible to do though.

 

[jhwkr542]

This sounds like a lot of work for maybe $1k that would get taxed.

[wawot1]

Why don't you just work on maxing out all of your other tax advantaged accounts early in the year (ie get in the market on those) and not earmark anything for the IRAs.  As the year progresses, you've maxed out the other accounts, now the attending paycheck comes in and you can fund the IRAs?

[DMFA]

jhwkr542 wrote:

This sounds like a lot of work for maybe $1k that would get taxed.

Click to expand...

True.  If he invests in the TIRA prior to converting, if there's gains, then he wouldn't have gotten them anyway if he'd waited to contribute.  Then again, if there's losses he can't harvest them, and he can't go back and contribute more than the limit.  However we're talking about small amounts here; say it changes by 20% (a lot for just a few months), that's still $1,100, not a big deal.

wawot1 wrote:

Why don’t you just work on maxing out all of your other tax advantaged accounts early in the year (ie get in the market on those) and not earmark anything for the IRAs.  As the year progresses, you’ve maxed out the other accounts, now the attending paycheck comes in and you can fund the IRAs?

Click to expand...

spartywrx wrote:

We (wife and I) currently max out our Roth IRAs, her Roth 401k, my 403b, HSA, and we save in a 529 for our children (we are blessed that she is still able to be working!).

Click to expand...

Looks like he's already doing that.

[spartywrx]

wawot1 wrote:

Why don’t you just work on maxing out all of your other tax advantaged accounts early in the year (ie get in the market on those) and not earmark anything for the IRAs.  As the year progresses, you’ve maxed out the other accounts, now the attending paycheck comes in and you can fund the IRAs?

Click to expand...

That's a good point. I can prioritize the HSA funding earlier in the year as a "substitute" for trying to fund those backdoor Roths all at once. Once the HSA is funded for the year, then I can move on to funding one backdoor Roth quickly (a savings snowball?). Its a lot simpler than fooling with monthly conversions or buying and selling in a taxable account.

 

I appreciate everyone's thoughts on the subject.

[pulmdoc]

The simple approach is to fund it when you have the cash, probably after you start getting attending paychecks. The mathematically superior (ie more time in market) but more time-intensive approach is to do multiple conversions over the course of the year. The difference between the two approaches may be a couple hundred bucks at most. Then you can fund the backdoor in following Januarys.

[Bonez]

Not to hijack the thread, but your intro paragraph is the similar situation I was in last year around this time. I was in an ortho fellowship last year and then took a month off prior to starting my "real" job. I contributed $5500 right away in January 2017 to a traditional IRA and then converted to my Roth IRA in anticipation of being over the income limit but wanting the $$ to be in there and able to grow over the entire year. The job I eventually took didn't give me a signing bonus and my pay is based on production, so after maxing out my 401k/HSA in just a few months with the new job my income didn't even reach the $189k limit for direct Roth IRA contribution as an unmarried person... I'm assuming in this case I just file taxes as anyone else who did a backdoor Roth IRA (even though in retrospect I could have just directly contributed to Roth IRA)?

[DMFA]

Bonez wrote:

my income didn’t even reach the $189k limit for direct Roth IRA contribution as an unmarried person… I’m assuming in this case I just file taxes as anyone else who did a backdoor Roth IRA (even though in retrospect I could have just directly contributed to Roth IRA)?

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Income limit for single filers starts at $118,000 and drops to zero at $133,000.

Your taxes have to show what you actually did. Money converted to Roth and directly contributed to Roth have fundamental differences in how they're treated in the event of a distribution (see 5-year rule). So you still need to file form 8606 showing that you made a non-deductible contribution, converted it to Roth, nothing was taxable, and you have zero residual basis.

Although I suppose, if you *really* wanted to, you could recharacterize the Roth conversion back to Traditional and then recharacterize the Traditional contribution to Roth...but that's fairly pointless since it's highly unlikely you'll be taking a Roth distribution within the next 5 years, and I *think* you'd end up paying some taxes on it (could be mistaken about the tax though).