Backdoor roth IRA question?

[Whereismynorco]

hey guys
need some clarification on backdoor ira, hopefully you guys can clarify my confusion.
I have approx 50k each in traditional and roth IRA (previous rolled over 401k to roth account ) invested in Target Retirement funds.
and this year i want to do back door roth ira.
my question and confusions:
1. I believe i have to roll over traditional IRA account to my current 401k account, making it balance zero @ traditional ira account, if i want to do back door roth ira???rt? yes or no? do i have to pay any taxes on this roll over amount? and how much taxes if i have to on 50k?
2. so now once I am done with step 1 , I make contribution of $5500 to my traditional ira and transfer that to roth ira in few days. rt? Do I have to pay any taxes on this transfer?

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[Momus]

1. No tax. Trad IRA and trad 401k is the same, pre-tax money.
2. No tax. Contribution to IRA is non deductible if your income is high enough and you max out 401k yrly. Then, you convert to Roth IRA a day after the account posted so you don't have any gain.

Some brokerage might charge a fee of $30-50 when you transfer/roll over.

 

[pezdispenser]

1. Yes, roll-in your traditional IRA to your 401k. Contact your 401k provider and have them transfer the money directly so that no taxes are withheld.

2. Correct. There are no taxes when you make the transfer from a traditional to Roth IRA, but you must declare the $5,500 as a nondeductible contribution using Form 8606 Part I on that year's tax return, then declare the conversion to a Roth on Form 8606 Part II. I had a friend screw this up and the IRS sent a letter charging full tax ($1,540) on the amount by default. Had to refile Form 8606.

 

[Monsterdaddy]

Do the benefits of a back door Roth IRA outweigh the loss of flexibility of a Traditional IRA? Most 401(k) are very limited in what you can invest in. For example, my IRA account allows trading in the stock market whereas none of the three 401(k) I have allow that. You can move your IRA around too, i.e. Vanguard if you seek low expenses.

I decided it wasn't worthwhile and I'm glad I didn't. I made much more money with the recent stock market run up buying leveraged ETFs. I may consider covered call writing too as a hedge.

 

[HouTX]

pez is correct. you will be taxed on your traditional if you try to do a backdoor roth. follow his instructions to avoid taxation.

 

[Whereismynorco]

one question
i have to do step 1 (emptying my traditional IRA account) to do backdoor roth IRA. I can not skip step 1 and do just conversion without paying taxes/penalty. ??rt?

 

[pezdispenser]

one question
i have to do step 1 (emptying my traditional IRA account) to do backdoor roth IRA. I can not skip step 1 and do just conversion without paying taxes/penalty. ??rt?

Right. If you left the traditional IRA there, you would have to pay taxes in proportion to that. So if you have $50k pre-tax in Trad IRA, then make a $5,500 nondeductible contribution, then convert $5,500 to Roth, you would have to pay taxes on $50,000/$55,500 = 90.09% of your $5,500 conversion = $4,954.95, so the taxes will be 28% of that = $1,387.

 

[pezdispenser]

Do the benefits of a back door Roth IRA outweigh the loss of flexibility of a Traditional IRA? Most 401(k) are very limited in what you can invest in. For example, my IRA account allows trading in the stock market whereas none of the three 401(k) I have allow that. You can move your IRA around too, i.e. Vanguard if you seek low expenses.

I decided it wasn't worthwhile and I'm glad I didn't. I made much more money with the recent stock market run up buying leveraged ETFs. I may consider covered call writing too as a hedge.

It depends on your personal circumstances and intentions. My goal was to build up a decent amount in my Roth IRA and use that money to trade stocks, while also maxing out my 401k to build a solid foundation in index funds. The S&P 500 Index Fund in my 401k has a super low expense ratio of 0.02%. The advantage is the Roth is completely tax free whereas with a traditional, you still have to pay taxes when you withdraw. So if you are expecting massive returns from your investments, don't you think a Roth would be better than a Trad IRA? You could even consider converting your Trad IRA to a Roth, which means paying tax on the smaller principal now so that you won't have to pay taxes on the larger grown and compounded amount later. Of course, this is not considering the tax rate which is another debate altogether.

 

[Monsterdaddy]

It depends on your personal circumstances and intentions. My goal was to build up a decent amount in my Roth IRA and use that money to trade stocks, while also maxing out my 401k to build a solid foundation in index funds. The S&P 500 Index Fund in my 401k has a super low expense ratio of 0.02%. The advantage is the Roth is completely tax free whereas with a traditional, you still have to pay taxes when you withdraw. So if you are expecting massive returns from your investments, don't you think a Roth would be better than a Trad IRA? You could even consider converting your Trad IRA to a Roth, which means paying tax on the smaller principal now so that you won't have to pay taxes on the larger grown and compounded amount later. Of course, this is not considering the tax rate which is another debate altogether.

All good points. For me it was a question of critical mass. I started an IRA at 18 before Roth was created and rolled in old 401(k) and pensions. Having a larger balance enables me to trade more efficiently -- lower % is eaten up by commissions, writing covered calls, etc. (My Trad IRA balance is like 8x my Roth) So I could get better returns on a Trad IRA vs Roth doing the same strategies most of the time.

I do like that you can bequeath a Roth IRA to heirs which is a nice benefit over a Trad IRA which can be a massive tax bomb. Most people say withdraw Roth IRA money before Trad but if you can withdraw Trad money at 15% vs. a potential 39.6% at death, I would do the Trad IRA.

For the OP, having $5500 extra in a Roth IRA vs. $50,000 in a Trad IRA vs. 401(k) really depends on investment strategy. Probably should Google 401(k) vs Trad IRA and see what benefits you would care about.

 

[Whereismynorco]

It depends on your personal circumstances and intentions. My goal was to build up a decent amount in my Roth IRA and use that money to trade stocks, while also maxing out my 401k to build a solid foundation in index funds. The S&P 500 Index Fund in my 401k has a super low expense ratio of 0.02%. The advantage is the Roth is completely tax free whereas with a traditional, you still have to pay taxes when you withdraw. So if you are expecting massive returns from your investments, don't you think a Roth would be better than a Trad IRA? You could even consider converting your Trad IRA to a Roth, which means paying tax on the smaller principal now so that you won't have to pay taxes on the larger grown and compounded amount later. Of course, this is not considering the tax rate which is another debate altogether.

I am little on the fence @ back door roth ira. i have read many articles and investment strategies but most will say you should consider tax rate when you are deciding roth or traditional or whether you want to do the back door roth ira. For most people tax bracket will be lower in retirement than now. so if you put that into consideration wouldn't be better to keep the money in traditional. why go to do this all hoops.

 

[Jamesla30]

I am little on the fence @ back door roth ira. i have read many articles and investment strategies but most will say you should consider tax rate when you are deciding roth or traditional or whether you want to do the back door roth ira. For most people tax bracket will be lower in retirement than now. so if you put that into consideration wouldn't be better to keep the money in traditional. why go to do this all hoops.

What do you expect your AGI to be for the foreseeable future? Are you married (filing jointly)? Also, do have a 401k at work and what is the match?

 

[Whereismynorco]

What do you expect your AGI to be for the foreseeable future? Are you married (filing jointly)? Also, do have a 401k at work and what is the match?

It will go down as one of us will go part time in future. and yes i file jointly. I max out my 401k and HSA and my company match up to 5%

 

[Jamesla30]

It will go down as one of us will go part time in future. and yes i file jointly. I max out my 401k and HSA and my company match up to 5%

What is your family's yearly income (AGI)? This will help me see where your tax rates fall. Also, when you say you max out your 401k does that mean just up to the match or you put in $18k/year plus the match?

 

[Whereismynorco]

What is your family's yearly income (AGI)? This will help me see where your tax rates fall. Also, when you say you max out your 401k does that mean just up to the match or you put in $18k/year plus the match?

right now its between 200 -250k so 28% tax bracket. I meant 18k/year before match. so total 36k/year for both.

 

[Momus]

right now its between 200 -250k so 28% tax bracket. I meant 18k/year before match. so total 36k/year for both.

Tiny savings for 250k/yr income... Use the backdoor Roth to save more to shelter your capital gain from IRS.
I'd aim minimum 20% savings for retirement. I save about 60% of my gross yearly. This is hard to do so I don't encourage this for everyone.

 

[BMBiology]

I stopped putting money in my ROTH IRA since last year.

I don't plan to work until I am 65. I hate to put my money into an account for 30 years when there is not that much tax benefits.

Instead, I am maxing out my 401 k ($18 k) plus $7 k in matches and maxing out my HSA ($3 k). That is $28 k a year in my retirement accounts.

Sent from my iPhone using SDN mobile app

 

[Jamesla30]

right now its between 200 -250k so 28% tax bracket. I meant 18k/year before match. so total 36k/year for both.

I am in a very similar tax situation, although in a higher bracket. I have researched all of these things in depth.

You are doing just fine. Keep doing what you are doing. Max out 401k's, max out HSA (if eligible). Look into 529 contributions if you have kids and you get state tax benefits.

Then, YES, I would definitely do the backdoor ROTH if you want to put a little more savings away (right now it would be $5500/year for you and $5500 for spouse). Keep in mind your income is too high to get a deduction for a traditional IRA contribution anyway. So the only choice is ROTH. You will make a "non-deductible" contribution to your TIRA, and then immediately roll that over to your ROTH. Before doing any of that, you need to transfer all of your TIRA money to your 401k so you aren't hit with taxes when you do your ROTH. Your TIRA balance should be zero before doing anything. Then contribute and do the rollover all at once.

You might research advantages/disadvantages of TIRA vs. 401k, but usually they are minimal. The only time I would suggest not combining is if there isn't many good (or cheap) investment options through your 401k. Most of the time you will be fine.

When you are deciding between TIRA vs. ROTH, it really isn't going to matter much until you get into higher tax brackets ($400k+ income). Trust me I have done the calculations. Once you reach that you will want to lean towards TIRA. But really you don't need to worry about this at all unless your 401k has ROTH options. If all your work offers is Traditional 401k, then max it out. Then do the backdoor ROTH contributions for your individual IRA. If you want to save more, dump it into a taxable investment account.

If you retire early and have lower tax brackets, you can covert a little of your traditional IRA (or 401k) to your ROTH every year, just keep it in the 25% (or preferably 15%) each year. This is called an IRA conversion ladder.

Don't worry so much, you are doing it exactly right. Keep doing it and you'll be living a great retirement.

 

[pezdispenser]

I am little on the fence @ back door roth ira. i have read many articles and investment strategies but most will say you should consider tax rate when you are deciding roth or traditional or whether you want to do the back door roth ira. For most people tax bracket will be lower in retirement than now. so if you put that into consideration wouldn't be better to keep the money in traditional. why go to do this all hoops.

It's true that most of the time, 401k or traditional IRA are better than Roth. So I usually recommend maxing out your 401k at $18,000 first. Then if you still want to save more (usual goal 15-20% of gross income), you can choose between:

- Roth or backdoor Roth using $5,500 after-tax money, so no additional taxes are due, and the principal and all earnings are completely tax free. You can even have a brokerage account in your Roth to trade stocks and options tax free.

- Taxable investing where you pay taxes on your dividends every year, and capital gains whenever you sell. However, since 2008 there has been a 0% long-term capital gains tax rate if your taxable income is below 38k single, 76k married. This may or may not be there in the future when you want to make withdrawals, so there is more risk with this strategy than doing the Roth which is quite unlikely that they will change the taxation on. Besides, it's only $5,500 so you'll probably blow through that and move on to taxable investing anyway.

 

[Whereismynorco]

so to follow up with my back door IRA conversion, i am done with my all the steps (emptying my tIRa) except the part where i have to make to contribution for 2017. Can I make contribution now and convert after a week or so OR do i have to wait for January,do contribution and conversion to Roth for 2017?

 

[pezdispenser]

You can make the contribution and conversion now. All that really matters is that you have no pretax balance in any traditional IRA on the last day of the year.