What's a backdoor Roth IRA?

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SClENCE

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Let me explain my understanding of the backdoor Roth IRA.

Say I make 120k a year and contribute 18k to a traditional 401k plan, lowering my effective taxable income to 102k.

I can then turn around and put 5.5k of post tax income (part of which could be my tax return for my 18k contribution to the 401k) into a non-deductible IRA and roll it over into my Roth IRA and pay no additional tax on the money.

So I can take full advantage of the tax breaks of the traditional 401k plan and still contribute to a Roth IRA. In addition, I can withdraw contributions to the Roth IRA without penalty or tax at any time (assuming rollovers are considered a contribution).

Is my understanding correct?

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Why not make a deductible contribution to the IRA, then pay the taxes on the conversion to the Roth? This in effect would yield the same result as making a direct contribution to the Roth.
 
Because I would not be able to make a deductible contribution seeing as I have maxed out the contribution limit with my 401k.
 
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Ok I understand.

However, how is this any different/better than contributing to a non-deductible IRA and rolling it over into my Roth IRA?
 
Ok I understand.

However, how is this any different/better than contributing to a non-deductible IRA and rolling it over into my Roth IRA?

Currently for a single person, the traditional IRA deduction phases out starting at MAGI of $60k and is gone by $70k when you have a 401k. Married, it starts phasing out at $96k and gone at $116k.

Roth for a single person can contribute the full amount up to MAGI of $114k, phasing out by $129k. Married people can contribute full up to $181k and phases out at $191k.

If you can contribute straight to a Roth IRA, it removes the need for a backdoor Roth. Just do a regular Roth contribution. It's less hassle, no worries about Form 8606. If you would rather get a tax deduction now and your MAGI falls in the phaseout range, you can put part into the tIRA and the remaining amount into the Roth and still avoid the backdoor conversion part. The backdoor Roth comes into play when your MAGI as single is over $129k and married at $191k.
 
What if your income is in the phase-out range? Can you just do the backdoor to make a 5.5k contribution as opposed to directly contributing a lesser amount?

Here's a better question... so If my salary is 120k a year but I contribute 18k to a 401k, my taxable income is only 102k therefore I wouldn't even be in the phase out range so I could just make a direct contribution of 5.5k?

EDIT: Nevermind - I actually looked up the definition of MAGI and understand that the answer to that question is yes. Thanks for the the explanation!
 
Let me explain my understanding of the backdoor Roth IRA.

Say I make 120k a year and contribute 18k to a traditional 401k plan, lowering my effective taxable income to 102k.

I can then turn around and put 5.5k of post tax income (part of which could be my tax return for my 18k contribution to the 401k) into a non-deductible IRA and roll it over into my Roth IRA and pay no additional tax on the money.

So I can take full advantage of the tax breaks of the traditional 401k plan and still contribute to a Roth IRA. In addition, I can withdraw contributions to the Roth IRA without penalty or tax at any time (assuming rollovers are considered a contribution).

Is my understanding correct?

You've got it. Pretty cool eh?

Just beware of the pro-rata issue and if you're really paranoid, the step doctrine issue.
 
You've got it. Pretty cool eh?

Just beware of the pro-rata issue and if you're really paranoid, the step doctrine issue.

Sorry to revive this old thread, but didn't want to make a new one since my question is about a backdoor Roth IRA. I'm still in the early stages of learning about all retirement options.

I'm about to take an attending job this summer that has both a governmental 457b and a 401k. Should I contribute to both if I only plan to be at that job for 1-2 years and then go on to open my own practice? I'm wondering what the implications are for those accounts once I leave the employer.

Do I still have an option to contribute to a traditional IRA and then rollover to a Roth IRA? Will utilizing the backdoor Roth IRA become harder and harder in the future as I accumulate traditional IRAs?
 
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No, you can keep contributing to the back door Roth as long as you have earned income, unless the government closes the loophole (which Obama threatens to do every year but hasn't done yet.)

The 457 and 401k (probably actually a 403b if it's a government employer) have separate contribution limits, so you can contribute a total of $36,000 for next year ($18,000 to each), assuming you're under age 50. Both of these types of accounts are pre-tax, so that $36,000 gets removed from your taxable income for next year. So say you gross $140,000 from six months of fellowship and six months of your attending job during your first year out (2017). If you max out both accounts, your modified gross for that year will be $140k - $36k = $104k. This means you will not need to do a backdoor Roth next year even if single. So in 2017, you can probably just contribute directly to your Roth (an additional $5500 or possibly $6000 if the contribution amount gets raised next year), using POST-tax money. This is again separate from your two pre-tax accounts.

Your total retirement contributions for 2017 will therefore be $36k pre-tax PLUS $5500 post-tax into your Roth. Starting in 2018, when you work FT as an attending, you will need to start using the backdoor Roth. This can still be done on top of contributing the $36k to your pre-tax accounts; you just put $5500 of post-tax dollars into a traditional IRA, convert it to a Roth, and done. No taxes will be due since you already paid taxes on that money, but you also cannot take a deduction (not that you would ever qualify for a tIRA deduction anyway as an attending).

After you leave your employer, account options vary. The Roth IRA is not through your employer, so it just stays with whatever custodian you select (say, Vanguard or Schwab). After separation, you generally have a few options for the 401k or 403b: 1) roll it into your new employer's 401k/403b (if they offer that option); 2) leave it with your previous employer; 3) roll it into a traditional IRA. Option 3 is probably not a good option if you plan to do backdoor Roth contributions in the future, since you will run afoul of the pro-rata rule that WCI mentioned, and depending on your state's laws, you may also lose creditor protection for your retirement account in the event that you get sued. (That is, the 401k may be protected from creditors, but the tIRA may not be.) The 457 can similarly be rolled into another account (either new employer's retirement account or tIRA), but it may not be a good idea to do this just because the rules for accessing 457 money are different than the rules for accessing 403b/401k/IRA money. Unlike a 401k/403b/IRA, you can have access to your 457 money upon separation from your employer without an age penalty, whereas the 403b/401k/IRA money often cannot be easily accessed until age 59.5 (subject to certain exceptions).

I'm going to be starting a fellowship next summer after working for a few years as an attending. I like my current employer's 403b plans (low cost index funds, some of them institutional funds I don't have access to as an individual investor), so I plan to leave those accounts alone when I quit my job at the end of the year. I have my 457 contributions in an annuity paying 3.5%, so I am going to leave that alone also. After my fellowship, I will likely roll the 403b/457 contributions from fellowship into the accounts I currently have, or possibly roll that money into my tIRA and then convert it into my Roth if I take some time off (because the Roth conversion in this case would require me to pay taxes on that money, so I don't want to do that if I'm working as an attending).
 
No, you can keep contributing to the back door Roth as long as you have earned income, unless the government closes the loophole (which Obama threatens to do every year but hasn't done yet.)

The 457 and 401k (probably actually a 403b if it's a government employer) have separate contribution limits, so you can contribute a total of $36,000 for next year ($18,000 to each), assuming you're under age 50. Both of these types of accounts are pre-tax, so that $36,000 gets removed from your taxable income for next year. So say you gross $140,000 from six months of fellowship and six months of your attending job during your first year out (2017). If you max out both accounts, your modified gross for that year will be $140k - $36k = $104k. This means you will not need to do a backdoor Roth next year even if single. So in 2017, you can probably just contribute directly to your Roth (an additional $5500 or possibly $6000 if the contribution amount gets raised next year), using POST-tax money. This is again separate from your two pre-tax accounts.

Your total retirement contributions for 2017 will therefore be $36k pre-tax PLUS $5500 post-tax into your Roth. Starting in 2018, when you work FT as an attending, you will need to start using the backdoor Roth. This can still be done on top of contributing the $36k to your pre-tax accounts; you just put $5500 of post-tax dollars into a traditional IRA, convert it to a Roth, and done. No taxes will be due since you already paid taxes on that money, but you also cannot take a deduction (not that you would ever qualify for a tIRA deduction anyway as an attending).

After you leave your employer, account options vary. The Roth IRA is not through your employer, so it just stays with whatever custodian you select (say, Vanguard or Schwab). After separation, you generally have a few options for the 401k or 403b: 1) roll it into your new employer's 401k/403b (if they offer that option); 2) leave it with your previous employer; 3) roll it into a traditional IRA. Option 3 is probably not a good option if you plan to do backdoor Roth contributions in the future, since you will run afoul of the pro-rata rule that WCI mentioned, and depending on your state's laws, you may also lose creditor protection for your retirement account in the event that you get sued. (That is, the 401k may be protected from creditors, but the tIRA may not be.) The 457 can similarly be rolled into another account (either new employer's retirement account or tIRA), but it may not be a good idea to do this just because the rules for accessing 457 money are different than the rules for accessing 403b/401k/IRA money. Unlike a 401k/403b/IRA, you can have access to your 457 money upon separation from your employer without an age penalty, whereas the 403b/401k/IRA money often cannot be easily accessed until age 59.5 (subject to certain exceptions).

I'm going to be starting a fellowship next summer after working for a few years as an attending. I like my current employer's 403b plans (low cost index funds, some of them institutional funds I don't have access to as an individual investor), so I plan to leave those accounts alone when I quit my job at the end of the year. I have my 457 contributions in an annuity paying 3.5%, so I am going to leave that alone also. After my fellowship, I will likely roll the 403b/457 contributions from fellowship into the accounts I currently have, or possibly roll that money into my tIRA and then convert it into my Roth if I take some time off (because the Roth conversion in this case would require me to pay taxes on that money, so I don't want to do that if I'm working as an attending).

Thank you very much, I appreciate the detailed answer!

In 2017 I anticipate making around 170k so I'll have to start utilizing the backdoor for Roth IRA contributions.

I'm asking the future employer for retirement details to see what account options they have. I currently have a small amount in a Roth IRA through Vanguard. I would be ecstatic if the future employer had nice index-fund options.

My other question is this: assuming I transition from governmental employee to self-employed in 2-3 years, and if I don't like the investment options that the employer offers, can I roll over everything that's in my 403b and in the 457b into a solo-401k, or not? Rolling over into a traditional IRA may not be a great option since I want to be able to utilize the backdoor Roth for years to come, and I obviously don't want to have to deal with the pro-rata rule.

Edit: Actually, I think I answered my own question. Looks like I could roll over both governmental 403b and 457b into a solo-401k, since it's a qualified plan, according to this nice chart.

https://www.irs.gov/pub/irs-tege/rollover_chart.pdf
 
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Thank you very much, I appreciate the detailed answer!

In 2017 I anticipate making around 170k so I'll have to start utilizing the backdoor for Roth IRA contributions.

I'm asking the future employer for retirement details to see what account options they have. I currently have a small amount in a Roth IRA through Vanguard. I would be ecstatic if the future employer had nice index-fund options.

My other question is this: assuming I transition from governmental employee to self-employed in 2-3 years, and if I don't like the investment options that the employer offers, can I roll over everything that's in my 403b and in the 457b into a solo-401k, or not? Rolling over into a traditional IRA may not be a great option since I want to be able to utilize the backdoor Roth for years to come, and I obviously don't want to have to deal with the pro-rata rule.

Edit: Actually, I think I answered my own question. Looks like I could roll over both governmental 403b and 457b into a solo-401k, since it's a qualified plan, according to this nice chart.

https://www.irs.gov/pub/irs-tege/rollover_chart.pdf

That is a handy chart. Thanks for sharing that.

Remember that SEP-IRAs and backdoor Roth IRAs are not compatible due to the pro-rata rule. Solo 401(k) yes, SEP-IRA no. Sorry, I don't write the rules.
 
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