Backdoor Roth and traditional IRA contribution limits

[dirtbiker]

I've been working on maximizing my tax strategy as of late, and I have some questions. We're both fairly young, in our mid-thirties with plans to retire in our mid to late 50s.

My wife and I are both maxing out our 401Ks and we're also dumping money into a brokerage account with each paycheck. We're over the income limits to contribute to a Roth IRA. And because my wife has a defined benefit plan at her job, we're also subject to income limits for a traditional IRA, and we're over those limits as well to contribute to a traditional IRA with pre-tax money.

So, with this being said, I recently found out about backdoor Roths. As I understand it, you contribute to a traditional IRA (in our case, it would already be taxed contributions), and then roll it over into a Roth IRA, which you can do once per year. Any interest, dividends, etc. that were earned would then be taxed. There is no income limits to doing this. Is this understanding correct? And to me, it makes no sense to contribute to a brokerage account that is fully subject to taxes if I can do a backdoor Roth with my after-tax income and keep this money from the tax man. And my wife and I can both do this backdoor Roth, right?

The second part of my question involves contribution limits. The IRA contribution limits are $6000 per year. Are these the limits for tax-deferred contributions? Or are they hard limits? IOW, since all of my contributions will be taxed contributions, can I contribute any amount I want?

And lastly, I rolled over my old 403B from my previous employer into a rollover IRA this year. Does this count as my one allowed IRA rollover for the year? Meaning I wouldn't be able to do a backdoor Roth this year?

Thanks!

[cathy63]

Quote:

Originally Posted by dirtbiker So, with this being said, I recently found out about backdoor Roths. As I understand it, you contribute to a traditional IRA (in our case, it would already be taxed contributions), and then roll it over into a Roth IRA, which you can do once per year. Any interest, dividends, etc. that were earned would then be taxed. There is no income limits to doing this. Is this understanding correct? And to me, it makes no sense to contribute to a brokerage account that is fully subject to taxes if I can do a backdoor Roth with my after-tax income and keep this money from the tax man. And my wife and I can both do this backdoor Roth, right?

This is basically correct. If you already have a traditional IRA with some untaxed money in it, then things are a bit more complex. When you do a Roth Conversion, the IRS treats all your tIRAs as if they were a single account and requires you to do the conversion proportionally from the taxed and untaxed money. So if you had a previous job with a 401K and have already rolled that into a tIRA, then converting to Roth may not be beneficial. You can do as many conversions each year as you want. At the end of the year, your broker will issue a 1099-R that sums them all together.

Quote:

Originally Posted by dirtbiker The second part of my question involves contribution limits. The IRA contribution limits are $6000 per year. Are these the limits for tax-deferred contributions? Or are they hard limits? IOW, since all of my contributions will be taxed contributions, can I contribute any amount I want?

The contribution limit is $6K per person or total of earned income for a married couple, whichever is larger. I.e. as long as the sum of yours and your wife's earnings is at least $12K, you can each make the max $6K contribution and then immediately convert it.

Quote:

Originally Posted by dirtbiker And lastly, I rolled over my old 403B from my previous employer into a rollover IRA this year. Does this count as my one allowed IRA rollover for the year? Meaning I wouldn't be able to do a backdoor Roth this year?

I believe you can still do a conversion this year (conversion and rollover are two different things), but if that 403b was pre-tax money, and the balance is much greater than $6K, it's probably not worth it. E.g. if you have $594K in pre-tax money and put in $6K of after-tax, then convert $6K of the balance to Roth, you'll end up with 99% of the conversion being taxable. You'll still have a basis in the tIRA of $5940, and you'll have to do this calculation every time you do a conversion in the future.

If you have any way to move that 403b money back to a new employer's 401K or some similar pre-tax account, you could do that, and then the backdoor Roth would become more viable for you.

[dirtbiker]

Quote:

Originally Posted by cathy63 This is basically correct. If you already have a traditional IRA with some untaxed money in it, then things are a bit more complex. When you do a Roth Conversion, the IRS treats all your tIRAs as if they were a single account and requires you to do the conversion proportionally from the taxed and untaxed money. So if you had a previous job with a 401K and have already rolled that into a tIRA, then converting to Roth may not be beneficial. You can do as many conversions each year as you want. At the end of the year, your broker will issue a 1099-R that sums them all together.

I have a current 401K, a brokerage account, and a rollover IRA from the previous 403B, and my wife has a rollover IRA from her previous 401K and her current 403B. I have not yet set up an after-tax traditional IRA, and neither has she. That is our next step. We'll decrease brokerage account contributions to fund the IRAs.

Quote:

Originally Posted by cathy63 The contribution limit is $6K per person or total of earned income for a married couple, whichever is larger. I.e. as long as the sum of yours and your wife's earnings is at least $12K, you can each make the max $6K contribution and then immediately convert it.

Okay, that's what I thought. Thanks.

Quote:

Originally Posted by cathy63 I believe you can still do a conversion this year (conversion and rollover are two different things), but if that 403b was pre-tax money, and the balance is much greater than $6K, it's probably not worth it. E.g. if you have $594K in pre-tax money and put in $6K of after-tax, then convert $6K of the balance to Roth, you'll end up with 99% of the conversion being taxable. You'll still have a basis in the tIRA of $5940, and you'll have to do this calculation every time you do a conversion in the future. If you have any way to move that 403b money back to a new employer's 401K or some similar pre-tax account, you could do that, and then the backdoor Roth would become more viable for you.

I'm not planning on rolling over that pre-tax IRA into a backdoor Roth. I'm just going to keep it in its own account. I'm also happier with it in an IRA with E*Trade, who I use for brokerage, as I have full control over my investments, as opposed to my current 401K, which is much more limited.

Thanks for all this information

[kaneohe]

https://www.irs.gov/retirement-plans...-distributions

"Beginning after January 1, 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own.

The one-per year limit does not apply to:

rollovers from traditional IRAs to Roth IRAs (conversions)
trustee-to-trustee transfers to another IRA
IRA-to-plan rollovers
plan-to-IRA rollovers
plan-to-plan rollovers"

Be sure you understand what cathy tried to tell you about doing a backdoor Roth with that rollover IRA in existence. You will pay taxes on that 6K IRA contribution since you can't deduct it. In addition, you will pay taxes on (perhaps) a significant fraction of that conversion . In the extreme case where rollover IRA size is much greater than your TIRA contribution/conversion, you will be paying twice the tax on that contribution/conversion.
Of course you will get credit for that non-deductible contribution later when you withdraw from TIRA.

[cathy63]

Quote:

Originally Posted by dirtbiker I'm not planning on rolling over that pre-tax IRA into a backdoor Roth. I'm just going to keep it in its own account.

You can't keep the pre-tax and after-tax money separate by putting them in separate IRAs. A "rollover" IRA is a traditional IRA, so you already have traditional IRAs with pre-tax contributions.

Even if you open up a new tIRA at a different brokerage for the after-tax contributions and conversions, the IRS treats all your tIRAs are treated as if they were one combined account. Every year when you do your taxes, you will fill out form 8606 and you will have to add up the value of all your tIRA accounts, calculate the basis, and use that to determine what percentage of your conversion is taxable.

[dirtbiker]

I'm probably being accidentally unclear about my intentions here. I don't plan to ever do anything with the rollover IRA, except leave it where it's at and let it grow. Because it's pre-tax money and I can't do any further pre-tax contributions, I won't be contributing to it any further or rolling it over to anything else.

What I'm planning on doing is opening up another traditional IRA that will be funded 100% with after-tax money (basically diverting from my brokerage to the IRA) and doing the backdoor Roth with that.

[dirtbiker]

Oh wait, crap. I see. I may have made a mistake rolling over my old 403B into a rollover IRA.

If I'm understanding this correctly, let's say for example I have two traditional IRAs, using round numbers for simplicity's sake
IRA #1: $90,000 pre-tax
IRA #2: $10,000 after-tax

If I roll over all of IRA #2, it will be treated as 90% pre-tax and 10% after-tax, even though the IRA I rolled over is all after-tax? Is this correct?

[bingybear]

Quote:

Originally Posted by dirtbiker I'm probably being accidentally unclear about my intentions here. I don't plan to ever do anything with the rollover IRA, except leave it where it's at and let it grow. Because it's pre-tax money and I can't do any further pre-tax contributions, I won't be contributing to it any further or rolling it over to anything else. What I'm planning on doing is opening up another traditional IRA that will be funded 100% with after-tax money (basically diverting from my brokerage to the IRA) and doing the backdoor Roth with that.

If I get this right you have an IRA with pre-tax money in your name that you are not going to do anything with. You want to contribute to an IRA in your name with after tax dollars and then convert it to a roth (back door). All sounds good so far?
Now the IRS considers all of your TIRAs as one account. Even though you just funded the TIRA with after tax dollars, at tax time you will have to look at the total tax basis and account value to pay tax on the conversion.

Having separate accounts may be convenient for you. But all accounts by a single owner are considered one account.

[bingybear]

Quote:

Originally Posted by dirtbiker Oh wait, crap. I see. I may have made a mistake rolling over my old 403B into a rollover IRA. If I'm understanding this correctly, let's say for example I have two traditional IRAs, using round numbers for simplicity's sake IRA #1: $90,000 pre-tax IRA #2: $10,000 after-tax If I roll over all of IRA #2, it will be treated as 90% pre-tax and 10% after-tax, even though the IRA I rolled over is all after-tax? Is this correct?

bingo! and if you try the backdoor you would just have used after tax to fund that IRA.

[dirtbiker]

Damn! My wife and I just rolled over each of our old 403Bs into IRAs within the last month. We did this to get more and lower cost investment options than were in the other accounts. I did not realize these implications. Is there any way to reverse this, since I just did it very recently? Or once done, it's done? What choices do I have? Roll over into current 401Ks, if that option is available? Damn do I wish I wouldn't have done this...

[SevenUp]

Quote:

Originally Posted by dirtbiker Roll over into current 401Ks, if that option is available?

Yes, that is probably the best choice. How good are your 401k options?

[timbervest]

The way to handle this is to roll any pre-tax money from IRA's into your 401(k) leaving only after tax basis in your tIRAs. Then convert to Roth.

[dirtbiker]

My 401K options are pretty limited, and most have high fees, but they do have an S&P 500 ETF with like a 0.05% fee, so I'm fine with that. Pretty much same with my wife. I'll have to look into seeing if they'll allow a rollover into it. As I understand it, many 401K and 403B plans won't allow that?

I was actually quite pleased with myself for getting these two funds into IRAs where I had more control over them...

[dirtbiker]

Thanks for the replies everyone

[euro]

[QUOTE=dirtbiker;2237313

I'm not planning on rolling over that pre-tax IRA into a backdoor Roth. I'm just going to keep it in its own account. I'm also happier with it in an IRA with E*Trade, who I use for brokerage, as I have full control over my investments, as opposed to my current 401K, which is much more limited.

[/QUOTE]

Be very careful with this. It doesn't matter that the rollover money sits in a separate account. If it is an "IRA" then you will have to convert it proportionally with your backdoor IRA. That is why the previous poster suggested you try to roll it back into an 401 or 403. In THAT case, it is protected from the proportional conversion rule.


Edit: sorry, I hadn't read the whole thread yet and jumped the gun. It looks like this has been addressed.

Yes, it looks like rolling it back into a 401k is the only clean choice. If they allow it (many do not). Otherwise you are pretty much stuck. Not the end of the world though - you just have to file form 8606 each year from here on out. I feel your pain - I got ensnared in it myself too... that's how I know....

One more thing: a little bit of good news is that you do have until the end of the year to fix this (roll it back into a 401 or 403)

[dirtbiker]

Quote:

Originally Posted by euro Be very careful with this. It doesn't matter that the rollover money sits in a separate account. If it is an "IRA" then you will have to convert it proportionally with your backdoor IRA. That is why the previous poster suggested you try to roll it back into an 401 or 403. In THAT case, it is protected from the proportional conversion rule. Edit: sorry, I hadn't read the whole thread yet and jumped the gun. It looks like this has been addressed. Yes, it looks like rolling it back into a 401k is the only clean choice. If they allow it (many do not). Otherwise you are pretty much stuck. Not the end of the world though - you just have to file form 8606 each year from here on out. I feel your pain - I got ensnared in it myself too... that's how I know.... One more thing: a little bit of good news is that you do have until the end of the year to fix this (roll it back into a 401 or 403)

I'll check into seeing if we can roll over the IRAs into our current 401K and 403Bs. I'm hoping so. Then we'll immediately set up IRAs to roll over into Roths. Fortunately neither of us has contributed any after tax money into an IRA yet, so both of our IRAs are 100% pre-tax right now.

[timbervest]

And if you really want to go bonkers on this read https://www.madfientist.com/after-tax-contributions/

[dirtbiker]

Quote:

Originally Posted by timbervest And if you really want to go bonkers on this read https://www.madfientist.com/after-tax-contributions/

This seems like a great workaround... But...

Assuming my plan allows it, wouldn't I be subject to the 10% penalty if I were to do an in-service distribution before age 59 1/2, even to roll over into a backdoor Roth?

[copyright1997reloaded]

I posted a similar situation here: http://www.early-retirement.org/foru...ml#post2231709

My plan is to move existing tIRA accounts to my current employer 457 plan, then do back door Roths as well as move some 401k after tax to a Roth.

[dirtbiker]

Quote:

Originally Posted by timbervest And if you really want to go bonkers on this read https://www.madfientist.com/after-tax-contributions/

Unfortunately I just called the company that handles my 401K and they don't allow after-tax contributions to the 401K unless it's specifically Roth. Because I'm over the income limits for Roth, I can't contribute this way. The good news is that I can rollover my rollover IRA into the 401K and then I'll be free and clear to rollover my traditional after-tax IRA into a backdoor Roth without worrying about pro-rata. Next we need to find out about my wife's 403B and if she has the ability to add after-tax and can do in-service distributions.