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Backdoor roth IRA
Old 02-06-2014, 10:47 PM   #1
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Backdoor roth IRA

DW and I have not been eligible to make deductible contributions to an IRA or contributions to a roth-IRA in many years due to high income restrictions. Lately, I have been thinking about taking advantage of the backdoor roth IRA option. We have no tax-free investment accounts at this point and it seems like it would be a good thing to have on order to manage taxable income down the road.

DW has a large, deductible traditional IRA (401K rollover from a previous job), so it would not be worth it for her to do a conversion as this point. I, on the other hand, have only one tiny, deductible traditional IRA. Even though we are in a high tax bracket, I am thinking about converting that traditional IRA to a roth IRA and take the tax hit. Then I would be able to make non-deductible contributions to the traditional IRA every year and transfer them immediately to the roth.

Questions:
Does the $5,500 limit on IRA contributions apply to non-deductible contributions?
Is there a limit on the dollar amount one can convert from IRA to roth IRA every year?
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Old 02-06-2014, 11:46 PM   #2
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The limit on contributions $5500 + $1000 if you are over 50, is the same for Roth IRA, or Traditional IRA both deductible and non deductible.

There is no limit on the amount that can be converted from IRA to Roth IRA every year, but you do pay tax on it based on your other income, so as a practical limit you don't want to do too much and incur higher marginal brackets. In fact if your brackets are high enough you might want to wait until you have lower income to do so. The backdoor avoids that problem when you have no deductible contributions and little or no earnings which are taxable on conversion.
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Old 02-07-2014, 12:06 AM   #3
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Originally Posted by growing_older View Post
The limit on contributions $5500 + $1000 if you are over 50, is the same for Roth IRA, or Traditional IRA both deductible and non deductible.

There is no limit on the amount that can be converted from IRA to Roth IRA every year, but you do pay tax on it based on your other income, so as a practical limit you don't want to do too much and incur higher marginal brackets. In fact if your brackets are high enough you might want to wait until you have lower income to do so. The backdoor avoids that problem when you have no deductible contributions and little or no earnings which are taxable on conversion.
Thanks for the info.

Our income should remain high for the foreseeable future and who knows what the rules will be when our income finally drops. For simplicity sake, I would like to avoid mixing deductible and non-deductible money in the tIRA, so I would like to convert the deductible contributions now. Even though our tax bracket is high, the tax bill on the conversion would be pretty small due to the low balance. Then, I would be able to do tax-free conversions every year.
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Old 02-07-2014, 08:09 AM   #4
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That sounds like a good plan, especially if it clears the decks to allow backdoor Roths.
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Old 02-07-2014, 09:36 AM   #5
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You should read this if you haven't yet:

Backdoor Roth IRA - Bogleheads

You don't want to get hit with the prorata deal on your existing deductible ira's and rollovers.
Probably the best solution is to roll your current deductible IRAs into your current employer's 401k plans, if available. This would avoid the problem. If you have some self employment income, you can start a solo 401k and roll the iras into this. If you go this route, I would use fidelity, as I believe vanguard doesn't allow rollovers into it's solo 401k.
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Old 02-07-2014, 10:03 AM   #6
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A market downturn of your tIRA investments can be an opportunity to convert to Roth: convert while their value is low and you take the tax hit at that low value. When the investment value rebounds, all the growth that would have been taxable in the tIRA is instead tax-free in the Roth. Those holding equities in their tIRAs who converted during the 2009 downturn, or even during 2010, have since reaped the rewards.
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Old 02-07-2014, 11:29 AM   #7
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Quote:
Originally Posted by panhead View Post
You should read this if you haven't yet:

Backdoor Roth IRA - Bogleheads

You don't want to get hit with the prorata deal on your existing deductible ira's and rollovers.
Probably the best solution is to roll your current deductible IRAs into your current employer's 401k plans, if available. This would avoid the problem. If you have some self employment income, you can start a solo 401k and roll the iras into this. If you go this route, I would use fidelity, as I believe vanguard doesn't allow rollovers into it's solo 401k.
I had read that BH wiki. Unfortunately, I do not have access to a 401K and have no self-employment income (I am ER'd).


Quote:
Originally Posted by GrayHare View Post
A market downturn of your tIRA investments can be an opportunity to convert to Roth: convert while their value is low and you take the tax hit at that low value. When the investment value rebounds, all the growth that would have been taxable in the tIRA is instead tax-free in the Roth. Those holding equities in their tIRAs who converted during the 2009 downturn, or even during 2010, have since reaped the rewards.
I am only holding bonds in my tIRA, so I don't expect a big drop in value any time soon.
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Old 02-07-2014, 11:32 AM   #8
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Thanks for the info.

Our income should remain high for the foreseeable future and who knows what the rules will be when our income finally drops. For simplicity sake, I would like to avoid mixing deductible and non-deductible money in the tIRA, so I would like to convert the deductible contributions now. Even though our tax bracket is high, the tax bill on the conversion would be pretty small due to the low balance. Then, I would be able to do tax-free conversions every year.
If it gives you any comfort, I was in almost the exact same situation last year where I needed to convert a small Traditional IRA into a Roth IRA to get a "clean" (i.e., no pro rata calc) start for future back door contributions. I did so despite the relatively high tax bracket hit. I viewed the tax hit it as an expense paid in order to gain access to clean Roth IRA contributions going forward. Like you, I didn't want to rely on a future decrease in income.
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Old 02-07-2014, 11:36 AM   #9
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I had read that BH wiki. Unfortunately, I do not have access to a 401K and have no self-employment income (I am ER'd).
You're both ER'd and in a high tax bracket? Wow.
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Old 02-07-2014, 11:39 AM   #10
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You're both ER'd and in a high tax bracket? Wow.
DW still works.
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Old 02-07-2014, 11:48 AM   #11
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A few comments that you may already know ...

- You will need to complete IRS Form 8606 at tax time (Nondeductible IRAs).

- You can make non-deductible IRA contributions for tax year 2013 up until April 15 of this year, so you may be able to double your contribution this year.

- If your wife has an active 401k, it may be possible to make backdoor Roth contributions here too. One can do this if the plan allows after-tax contributions and in-service withdrawals of after-tax contributions (and their earnings). My impression is that most plans do not allow this, but some do (mine does). If so, it may be possible to make an additional $34.5K in backdoor Roth contributions for 2014, bringing the total up to $41K ($34.5K using 401k plus $5.5K using IRA plus $1K using IRA if over age 50). The $34.5K is based on the IRS 415c limit of $52K for 2014, which includes employee contributions to the 415k (before and after-tax), employer contributions to the 401k (if any), and employee contributions to a qualified defined benefit pension plan (if any). It does not include the $5.5K age 50 catchup provision.

I agree that if your current IRA balance is small, it makes some bookkeeping sense to take the tax hit on a conversion to get that aspect out of the way.
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Old 02-07-2014, 12:18 PM   #12
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A few comments that you may already know ...

- You will need to complete IRS Form 8606 at tax time (Nondeductible IRAs).

- You can make non-deductible IRA contributions for tax year 2013 up until April 15 of this year, so you may be able to double your contribution this year.

- If your wife has an active 401k, it may be possible to make backdoor Roth contributions here too. One can do this if the plan allows after-tax contributions and in-service withdrawals of after-tax contributions (and their earnings). My impression is that most plans do not allow this, but some do (mine does). If so, it may be possible to make an additional $34.5K in backdoor Roth contributions for 2014, bringing the total up to $41K ($34.5K using 401k plus $5.5K using IRA plus $1K using IRA if over age 50). The $34.5K is based on the IRS 415c limit of $52K for 2014, which includes employee contributions to the 415k (before and after-tax), employer contributions to the 401k (if any), and employee contributions to a qualified defined benefit pension plan (if any). It does not include the $5.5K age 50 catchup provision.

I agree that if your current IRA balance is small, it makes some bookkeeping sense to take the tax hit on a conversion to get that aspect out of the way.
Thanks for the reminders. I had forgotten that I could still make 2013 IRA contributions until April 15. That's great! I will have to look into DW's 401K plan to see if they allow after tax contributions. I know that she has the option to fund a Roth 401K at work, so this could be a backdoor to a Roth IRA for her.
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Old 02-07-2014, 01:45 PM   #13
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If you have some self employment income, you can start a solo 401k and roll the iras into this. If you go this route, I would use fidelity, as I believe vanguard doesn't allow rollovers into it's solo 401k.
Yes, I can confirm this. Use Fido to push a deductible IRA into a solo 401k.
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Old 02-13-2014, 01:52 PM   #14
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I went ahead with the tIRA to Roth IRA conversion earlier this week (easily done at Vanguard) and I am planning on making my 2013 non-deductible IRA contribution next week. Turbotax seems to handle non-deductible IRA contributions (form 8606) pretty easily. I assume I'll get a 1099-R next year for the conversion.
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Old 02-13-2014, 04:28 PM   #15
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Originally Posted by FIREd View Post
I went ahead with the tIRA to Roth IRA conversion earlier this week (easily done at Vanguard) and I am planning on making my 2013 non-deductible IRA contribution next week. Turbotax seems to handle non-deductible IRA contributions (form 8606) pretty easily. I assume I'll get a 1099-R next year for the conversion.
I did something similar in that I converted by deductible tIRA to a ROTH, paying taxes on the portion above the basis. Vanguard did send me a 1099-R on that.

The following year I rolled over my 401k to a tIRA so that I no longer had a basis in my tIRA.
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