Back door Roth - have you ever been audited?

[drk787]

We just learnt about back door Roth. Wish we knew this a long time ago. We are considered high income earners and although one of our companies offered Roth 401K, we don’t think it’s a good choice paying the high tax rate now.

We have 401Ks and max those contributions for years. We also have a taxable portfolio with Vanguard. No other IRAs. We plan to open a traditional IRA account and put $5500 of after tax, non-deductible money each. Then wait a month and convert that into a Roth IRA. Plan to repeat this every year from now on.

Question: we read somewhere that recommends waiting a full year before converting into Roth. What are your thoughts? Any advice to go about this ‘safely’? Have you gotten audited or know somebody that was with backdoor Roth?

 

[joeea]

We are considered high income earners and although one of our companies offered Roth 401K, we don’t think it’s a good choice paying the high tax rate now.

We plan to open a traditional IRA account and put $5500 of after tax, non-deductible money each.

Won't you be paying the same "high tax rate now"?

I don't think I understand your Roth 401k objection.

 

[bingybear]

you will pay the high tax that you say you don't want to pay. By waiting you will have more of a chance that you get a gain or loss that which could cause you to prorate taxes on the roth conversions.

I've not done a backdoor roth as I have existing IRAs that just made these roth conversions.

 

[SecondCor521]

It's perfectly legal, no reason to fear an audit other than the hassle factor. Open, contribute, then convert all in a week if you want.

IIRC, the earnings get taxed and 10% penalized on conversion, so doing it more quickly (or investing in stable value investments while it's in the traditional IRA) will minimize that cost. Maybe that's what bingybear meant.

 

[bingybear]

It's perfectly legal, no reason to fear an audit other than the hassle factor. Open, contribute, then convert all in a week if you want.

IIRC, the earnings get taxed and 10% penalized on conversion, so doing it more quickly (or investing in stable value investments while it's in the traditional IRA) will minimize that cost. Maybe that's what bingybear meant.

Not sure why earnings would be penalized 10%. I would think it you would get penalized if you used some of the conversion to pay taxes on the taxable part of the conversion.

With a roth conversion you pay tax based on the prorated tax basis of all the TIRAs the owners have. If you had no TIRAs and made an after tax IRA contribution and convert before there is any change in value, then you would not owe tax. If the TIRA doubles in value before you convert, then you will need to pay tax on 50% of the conversion.

I don't believe you pay penalties on roth conversions.

 

[drk787]

Won't you be paying the same "high tax rate now"?



I don't think I understand your Roth 401k objection.

Sorry for the confusion. I wasn’t asking about Roth 401k. Just wanted to state that we always do 401K instead of Roth 401k because of our high tax rate.

I’m talking about (backdoor) Roth IRA using after tax dollars. This money is currently invested in a taxable portfolio. Trying to save some tax on capital gains.

 

[SecondCor521]

Not sure why earnings would be penalized 10%. I would think it you would get penalized if you used some of the conversion to pay taxes on the taxable part of the conversion.

With a roth conversion you pay tax based on the prorated tax basis of all the TIRAs the owners have. If you had no TIRAs and made an after tax IRA contribution and convert before there is any change in value, then you would not owe tax. If the TIRA doubles in value before you convert, then you will need to pay tax on 50% of the conversion.

I don't believe you pay penalties on roth conversions.

I forget why too; it's been six or seven years since I did one myself.

I'd suggest to OP that they consult with a CPA and/or just put things into a tax program and see what Form 8606 does to them.

 

[GrayHare]

Per Kitces (I think it was) a strict interpretation of the law does make the backdoor Roth IRA of questionable legality, however the strategy has been so widely used for so long that enforcement of that law is probably not going to happen.

 

[RetiredAt55.5]

Note, Vanguard provides info on how to use the backdoor Roth.

I doubt they'd be providing this if they felt there were any legal issues.



https://www.vanguard.com/pdf/ISGIRA9.pdf

and

https://investor.vanguard.com/ira/roth-conversion

 

[jazz4cash]

Sorry for the confusion. I wasn’t asking about Roth 401k. Just wanted to state that we always do 401K instead of Roth 401k because of our high tax rate.

I’m talking about (backdoor) Roth IRA using after tax dollars. This money is currently invested in a taxable portfolio. Trying to save some tax on capital gains.

I still don't follow your objection to not using the Roth 401k. You will pay the same high rates whether you contribute to a Roth 401k or non deductible tIRA. The IRA contribution limit is pretty low also. I don't see how this will save on capital gains either.

I just do a rollover from 401k to tIRA and convert to Roth immediately, pay taxes at my regular rate for income.

 

[free2020]

I still don't follow your objection to not using the Roth 401k. You will pay the same high rates whether you contribute to a Roth 401k or non deductible tIRA. The IRA contribution limit is pretty low also. I don't see how this will save on capital gains either.

I just do a rollover from 401k to tIRA and convert to Roth immediately, pay taxes at my regular rate for income.

Same here. I have not converted immediately but opportunistically. I converted a bunch in 2010 with a low basis. The market paid me back the tax burden and some. Looking for another market decline.

 

[bingybear]

I still don't follow your objection to not using the Roth 401k. You will pay the same high rates whether you contribute to a Roth 401k or non deductible tIRA. The IRA contribution limit is pretty low also.

While I agree the tax on the 401k would be the same, I think the OP is looking at is the funding of the T401k save him tax dollars now. Funding a backdoor roth gets more in tax preferred tax status.

To me this makes sense, but not for the reasons the OP provided.

 

[drk787]

While I agree the tax on the 401k would be the same, I think the OP is looking at is the funding of the T401k save him tax dollars now. Funding a backdoor roth gets more in tax preferred tax status.



To me this makes sense, but not for the reasons the OP provided.

Maybe I’m missing something since a few people brought up why we don’t use Roth 401k. DH and I have a combined $1M in our 401K accounts. To convert that to Roth 401K we’d have a huge tax bill at our current tax rate. We definitely count on the tax rate will be much much lower in our RE years.

We also have a taxable portfolio that we are contributing aggressively, currently growing $80K/year just in contribution. We already paid taxes on it and will have to pay that of the earnings every year. We will use $11K of this $80K for the backdoor Roth. Though the limit is low, it allows us to save a little bit $ on the earning tax. We figure if we do backdoor Roth for 20 years, that’s a good amount to grow tax free. This money we won’t likely need until we exhaust the tax deferred and taxable portfolios.

Does that not make sense? How would you do it?

 

[Bigdawg]

Maybe I’m missing something since a few people brought up why we don’t use Roth 401k. DH and I have a combined $1M in our 401K accounts. To convert that to Roth 401K we’d have a huge tax bill at our current tax rate. We definitely count on the tax rate will be much much lower in our RE years.

We also have a taxable portfolio that we are contributing aggressively, currently growing $80K/year just in contribution. We already paid taxes on it and will have to pay that of the earnings every year. We will use $11K of this $80K for the backdoor Roth. Though the limit is low, it allows us to save a little bit $ on the earning tax. We figure if we do backdoor Roth for 20 years, that’s a good amount to grow tax free. This money we won’t likely need until we exhaust the tax deferred and taxable portfolios.

Does that not make sense? How would you do it?

I just finished my second backdoor ROTH. Same boat as you. We max 401K then at $6500(I'm over 50) to Tira. About a week later I convert it to ROTH. First year it was in an etrade account and for 2017 it was Vanguard. Easy peasy. No issues on the irs front.

 

[drk787]

I just finished my second backdoor ROTH. Same boat as you. We max 401K then at $6500(I'm over 50) to Tira. About a week later I convert it to ROTH. First year it was in an etrade account and for 2017 it was Vanguard. Easy peasy. No issues on the irs front.

Thank you for the assurance.