Should I move T-IRA into my active 401k and do backdoor ROTH IRA?

[dvalley]

I have approx. $110k in T-IRA (rollover 401ks) and $110k in employer 401k. Due to my income I haven't been able to contribute to my ROTH IRA in almost 10 years. After recently returning my attention to my finances and reading as much as possible I realized that ROTH IRA has lots of benefits and now there's a way for the higher income earners to contribute to it. Heck I think it's a great place to put emergency funds and dividends since you can take out your contributions anytime you want (of course keeping a portion liquid for this to work).

The only issue is that for me to contribute to ROTH IRA via the backdoor method I have to sell all my T-IRA stuff, then roll it over into my existing 401k which is (currently) all invested in a age based target retirement mutual fund - because I didn't quite like the other funds they offer. Conversely the T-IRA has some better equities and funds including dividend paying stocks.

Any thoughts or advice?

[Alan]

If your marginal tax bracket is 25% or higher then I wouldn't be doing tIRA contributions followed by ROTH conversions because, as you point out, your existing zero cost basis tIRA will get in the way. Why not simply do a tIRA, nondeductible contribution, and not do the conversion. In 10 years time when you ER you may well be in a much lower tax bracket and start doing conversions then.

[dvalley]

My marginal tax bracket is 25% but the effective tax rate a bit lower, for what it's worth.

Currently most of my assets are in tax deferred accounts but if I ER at 48/50 I'll need access to (some of) the money before I'm 59.5yo so I thought ROTH could help there as I could at least pull my contributions (potentially 10-12years worth) if I need to. I can't do that with t-IRA (well may be with 72t?).

For ER I really need to think in terms of buckets-of-assets (taxable, tax deferred, tax-free) and when I could access them. I recently realized that I must ramp up my taxable accounts and start paying down the mortgage. The latter isn't very sexy from the returns perspective but I think the value of a paid house is far greater in ER than anything else. A while ago when I played with FireCalc it showed that if my spending went down from $40k/yr to $30k/yr my chances of success were almost 30% higher (67-99%). But I digress

[gauss]

Quote:

Originally Posted by dvalley .. The only issue is that for me to contribute to ROTH IRA via the backdoor method I have to sell all my T-IRA stuff, then roll it over into my existing 401k

Are you trying to "isolate the basis" in your T-IRA and only convert the non-deductible contributions to ROTH so that you will not have to pay any Tax now? If not, I don't see why you would have to roll your T-IRA into your 401k to facilitate a Roth conversion.

[EDIT]: On closer reading I see that the source of your T-IRA funds appears to be from a 401k rollover which implies that you have no cost basis in your T-IRA. The Pro-Rata rules will indeed cause you problems (ie tax due) if you try to do conversions of future non-deductible T-IRA contributions if you don't "isolate the basis" first.

-gauss

[gauss]

Quote:

Originally Posted by dvalley Currently most of my assets are in tax deferred accounts but if I ER at 48/50 I'll need access to (some of) the money before I'm 59.5yo so I thought ROTH could help there as I could at least pull my contributions (potentially 10-12years worth) if I need to. I can't do that with t-IRA (well may be with 72t?).

You would not have any Roth contributions with your scenario described.

They would be Roth conversions which are treated a bit differently during Non-Qualified (ie under 59 1/2) distributions. They still have the potential to be penalty and tax free as long as you understand the rules and set things up appropriately. I believe that one of the big differences between Non-Qualified contributions and conversions is that each conversion has it's own 5 year waiting period. If you wait until you are retired to begin the conversions as Alan suggests, you may need 5 years worth of living expenses from non-retirement assets to avoid penalties.

FWIW I am in a very similar situation as you. I am currently 49, FIRED several years ago, DW plans to work 4 more years. Both DW and I had access to After Tax contributions in our 401k plans so since 2010 we have both been contributing the IRS max ($52,000 in 2014). We would then convert these after tax contributions to Roth IRAs with no tax due, being after tax money and all that the "basis in the IRAs has been isolated".

What this has allowed us to do is build up tax-diversity in our retirement assets. If the tax laws change in the future, we can change our withdrawal strategy in that we will have both tax-deferred and Roth assets available in close to a 50:50 distribution.

The issue is how to fund living between the age of 53 (when DW retires) and when I turn 59 1/2 (about 6 years later)? My current plan is to monitor my available non-retirement assets during the next 4 years. If it looks like they may be short of what is required to fund the 6 years until 59 1/2, we may forgo the $52,000 yearly deferral to the after-tax 401k for a few years to supplement our free funds to get us to 59 1/2.

Please keep us informed to your strategy and progress.

-gauss

[dvalley]

Hi Gauss, congrats on becoming FIREd! and thanks for the additional input/thoughts on after tax 401k contributions too which I hadn't looked into.

I think from the taxes perspective really the distinction between t-IRA or ROTH is whether you want to pay income taxes on the contributions now but not on the gains when you access the funds or if would you rather defer taxes but pay income taxes later, but on the entire amount, after reaching the retirement age. I wish there was a good calculator to show exactly which strategy would work better for our each different situations (I guess Quicken's lifetime planner does this?). Other than that access to the money should you need it before the qualified retirement age is more or less available from both retirement vehicles but ROTH IRA just seems easier.

As for funding ER between the time one ERs and when they become qualified to access their retirement assets (IRAs, 401k, SS etc) the answer is the obvious cash, taxable account and other assets. This is where I have a large gap and I need to start funding it ASAP.

I'll be sure to keep updating my progress in my 'Hi I'm...' thread.

[Alan]

Quote:

Originally Posted by dvalley My marginal tax bracket is 25% but the effective tax rate a bit lower, for what it's worth. Currently most of my assets are in tax deferred accounts but if I ER at 48/50 I'll need access to (some of) the money before I'm 59.5yo so I thought ROTH could help there as I could at least pull my contributions (potentially 10-12years worth) if I need to. I can't do that with t-IRA (well may be with 72t?). For ER I really need to think in terms of buckets-of-assets (taxable, tax deferred, tax-free) and when I could access them. I recently realized that I must ramp up my taxable accounts and start paying down the mortgage. The latter isn't very sexy from the returns perspective but I think the value of a paid house is far greater in ER than anything else. A while ago when I played with FireCalc it showed that if my spending went down from $40k/yr to $30k/yr my chances of success were almost 30% higher (67-99%). But I digress

It is your marginal tax rate that the ROTH conversions are taxed at, so maybe you should consider your overall AA and then start investing in Stock mutual funds in your after tax account, and using your tax deferred IRA and 401k to hold your bonds. As you get closer to ER you can then start selling some stock funds and putting it in cash, paying LTCG's at 15% instead of the 25% marginal gain you are at for regular income.

In the years leading up to ER I used IBonds for building a cash reserve as the interest is not taxed until you start cashing them (after I ER'ed at 55 and was in a lower tax bracket).

Those are just some suggestions, but there are many ways to deal with this.