Backdoor ROTH IRA strategy may not last

[SecondCor521]

Just to be clear, I think this only affects conversions that involve plans that include both pre and post tax contributions. All of my plans only include pre-tax contributions so I can still do Roth conversions, correct?

Correct. For now, at least.

 

[Sunset]

Just to be clear, I think this only affects conversions that involve plans that include both pre and post tax contributions. All of my plans only include pre-tax contributions so I can still do Roth conversions, correct?

So long as ALL your plans have only pre-tax contributions, then yes.

But 1 plan with a post-tax contribution screws it up.

 

[Ian S]

So long as ALL your plans have only pre-tax contributions, then yes.

But 1 plan with a post-tax contribution screws it up.

I never saw much benefit in my financial situation to putting post tax contributions into anything other than a Roth so I guess I lucked out.

 

[camfused]

I plugged this estimated hit into my model, and for me, it looks like I would have just under 2% (~$100k) less at age 90, if this takes place. Perturbed, but I guess I can live with that.

 

[CRLLS]

I wouldn't hit the panic button yet... the DC sausage machine is still churning and who knows what might happen.

If recent history is any indication, by the time the sausage machine is done making the sausage, the sausage may have an earlier date for a cut off. This is what I am worried about.

 

[pb4uski]

While most tax law changes are prospective, there have been some tax law changes that have been retroactive so I understand your concern.

 

[bingybear]

If I recall correctly my IRA started in the early '90s and the plan allowed additional after tax contributions. I can't use a company plan to clean it since I am not in a company plan.

really kind of bites.

 

[pjigar]

Our differed comp plan sign up deadline was last month. For now I bumped up differed comp by half of the amount I contributed to post-tax 401K. If the law changes then I will stop post-tax contributions to 401K. 401K max out will be spread out equally between Roth 401K and pretax 401K contributions. If this bill die down then we will go back to original 401K post-tax contributions in which case I will save little too much next year which is not bad either!


I still have lot of post-tax contributions stuck in 401K plan. I wonder I will ever be able to get it converted to Roth?

 

[bingybear]

I have a small % of after tax assets in our IRA

 

[cathy63]

... It's not a matter of the accounting. Vanguard and Fidelity can definitely write software to keep track of the pre-tax portions. But I seriously doubt Vanguard or Fidelity would break the law with you, me, or anyone else (again, assuming this passes, and assuming we're talking specifically about 2022 Roth conversions where someone has after-tax contributions in their traditional IRA).

I agree with you that no broker would break the conversion law intentionally, but I disagree that they could track your basis for an existing account. When you make a contribution to your tIRA, you don't tell the broker whether it's going to be deductible or not, and the deductibility might even change between the time you make the contribution and when you do your taxes, so they have no way to know. Likewise with rollovers, there's no basis info transferred with the funds.

I expect that if this change goes into effect, the brokers will still allow conversions because the law allows it for most accounts. Lots of people will probably find out at tax time that they shouldn't have converted and will have to scramble to undo it.

 

[oldtimer]

^^^ Ok, but what is to prevent financial institutions (like Fidelity or Vanguard) from rolling out software that CAN figure out the pre-tax portions, and therefore allow you to convert next year? Or, am I missing something?

Financial institutions do not know it you claimed a deduction or not for money you put in an IRA. Only your Uncle Sam and you know. So don't expect the financial institutions to track it for you - it is up to you to track.

 

[SecondCor521]

I agree with you that no broker would break the conversion law intentionally, but I disagree that they could track your basis for an existing account. When you make a contribution to your tIRA, you don't tell the broker whether it's going to be deductible or not, and the deductibility might even change between the time you make the contribution and when you do your taxes, so they have no way to know. Likewise with rollovers, there's no basis info transferred with the funds.

I expect that if this change goes into effect, the brokers will still allow conversions because the law allows it for most accounts. Lots of people will probably find out at tax time that they shouldn't have converted and will have to scramble to undo it.

Sorry, I should have been more clear.

Yes, they can't figure it out now, because, as you rightly point out, they don't have the information. And they don't have to.

@camfused seemed to think it was just a matter of accounting for and keeping track of the basis (much like is done with taxable accounts and covered securities). I was pointing out - inartfully, as it seems - that it's not merely a matter of accounting, but a matter of law. The accounting could, in principle, be figured out with some additional information and data. But that would still leave the pro rata law / rule to be contended with.

I agree with you on your last paragraph. Since custodians have no way (currently) of knowing your basis, they can't enforce the law. And yep, plenty of people will be caught unawares. I wonder what the penalty is for breaking the rule...from what I read in the law it just says "you can't do this anymore".

 

[Sunset]

As a person with $500K IRA that contains $100 post-tax contribution is stuck forever, as the $100 is proportionally withdrawn on any withdrawal.

I wonder what if that person , just claims the $100 is not post-tax and pays the extra tax required. This of course would not work for the person with huge post-tax contributions, but that is the intent of the proposal.

 

[Montecfo]

As a person with $500K IRA that contains $100 post-tax contribution is stuck forever, as the $100 is proportionally withdrawn on any withdrawal.

I wonder what if that person , just claims the $100 is not post-tax and pays the extra tax required. This of course would not work for the person with huge post-tax contributions, but that is the intent of the proposal.

I had wondered the same. It seems like an approach that should work practically, and unlikely to be challenged on audit.

Of course, the numbers must work.

 

[Alan]

I made non-deductible IRA contributions for many years. Every year I made such an IRA contribution I had to complete form 8606 as part of my tax return. For me I and the IRS always knew the basis of my IRAs.

I never had the option of non-deductible 401k contributions so don’t know about tracking the basis on that.

I completed my last Roth conversion a couple of years ago, and in 2 years my wife will have completed her Roth conversions. (This year and next)

 

[pb4uski]

I guess I don't see the purpose of allowing Roth conversions for IRAs that have all deductible contributions while at the same time prohibiting Roth conversions for IRAs that include some non-deductible contributions. Just let anybody do a conversion pay the taxes due.

 

[RockyMtn]

It seems to me the proposed legislation is partially designed to get people to hurry up and convert IRA's to Roth IRA's in the next ten years so that the IRS can collect a whole bunch of tax dollars.

To exclude anyone who has some after tax contributions in the IRA from making the conversion if they otherwise qualify on all other points seems to be counter productive to the intended effect.

As mentioned earlier in this thread it should be relatively easy to allow folks to convert pre tax contributions and after tax contributions with pre tax being taxed and going into the Roth and the after tax going to a bank account or any other non tax advantaged account.

 

[ncbill]

As other posters mention I also suspect people with only a small (single digits?) percentage of after-tax money "contaminating" their pre-tax account will fudge the issue, convert, and pay tax on the entire amount converted.

Now, if the pre-tax contributions constitute 2/3, and post-tax 1/3 of the account balance the above is probably not gonna work.

 

[Montecfo]

I think what they are trying to prevent is these huge Roth's that people have managed to accumulate completely legally.

The back door Roth is probably the largest culprit but allowing unregistered securities (also prohibited in the proposed legislation) is where you really get the eye-popping numbers.

Of course most unregister securities which go into IRAs probably do not generate large gains but non-deductible losses but hey who tracks that?

 

[gauss]

It seems to me the proposed legislation is partially designed to get people to hurry up and convert IRA's to Roth IRA's in the next ten years so that the IRS can collect a whole bunch of tax dollars.

To exclude anyone who has some after tax contributions in the IRA from making the conversion if they otherwise qualify on all other points seems to be counter productive to the intended effect.

As mentioned earlier in this thread it should be relatively easy to allow folks to convert pre tax contributions and after tax contributions with pre tax being taxed and going into the Roth and the after tax going to a bank account or any other non tax advantaged account.

+1

Yes - I agree with this also.

The law as proposed will indeed ban the Roth conversion of after-tax contributions -- this is very clear to me.

Some have suggested that the existing pro-rata rules will prevent any roth conversions if there are ANY after-tax contributions held.

I believe that the pro-rata rules (aka the cream in the coffee rules) that force pro-rata treatment of pre-tax and after-tax contributions for any Roth conversion or distribution will be revised. My understanding is that the pro-rata rules were a creation not of law, but of regulation. I don't think there is congressional intent in the new bill to ban Roth conversions in an account if there is as little of $1 of after tax contributions held there.

As such, I think the the regulators will update the regulations, the IRS pubs and the IRS tax forms to revise the pro-rata rules to comprehend the new ban on Roth conversions of after-tax contributions but to continue to allow, in some fashion, Roth conversion of pre-tax portions, albeit with perhaps a modified pro-rata rule.

I am not a lawyer, regulator or congressional expert, so it may possibly go some other way.

This is just the way I see it. Viewing the pro-rata rules as regulations and not legislation is key to my analysis.

-gauss

 

[pjigar]

I just requested distributions of post-tax contributions (and pro-rata gains on them) from my 401k. I will get two checks which will go into Roth IRA and Rollover IRA respectively. I had to jump through lot of hoops to find a person who can understand what I was requesting AND execute! Our 401K plan document allows such a distribution but most reps will tell me that it can't be done. My persistence paid off. This is just in preparation of this bill. If bill does not pass then I will roll back the pro-rata gains to 401K in order to do backdoor IRA contributions next year.

 

[Perryinva]

When I retired, I converted the balance of my 401k to my FIDO Roth & tIRA. Over the last 6-7 years while employed, I maxed Roth & after tax 401k accounts best I could afford, once I realized that RMDs were going to (relatively) kill me due to the size of the 401k pretax which I had been doing exclusively rather blindly. The idea that post retirement tax rate could be higher than employed tax rate didn’t seem possible. Now its about a certainty between pensions, SS & RMDs. The only pretax monies were company match and all earnings, once I realized this, as the 401k had no Roth option. However, the amounts earned in the pretax accounts dwarfed the smaller Roth and still do. I finally can start Conversions for the next few years while I delay filing SS which will only help a little, but it’s something. I wish I had found this site 10 years earlier.

 

[38Chevy454]

When I retired, I converted the balance of my 401k to my FIDO Roth & tIRA. Over the last 6-7 years while employed, I maxed Roth & after tax 401k accounts best I could afford, once I realized that RMDs were going to (relatively) kill me due to the size of the 401k pretax which I had been doing exclusively rather blindly. The idea that post retirement tax rate could be higher than employed tax rate didn’t seem possible. Now its about a certainty between pensions, SS & RMDs. The only pretax monies were company match and all earnings, once I realized this, as the 401k had no Roth option. However, the amounts earned in the pretax accounts dwarfed the smaller Roth and still do. I finally can start Conversions for the next few years while I delay filing SS which will only help a little, but it’s something. I wish I had found this site 10 years earlier.

I'm basically in similar position as Perryinva. Did all the pre tax savings up to max, and then smaller amounts after tax which I did some back door Roth while working. Now since retired I have been doing std Roth conversions out of the rollover IRA, but will still get a big tax bite once RMDs come into play. Knowing now, I also should have done more after tax and Roth while working, and minimized the pre tax. Could be worse problems to have of course With respect to RobbieB, I can't even blow the dough out of the rollover IRA for approx 2 years to avoid the 10% penalty (yes I am aware of 72t, not needed at this time).

 

[pjigar]

You guys made me run some scenarios on RMD tax brackets. I ran the scenarios manually but it got out of the hand very quickly. So created semi-generic google sheet to explore various options for FMJ couple. Feel free to use this sheet if you like to analyzed your own situation.


Long story short: This exercise was very useful and made me change my future contributions from Pretax 401K to Roth 401K. I am glad I talked with you guys.

 

[Magus]

The two main problems most folks miss when they compare pre-tax 401k to Roths is

1) You have to add in the value from your tax savings in pre-tax 401k in a taxable account to the value of your 401k. Me putting in $19,500 into a pre-tax 401k allows me to save $8,190 in taxes, which I can and will use to invest elsewhere. So I have to compare the value of both the 401k ($19.5k) + investments in a taxable account ($8.2k) in 25-45 years after taxes to the Roth in the same time period. You can't ignore the value of the tax savings up front and only compare on the back end.

2) Roths can and likely will be changed in the future - look at the current proposals. It's very likely Roth accounts over just a couple million will have taxes at some point IMO. Just like SS was not taxed for a long time but now 85% of it is taxed for anyone with other assets. I'd much rather have the guaranteed tax savings today than the hope that it'll be tax free in 25-45 years.

The only people I think roth's really make sense for are very young folks not making any money that have family that will contribute to Roth OR folks who are going to inherit a ton of money OR will make a fortune with company they started or startup that made it huge.