High Income Earner / Trad IRA

[upupandaway]

I need some help. I'm a high income earner north of 200k with a retirement plan offered at w@rk. I max the 401k and my tax bracket is too high for Roth. I wouldn't do backdoor Roth at this tax bracket so I have been investing in after-tax brokerage and 529s. I don't have an HSA option as we have no high deductible plan. From my understanding I can still invest in a traditional IRA to the current limit with after tax contributions. These contributions and growth would not be taxable from my feeble understanding. I also have read that not mixing these funds with pretax traditional IRA contributions makes accounting easier. Here are my questions for this great group of folks.

(Married filing jointly)(already have emergency and lumpy expense savings)

1. Do I have the above correct or did I butcher it?
2. Should I open a new trad IRA account for the after tax contributions?
3. My spouse has a job that gives us medical and makes a low income. Can she also contribute to the limit of a trad IRA?
4. Is there any other retirment account I can put excess funds or does after tax brokerage make sense?

Thanks in advance!

 

[SevenUp]

1. Why not use the Backdoor Roth process? Getting money into Roth is better than putting money into taxable accounts.
2. How much do each of you have in traditional IRAs now?
3. Yes, regardless of whether she has a job or not, given your income.
4. The Investment Order suggestions are appropriate for most.

 

[pb4uski]

I think you are trying to hard to defer taxes. I was similarly situated when I was working, a high earning W-2 employee. I paid more in federal income taxes than the average household had in income. There is only so much that you can do as a W-2 employee. Have you looked into municipal bonds in a taxable account or just no or low dividend equities in a taxable account?

 

[NgineER]

Seven up is right. Back door Roth is what you will want to do. Your brokerage contributions are also made at a high marginal tax bracket, same as backdrop Roth would be. Your brokerage contributions will be taxed on the gains whereas the Roth will be tax free.

 

[pjigar]

After-tax contributions to traditional IRA must be "converted" to (backdoor) Roth IRA for the gains to be not taxable in future. Note that your traditional IRA should NOT have any pre-tax balance for the backdoor conversion to work at it's full potential. If you don't want to jump through hoop then a better option would be to leverage the 401(k) plan(s) you already have.

Most traditional 401(k) plans allow after-tax contributions. Maximum total contribution limit for 401(k) is $69,000. Maximum total contribution limit includes pre-tax contributions, employer match AND after-tax contributions. Assuming you empower contributes $5,000, you can contribute up to $41,000 ($69,000 - $23,000 - $5,000) after-tax money in your traditional 401(k) plan. The after-tax "contributions" made in your traditional 401(k) can be rolled over to a Roth IRA when you leave the current employer, or while in-service (if plan allows). This approach is called "mega backdoor IRA". Gains on the after-tax contributions are always taxable and can be rolled over to a traditional IRA or any other traditional 401(k) plan.

Even batter option would be to contribute $23,000 to Roth 401(k) if you employer offers it (if your aim is to build up the Roth bucket). After-tax contribution should be made to traditional 401(k). If your aim is to reduce current tax bill then I would put all contributions in traditional 401(k).

PS: I rather park my after-tax money in traditional 401(k) instead of brokerage. Make sure you balance your funds across three buckets (tax-differed, Roth and brokerage) strategically if you are planning to FIRE. You will have a harder time tapping the funds in tax-differed and Roth buckets before you turn 55.

 

[NgineER]

Good detail above. White coat investor has great detail on the back door Roth method. Gains are only taxable if you keep it in the 401k, if you roll it over or roll it into your Roth 401k you won’t be taxed on the gains (except for the gains before rolled over).

 

[retire48in2018]

I’d have some $ going into brokerage account investing in low turnover funds that will generate little annual taxable income. This allows tax diversification when retiring. But as other earlier posters stated - after back door Roths.

 

[pb4uski]

... PS: I rather park my after-tax money in traditional 401(k) instead of brokerage. Make sure you balance your funds across three buckets (tax-differed, Roth and brokerage) strategically if you are planning to FIRE. You will have a harder time tapping the funds in tax-differed and Roth buckets before you turn 55.

You have no trouble tapping funds in a taxable brokerage account before you turn 55 and if you invest in tax-free municipal bonds or no or low dividend equities in that taxable account then you will not pay taxes on that growth... never on the muni-bonds and only when sold on the equities and even than at favorable tax rates or even 0% depending on your income after you stop working.

That said, since we don't know how much the OP has in each bucket... taxable, tax-deferred or tax-free then is it hard to say for sure.

 

[upupandaway]

Wow! I think you guys hit my biggest misconception that somehow I would get taxed again for doing backdoor Roth. I will look at my current retirement plan offering at w@rk as well and see what our features are.

Here are my rough details if it helps narrow your advice. I think Roth conversion make sense for me.

Early 40s, Married, MCOL, These numbers are our combined assets
40K - Efund high interest saving
71K - ROTH
315K - 401k (current employer)
167K - roll over IRA
10K - after tax contrib to a trad IRA with growth (This was a reclassification one year. Would love to eliminate)
183K - Normal Brokerage

 

[SevenUp]

I think Roth conversion make sense for me.

Probably not. At least, for most people doing taxable Roth conversions while still working is not worthwhile.

...
167K - roll over IRA
10K - after tax contrib to a trad IRA with growth (This was a reclassification one year. Would love to eliminate)

The rollover IRA will complicate the backdoor Roth process. See the wiki article linked earlier for details.

 

[upupandaway]

I read the wiki article and I have a question. My wife does not have a roll over IRA and the only traditional IRA she has is after tax. Can she do roth conversion in a manner that is not affected by my existing roll over IRA? Would that be subject to her earned income limit or our joint income limit? I would not be interested in doing back door roth conversion at my current tax rate if it has to be spread across the after tax finds I'm putting in now and that roll over IRA.

 

[NgineER]

If you are MFJ then any roth conversion/rollover would be done at the current tax rate. All earnings in her after-tax IRA would be taxed upon rollover, but her after-tax contributions would not be taxed.

 

[SevenUp]

I read the wiki article and I have a question. My wife does not have a roll over IRA and the only traditional IRA she has is after tax. Can she do roth conversion in a manner that is not affected by my existing roll over IRA?

The phrase Roth conversion by itself usually refers to converting pre-tax money in a traditional account to a Roth account. The amount converted is then taxable for the tax year that equals the calendar year in which the conversion occurs.

The phrase Backdoor Roth refers to a two-step process:

1. Make a non-deductible contribution to a traditional IRA.
2. Convert (preferably immediately) that contribution to a Roth IRA. Because the traditional contribution is not deducted, the conversion of that amount is not taxed.

Reading your question as "Can she use the backdoor Roth process...not affected by my existing rollover IRA?" the answer is "yes".

Would that be subject to her earned income limit or our joint income limit? I would not be interested in doing back door roth conversion at my current tax rate if it has to be spread across the after tax finds I'm putting in now and that roll over IRA.

There are no income limits on conversion amounts. For MFJ filers, the combined tax return is used to determine the MAGI for traditional IRA purposes.

 

[N02L84ER]

"315K - 401k (current employer)
167K - roll over IRA
10K - after tax contrib to a trad IRA with growth (This was a reclassification one year. Would love to eliminate)"

If your current employer allows you to roll your traditional IRA into the 401k, you could eliminate the 10K after tax IRA. I think the steps are 1) roll the roll over 167K IRA into the 401k this year, 2) early next year you convert the 10K after tax IRA into a Roth IRA, 3) from then on you can do backdoor Roth contributions..

 

[upupandaway]

"315K - 401k (current employer)
167K - roll over IRA
10K - after tax contrib to a trad IRA with growth (This was a reclassification one year. Would love to eliminate)"

If your current employer allows you to roll your traditional IRA into the 401k, you could eliminate the 10K after tax IRA. I think the steps are 1) roll the roll over 167K IRA into the 401k this year, 2) early next year you convert the 10K after tax IRA into a Roth IRA, 3) from then on you can do backdoor Roth contributions..

This is my understanding. I have reached out to our 401k plan admin as there was no useful info on the portal for this. The only other thing is that 10K is my wife's IRA so it might just be able to be converted but I believe we would need to pay tax on the growth during the conversion. That growth is only $1200 and there is indeed a "convert to Roth IRA" button for it right on Vanguard.

 

[SevenUp]

"315K - 401k (current employer)
167K - roll over IRA
10K - after tax contrib to a trad IRA with growth (This was a reclassification one year. Would love to eliminate)"

If your current employer allows you to roll your traditional IRA into the 401k, you could eliminate the 10K after tax IRA. I think the steps are 1) roll the roll over 167K IRA into the 401k this year, 2) early next year you convert the 10K after tax IRA into a Roth IRA, 3) from then on you can do backdoor Roth contributions..

Even if the $167K and $10K were for the same person, there would be no need to wait until next year for step #2. It is the non-Roth IRA balance on 31-Dec that matters to Form 8606.

 

[SevenUp]

...10K is my wife's IRA so it might just be able to be converted but I believe we would need to pay tax on the growth during the conversion. That growth is only $1200 and there is indeed a "convert to Roth IRA" button for it right on Vanguard.

Yes on all counts.

 

[N02L84ER]

Yes, if the $10K IRA belongs to your wife and she has no traditional IRA money, you can simply convert the $10K to a Roth and all earnings/growth in that IRA would be what is taxable. If you wish to do back door Roth contributions, you will still need to roll your traditional IRA into your 401K first so that your traditional IRA balance is $0 on 12/31.

 

[upupandaway]

If I can roll my self directed roll over IRA into my current 401k that would pave the way for backdoor Roth without triggering pro-rata rules. What I don't understand is wouldn't I still be up against the annual contribution limit for an IRA (7000) or is there no contribution limit to after-tax dollars into an IRA? I apologize as I have searched and can't find the answer or the IRS documentation for this one.

 

[SevenUp]

What I don't understand is wouldn't I still be up against the annual contribution limit for an IRA (7000)...?

Yes, that is the contribution limit.

Rollovers and conversions, however, are not contributions and don't count against that limit.

 

[N02L84ER]

Yes, that is the contribution limit.
If your 401k employer allows after tax contributions that can be rolled over into a Roth 401k or Roth IRA, I think the after tax contributions can around $24K. I never had an employer that offered this, so I could be totally wrong.

 

[upupandaway]

update - my current 401k does not offer the ability to roll in my self directed IRA of pre-tax dollars. It also does not offer after tax contributions or any Roth options. I logged a request for next time they are reworking the agreement.

 

[zaqxsw]

Max out 401K's, IRAs, and the last option in "common" tax deferred investments are tax deferred annuities. I bought one decades ago. What kind depends on your AA but go with a low fee one (Fidelity). Fixed is pretty good right now vs. variable but it depends on your overall AA.

I'll never annuitize, it will just be inherited.

Not a bad asset to pass on. I appreciated the one I inherited years ago.

 

[BlueberryPie]

Backdoor is good if you can, but as others pointed out the pro-rata rule may prevent you from doing it if you can't "hide" your IRA into your 401(k). some people have suggested getting a side gig and opening a solo-401(k) and rollover into that, that seems like a lot of work for $7000 (or more if you qualify for the catchup)

It's good to have a decent taxable account, either because you want to retire early (no 59 1/2 limitation) or if you want to control your income in retirement: capital gains at that time may be in the 0% or 15% bracket

If you retire early, do Toth conversions before you claim SS, and your taxable will again help minimize taxes and pay for taxes on the conversions.

Don't let the tax tail wag the dog