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Backdoor Roth vs Traditional Decision

2,749 Views | 17 Replies | Last: 3 yr ago by YouBet
Pepper Brooks
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AG
Looking for input.

Early 30s couple
Household AGI for 2020: $200-250k
2020 Tax Bracket: 24%

Current retirement holdings
Traditional IRAs: $120k
Roth IRA: $15k(early in my career)
401ks: $150k

We have some money in an investment account I manage but am not factoring that in here.

If you were in this position, would you be converting all traditional IRA contributions into the roth or not? I'm on the fence and my forecasts are suggesting it's likely to be a toss up by the time we get to an age where we have RMDs. This assumes the tax laws aren't changed dramatically in the next 35-40 years.
YouBet
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AG
We do 100% backdoor Roth instead of Traditional as higher income earners.

FA ran comparison analysis over long haul and Roth still came out ahead although it wasn't a large gap.

Plus, the government is going to increase taxes over the next several years out of necessity, so I'd rather not have any additional tax burden on the other end. Granted, we have zero assurances they won't change the tax rules with Roths at some point.
Harkrider 93
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If you make a non deductible IRA contribution and convert it to a Roth, then most of it will be taxable. You have to account for your Traditional IRA money.

A couple of ways to reduce/eliminate that tax. Most 401ks will allow you to rollover your pretax IRAs into the 401k. If you do this, then you can do a backdoor Roth with no tax hit.

You can also do it for one person if they have very little in the IRA.

There are a few details to know, so if you are looking to move forward, reply to this and someone can help with the details.
sellthefarm
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I'm in a similar spot and trying to decide what to do. Supposed to talk to my FA today.

My IRA has about 20k Tradition and about 30k Roth. I don't have a 401k so no ability to roll Tradition over to avoid tax issues. Hopefully my FA will help me figure it out.
FrontPorchAg
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OP, this comes up as a frequent topic here and I've heard a lot of good arguments both ways. Unfortunately, as you already alluded to, there are a lot of variables in the decision making. Namely, you don't know what tax bracket you are going to be paying when you retire and the calculation on whether it's worth contributing to one versus the other is highly dependant on current tax rate vs time to retirement.

My wife and I have done well enough and fortunate enough that most years we can just max out both.

My personal feeling is that Roth's are the preferred method until you are closing in on retirement. At some point, the tax deduction will likely be worth more than the tax-free withdrawal on the gains.
All animals are equal, but some animals are more equal than others
evan_aggie
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AG
I'm convinced the slowing growth of population, the fiscal "spend our way out of it" mentality, will catch up with us and increase tax rates across the board.

The county is slowly moving to "we deserve and are entitled to everything" and I don't see how we provide it all without raising taxes like Europe.
YouBet
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I think I missed the distinction that you were talking about rolling your existing Traditional balance all into Roth. My first post was for ongoing/future contributions. I have $0 in Traditional IRA's. Every year I contribute the annual max to our Traditional IRA's in one lump sum and then immediately turn around and transfer it into our Roth IRA's.
permabull
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AG
Pepper Brooks
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I'm curious about how this would work, tax wise, as I opened the account in late 2017 with the rollover from a previous employers 401k. This is the current asset allocation of my IRA, which makes up most of the IRA balance.


Rollover 401k Contribution: $64,938.54
Rollover "Pension" Contribution: $11,988.74
Non-deductible Contribution: $14,006.87
Gains/Appreciation: $20,408.85
Total: $111,343.00

Questions:
Would the rollover contributions be eligible for a backdoor roth coversion? I've never paid taxes on either of the rollover buckets.
Would we just owe our current income tax rate if we converted the non-deductible contributions?
Do you have any suggestions on how to rollover any of this and limit our current tax liability?

My understanding is that the IRS isn't sophisticated enough to know what amounts are pre-tax/post-tax contributions and they'd tax it all the same.

For example, say I wanted to covert $10,000 of a $100,000 IRA to my roth.
10,000 * .24 = $2,400
10,000/100,000 = 10%
Total Tax Obligation = $2,400 *.90 = $2,160
cjsag94
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AG
Carol Baskin said:

I'm curious about how this would work, tax wise, as I opened the account in late 2017 with the rollover from a previous employers 401k. This is the current asset allocation of my IRA, which makes up most of the IRA balance.


Rollover 401k Contribution: $64,938.54
Rollover "Pension" Contribution: $11,988.74
Non-deductible Contribution: $14,006.87
Gains/Appreciation: $20,408.85
Total: $111,343.00

Questions:
Would the rollover contributions be eligible for a backdoor roth coversion? I've never paid taxes on either of the rollover buckets.
Would we just owe our current income tax rate if we converted the non-deductible contributions?
Do you have any suggestions on how to rollover any of this and limit our current tax liability?

My understanding is that the IRS isn't sophisticated enough to know what amounts are pre-tax/post-tax contributions and they'd tax it all the same.

For example, say I wanted to covert $10,000 of a $100,000 IRA to my roth.
10,000 * .24 = $2,400
10,000/100,000 = 10%
Total Tax Obligation = $2,400 *.90 = $2,160


Backdoor Roth is slang for the process for funding a Roth when you make to much to fund it directly. What you are actually doing is converting a traditional IRA to a Roth (distinction is relevant because conversion rules are what you need to understand.. It doesn't matter where the IRA money came from, only how it was taxed).

To answer your question, you will pay tax (no penalty) on the pro rata portion of any amount you convert that was pre tax in all of your traditional IRAs. So, in your breakdown above, about 12.6% of your IRA is post tax, 87.4% is pre tax.. so you will pay tax on 87.4% of whatever amount you convert.

A strategy is to continue to max contribute non deductible contributions as you convert, this accelerates the pro rata swing allowing you to convert more and more over time without increasing tax liabilities beyond the baseline.

Lastly, the IRS doesn't have to be sophisticated... The custodian of your retirement account gives them a1099 and 5498 with everything you've done... And you have told them through the years you've made deductible contributions. All they have to do when you claim this stuff is cross reference the basic tax information they already have or are given.
Pepper Brooks
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AG
Great, thanks!
Jethro95
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With some planning you may be able to avoid the tax on the pro rata portion of your existing Traditional IRA when doing conversions.

See Step 3, number 3 in this article.

https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/

You would be rolling over your Traditional IRA to your 401k, if the plan allows it, or setting up a Solo 401k if your circumstances allow for it and rolling into that.

Pepper Brooks
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AG
The investment options in my current 401k are terrible so I'd like to avoid that if possible.
Agswinning
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Why are they terrible? Who does your company use?
Herknav
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//Just redirect your investments for a couple of years to the Roth. Rather than convert and have atax bill.//
Pepper Brooks
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Fidelity but they don't have any tickers. It will say large/mid/small cap, bond, intl, etc. but that's all I can see.

The large cap tells me it tracks the S&P but doesn't provide any info past that. It's under performed my vanguard but 3-5% over the last 3 years.
Pepper Brooks
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I switched the 401k to mostly Roth a few months ago.
Endo Ag
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Go get some token 1099 income, and open a solo 401k. You can roll your IRA balance into your solo k. This has the added advantage of being a placeholder for all future 401k rollovers and keeps you from having to put old 401k money into a plan that you don't like.

Attempting to predict the future is a fools errand.
YouBet
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Carol Baskin said:

Fidelity but they don't have any tickers. It will say large/mid/small cap, bond, intl, etc. but that's all I can see.

The large cap tells me it tracks the S&P but doesn't provide any info past that. It's under performed my vanguard but 3-5% over the last 3 years.


Sounds like what you have are collective investment trust options. A lot of our 401k fund options have moved to these as well. It's a PITA for tracking.

I'm assuming the company gets some kind of cost break for using these vs actual mutual funds but never looked into it.
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