Author Topic: Help: I never did a backdoor Roth on my non-deductible IRA  (Read 2475 times)

TheAnonOne

  • Handlebar Stache
  • *****
  • Posts: 1753
Help: I never did a backdoor Roth on my non-deductible IRA
« on: February 21, 2018, 11:54:31 AM »
Hello-

We make too much to deduct the IRA during tax season and I have just been maxing the IRA's for the last few years anyway. Our HHI is around 180k->200k so our tax rates can be high.

Mine- 29k
Wife- 29k

For a total of - 58k sitting in traditional IRAs

Now this year, I will be maxing these again for the full 11k and I think its beneficial to roll that over into a ROTH.


Question 1. Can I roll just the newly deposited 11k over to ROTH? (To avoid paying cap-gains)

Question 2a. Should I just roll the entire 58k over? The gain on mine is 6k (so lets assume 12k gain total)
Question 2b. Am I correct in assuming I only pay taxes on the 12k as cap gains? (15% * 12,000 = $1,800 in taxes?????)

Question 3. How bad did I mess up here?

secondcor521

  • Walrus Stache
  • *******
  • Posts: 5503
  • Age: 54
  • Location: Boise, Idaho
  • Big cattle, no hat.
    • Age of Eon - Overwatch player videos
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #1 on: February 21, 2018, 01:16:14 PM »
Question 1. Can I roll just the newly deposited 11k over to ROTH? (To avoid paying cap-gains)

Question 2a. Should I just roll the entire 58k over? The gain on mine is 6k (so lets assume 12k gain total)
Question 2b. Am I correct in assuming I only pay taxes on the 12k as cap gains? (15% * 12,000 = $1,800 in taxes?????)

Question 3. How bad did I mess up here?

Answer 1.  Yes.

Answer 2a.  Depends.  See answer to 2b.

Answer 2b.  No.  You will pay ordinary income taxes on anything above your basis.  See Form 8606 Part II, which is where you would report such a conversion, which flows to Form 1040 line 15b, which ends up becoming part of your taxable income.  So you should look at your marginal rate to determine if it is worth it, not your cap gains rate.

Answer 3.  Eh.  It's paperwork, and as a previous poster noted, loss on some tax free growth on those earnings for a few years.  I think you probably should have been filing Form 8606 with your prior year returns to establish the basis in your IRAs.  If you or your tax preparer did not, I believe you can file Form 8606s retroactively for the applicable years.  You can also, I believe, file the 8606s independently; that is, you don't actually need to send in amended tax returns for the applicable years, just the 8606s.

TheAnonOne

  • Handlebar Stache
  • *****
  • Posts: 1753
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #2 on: February 21, 2018, 07:08:15 PM »
Question 1. Can I roll just the newly deposited 11k over to ROTH? (To avoid paying cap-gains)

Question 2a. Should I just roll the entire 58k over? The gain on mine is 6k (so lets assume 12k gain total)
Question 2b. Am I correct in assuming I only pay taxes on the 12k as cap gains? (15% * 12,000 = $1,800 in taxes?????)

Question 3. How bad did I mess up here?

Answer 1.  Yes.

Answer 2a.  Depends.  See answer to 2b.

Answer 2b.  No.  You will pay ordinary income taxes on anything above your basis.  See Form 8606 Part II, which is where you would report such a conversion, which flows to Form 1040 line 15b, which ends up becoming part of your taxable income.  So you should look at your marginal rate to determine if it is worth it, not your cap gains rate.

Answer 3.  Eh.  It's paperwork, and as a previous poster noted, loss on some tax free growth on those earnings for a few years.  I think you probably should have been filing Form 8606 with your prior year returns to establish the basis in your IRAs.  If you or your tax preparer did not, I believe you can file Form 8606s retroactively for the applicable years.  You can also, I believe, file the 8606s independently; that is, you don't actually need to send in amended tax returns for the applicable years, just the 8606s.

I think it makes sense to just do a Backdoor Roth for the new 11k

My thinking was that it was going into the exact same account, so they might try to claim that some of it was gains.

Under the new law, my marginal rate is 24% https://taxfoundation.org/2018-tax-brackets/

Maybe if I become somehow become unemployed one year, and have income way under 77k and can squeeze into that 12% rate zone. I assume that's how most do their ROTH ladders though.
« Last Edit: February 21, 2018, 07:10:59 PM by TheAnonOne »

brooklynmoney

  • Pencil Stache
  • ****
  • Posts: 707
  • Location: Crooklyn
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #3 on: February 21, 2018, 08:22:19 PM »
I am no tax expert but am in the same situation. One thing to watch out for is if you also have as I do rollover IRAs. You can’t just  choose to convert only the non deductible  i believe you have to pay based on the % of total IRAs that are non deductible out of all your IRAs. I’m doing a bad job of describing this but it’s a thing you have to worry about if you have other IRAs that are deductible or rolllivers.

seattlecyclone

  • Walrus Stache
  • *******
  • Posts: 7254
  • Age: 39
  • Location: Seattle, WA
    • My blog
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #4 on: February 21, 2018, 08:37:59 PM »
Question 1. Can I roll just the newly deposited 11k over to ROTH? (To avoid paying cap-gains)

The pro-rata rule makes it so that if you convert less than all of your traditional IRA balance to Roth, the conversion will be prorated based on what fraction of all your traditional IRA accounts is pre-tax vs. post-tax.

You have $29k in your traditional IRA, $23k of after-tax contributions and $6k of growth. If you add another $5.5k tomorrow, you'll have $28.5k of post-tax basis (82.6% of the total), and $6k of pre-tax growth (17.4% of the total).

You're allowed to convert any fraction of your $34.5k to Roth. Whatever amount you convert, 17.4% of it will be taxable income due to the pro-rata rule.

Quote
Question 2a. Should I just roll the entire 58k over? The gain on mine is 6k (so lets assume 12k gain total)

Probably. The pro-rata rule means you're paying tax from the first dollar of the rollover, and leaving money in the traditional IRA just means that the money will have more time to grow in there (where growth is pre-tax) instead of in Roth (where the growth is post-tax). An exception might be if you're close to the top of your current tax bracket, you may find an advantage to splitting the conversion between two separate years.

Quote
Question 2b. Am I correct in assuming I only pay taxes on the 12k as cap gains? (15% * 12,000 = $1,800 in taxes?????)

You only pay tax on the gains, yes, but it's taxed at normal income tax rates rather than capital gains rates.

Quote
Question 3. How bad did I mess up here?

If you had converted immediately you would have had that $6k of gains be in a Roth account where you will eventually be able to withdraw it tax-free, instead of in a traditional IRA where you still have to pay tax on it. Multiply $6k by your tax rate. A somewhat expensive lesson, I suppose, but probably shouldn't set your retirement back too much.

TheAnonOne

  • Handlebar Stache
  • *****
  • Posts: 1753
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #5 on: February 22, 2018, 10:21:46 AM »
Question 1. Can I roll just the newly deposited 11k over to ROTH? (To avoid paying cap-gains)

The pro-rata rule makes it so that if you convert less than all of your traditional IRA balance to Roth, the conversion will be prorated based on what fraction of all your traditional IRA accounts is pre-tax vs. post-tax.

You have $29k in your traditional IRA, $23k of after-tax contributions and $6k of growth. If you add another $5.5k tomorrow, you'll have $28.5k of post-tax basis (82.6% of the total), and $6k of pre-tax growth (17.4% of the total).

You're allowed to convert any fraction of your $34.5k to Roth. Whatever amount you convert, 17.4% of it will be taxable income due to the pro-rata rule.


Quote
Question 2a. Should I just roll the entire 58k over? The gain on mine is 6k (so lets assume 12k gain total)

Probably. The pro-rata rule means you're paying tax from the first dollar of the rollover, and leaving money in the traditional IRA just means that the money will have more time to grow in there (where growth is pre-tax) instead of in Roth (where the growth is post-tax). An exception might be if you're close to the top of your current tax bracket, you may find an advantage to splitting the conversion between two separate years.

Quote
Question 2b. Am I correct in assuming I only pay taxes on the 12k as cap gains? (15% * 12,000 = $1,800 in taxes?????)

You only pay tax on the gains, yes, but it's taxed at normal income tax rates rather than capital gains rates.

Quote
Question 3. How bad did I mess up here?

If you had converted immediately you would have had that $6k of gains be in a Roth account where you will eventually be able to withdraw it tax-free, instead of in a traditional IRA where you still have to pay tax on it. Multiply $6k by your tax rate. A somewhat expensive lesson, I suppose, but probably shouldn't set your retirement back too much.

Super helpful, hmm...

I don't know what to do now. I can just throw another 5.5k at each and forget about it another year. . . or bite the bullet and pay the taxes....


seattlecyclone

  • Walrus Stache
  • *******
  • Posts: 7254
  • Age: 39
  • Location: Seattle, WA
    • My blog
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #6 on: February 22, 2018, 11:09:56 AM »
I'd bite the bullet unless I planned to retire and have a much lower tax rate within just a few years, before the money has a chance to grow much. Better not to let that $6k of taxable growth become $12k or $50k.

TheAnonOne

  • Handlebar Stache
  • *****
  • Posts: 1753
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #7 on: February 22, 2018, 08:23:02 PM »
I'd bite the bullet unless I planned to retire and have a much lower tax rate within just a few years, before the money has a chance to grow much. Better not to let that $6k of taxable growth become $12k or $50k.

FIRE is maybe 3-5 years away so, that 6k might be around $8,500 given the full 5 years @ 7%

Still worth it?

seattlecyclone

  • Walrus Stache
  • *******
  • Posts: 7254
  • Age: 39
  • Location: Seattle, WA
    • My blog
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #8 on: February 22, 2018, 08:58:19 PM »
The whole balance will grow over time, not just the existing taxable growth. If you start with $34.5k this year, and it grows 40% by the time you retire, the total balance will be $48,300: your original principal of $28.5k remains the same, leaving $19,800 of growth. Contribute more between now and then, and you only increase the expected growth amount.

TheAnonOne

  • Handlebar Stache
  • *****
  • Posts: 1753
Re: Help: I never did a backdoor Roth on my non-deductible IRA
« Reply #9 on: February 22, 2018, 09:15:19 PM »
The whole balance will grow over time, not just the existing taxable growth. If you start with $34.5k this year, and it grows 40% by the time you retire, the total balance will be $48,300: your original principal of $28.5k remains the same, leaving $19,800 of growth. Contribute more between now and then, and you only increase the expected growth amount.

Wow, duh(me not you). Thanks!

I will debate doing it all now (costing me around 3k which I WONT be able to invest)
Doing part of it every year for a few years (basically fooling myself into not feeling the tax hit, but having more money to invest)
Doing NONE of it until FIRE (Lower tax rate to 10-12% on the rollover, and have the MOST money to invest)