Backdoor Roth

[Icecreamarsenal]

Can someone break down how to back door a Roth, explicit splaining-to-a-5th grader style?

Context:
I have a tIRA already, with a balance of 30k. I have yet to contribute my 5.5k for 2014. Vanguard.

Married filing jointly. Gross income is well above 191k.  But reading bogleheads wiki, backdoor Roth seems immune to income contribution.

Any help is much appreciated.

Specifics:
Since I already have a tIRA, is it too late?
Do I add to ira 5.5k, then convert only 5.5k or the 35.5k?
How long do I wait between converting?
What questions haven't I asked that I should be asking?

[Icecreamarsenal]

Copy pasta: http://www.bogleheads.org/wiki/Backdoor_Roth_IRA

Even reading this I'm confused. I'm in the 2nd highest tax bracket now but I plan on being in a lower one. I also plan on retiring from my day job in 12 years and being in a lower tax bracket.

So does it even make sense?

[FrugalSpendthrift]

If you didn't have anything in a traditional ira, it would be simple, just contribute $5.5k and convert it.  Your traditional ira is going to affect how the conversion is taxed, so you need to consider that.  If you convert the whole thing, it will really bump up your tax bill.

[seattlecyclone]

Can someone break down how to back door a Roth, explicit splaining-to-a-5th grader style?

Many people have income that is too high to contribute to a Roth IRA directly. These people are often also unable to qualify for deductible traditional IRA contributions due to their income. However, it is legal for these people to make non-deductible traditional IRA contributions. That fact, combined with the fact that there is no income limit for converting a traditional IRA to a Roth IRA, means that these people can put money in a Roth IRA by first contributing it to a traditional IRA and then converting it to Roth.

Something to be aware of is that there is a "pro-rata rule" that applies when you convert money from a traditional IRA to a Roth IRA. Any conversion is pro-rated between pre-tax funds (that will be taxed when you convert) and post-tax funds (that won't be taxed). In your situation this means that if you contribute $5k after-tax in addition to your $30k of pre-tax funds, you'll end up paying tax on about 85% of the amount you convert. At your income this is probably not worthwhile.

If you have access to a 401(k) plan at work, you may be able to get around this by first rolling over your IRA into your 401(k). This will bring your traditional IRA balance down to zero, at which point you can make a non-deductible traditional IRA contribution and convert it to Roth without the pro-rata rule coming into effect.

This may sound like loopholes on top of loopholes, which is exactly what it is.

Since I already have a tIRA, is it too late?

Not necessarily. The only way around the pro-rata rule is to roll any pre-existing traditional IRA balance into a 401(k) or other employer plan, but this will work if your employer plan accepts IRA rollovers.

Do I add to ira 5.5k, then convert only 5.5k or the 35.5k?

If you contributed after-tax money to your pre-tax IRA, you are allowed to convert as much or as little as you want to Roth. The pro-rata rule makes it so that you pay tax on an equal proportion of the funds no matter how much is rolled over. Again, at your current tax bracket, converting pre-tax funds to Roth in any amount is probably not a good idea.

How long do I wait between converting?

There is no time requirement. You can convert whenever you want.

Is it starting to make more sense?

[Icecreamarsenal]

Can someone break down how to back door a Roth, explicit splaining-to-a-5th grader style?

Is it starting to make more sense?

Yes, very much so; thank you!

The loophole within the loophole sounds intriguing.

Currently I have my vanguard tIRA set up very moderate risk with malkiel/boglehead proportions. If I roll that into my employers 401k, there is loss of control: it's all fidelity Spartan 500 index.

Are the benefits of a Roth IRA vs a tIRA worth the loss of control? Hmm. Going to leave my current setup unless one of you financial whizzes strongly think otherwise.

Also, had my taxable account at VTSAX, recently changed it all over to VNJTX, a tax exempt bond fund with solid returns but unfortunately an expense ratio of 0.2%.  Thoughts?

Should I move this over to bogleheads instead? This is more a lifestyle forum but perusing I see some finance pros commenting here and there so it was worth a shot. Plus I was an MMM'er before a Boglehead!