I thought I was on track, but now confused about retirement planning...

[rxmurphy]

Hi all. looking for some guidance from the community. I am having difficulty deciphering steps 4-6 in the US Investment order plan noted in the Investor Alley sticky. My situation is my income is too high (yeah, I know) for Roth IRA, and for deducting a traditional IRA. Knowing this, why would I not just keep maxing out 401K beyond the company match (only $3000) to the $24,500 limit (old guy), then do taxable account with money left for saving? Is it better to max t-IRA even without deductibility? My assumption is that when I retire in ~4 years, I will be in a lower tax bracket so I am thinking backdoor Roth would not be optimal for me. I think I can continue to put away about $2,800 a month total. I think I have a good-sized stache and will be able to pull trigger in 4 years. I would like to maximize the stache as much as I can tax-wise and growth-wise. I have been 90/10 all along but am now starting to morph to 70/30 with current contributions.

Thanks for reading and please be kind.  :-)

[Ben Kurtz]

Yes, max out your 401k to take full advantage of the deduction.

After that, the main point is that as between a backdoor Roth IRA and a taxable account, there is no downside to putting cash in a backdoor Roth IRA, so max that out first rather than simply putting everything in taxable. All your dividends and capital gains will come out of the backdoor Roth IRA tax-free, whereas in a taxable account they would attract tax. You can also pull principal out of a Roth IRA tax and penalty free whenever you like. About the only downside to having such investments in a Roth IRA is that you cannot access any gains on the investment before retirement age without paying an additional tax or penalty -- but if this is retirement savings, it's probably very unlikely that you'll try to grab that cash early.

If you could have deducted the IRA contribution that would probably have been better, but without the deduction the backdoor Roth IRA is at least superior to the taxable account.

Given that you are fairly close to retirement at a traditional retirement age, it is also worth looking up advantageous withdrawal strategies. If your retirement living expenses are, for example, $40,000 per year, you might consider withdrawing that from the 401k, and then converting an additional $10,700 of 401k money into Roth IRA money, which in total will give you a paper income of $50,700 for the year (assuming you have no other sources of income in retirement). The reason for doing such a conversion is that the 12% tax bracket maxes out at around $50,700 of income ($12,000 standard deduction plus $38,700 of bracket size), and getting money out of the 401k at such a cheap tax rate is usually a good deal. This is particularly true if you have a very large 401k -- so large that by the time you reach 70.5 years old you will likely be stuck with required minimum distributions well in excess of your $40,000 living expenses budget, pushing you involuntarily into a higher tax bracket. Better to get the money out early when you have spare headroom in cheap tax brackets, stick it in a tax advantaged account which does not have required minimum distributions, and allow it to grow in the Roth IRA where it will give you fewer problems. There is plenty of discussion of this sort of thing on various personal finance sites: https://www.bogleheads.org/forum/viewtopic.php?t=223701

[rxmurphy]

Yes, max out your 401k to take full advantage of the deduction.

After that, the main point is that as between a backdoor Roth IRA and a taxable account, there is no downside to putting cash in a backdoor Roth IRA, so max that out first rather than simply putting everything in taxable. All your dividends and capital gains will come out of the backdoor Roth IRA tax-free, whereas in a taxable account they would attract tax. You can also pull principal out of a Roth IRA tax and penalty free whenever you like. About the only downside to having such investments in a Roth IRA is that you cannot access any gains on the investment before retirement age without paying an additional tax or penalty -- but if this is retirement savings, it's probably very unlikely that you'll try to grab that cash early.

If you could have deducted the IRA contribution that would probably have been better, but without the deduction the backdoor Roth IRA is at least superior to the taxable account.

Given that you are fairly close to retirement at a traditional retirement age, it is also worth looking up advantageous withdrawal strategies. If your retirement living expenses are, for example, $40,000 per year, you might consider withdrawing that from the 401k, and then converting an additional $10,700 of 401k money into Roth IRA money, which in total will give you a paper income of $50,700 for the year (assuming you have no other sources of income in retirement). The reason for doing such a conversion is that the 12% tax bracket maxes out at around $50,700 of income ($12,000 standard deduction plus $38,700 of bracket size), and getting money out of the 401k at such a cheap tax rate is usually a good deal. This is particularly true if you have a very large 401k -- so large that by the time you reach 70.5 years old you will likely be stuck with required minimum distributions well in excess of your $40,000 living expenses budget, pushing you involuntarily into a higher tax bracket. Better to get the money out early when you have spare headroom in cheap tax brackets, stick it in a tax advantaged account which does not have required minimum distributions, and allow it to grow in the Roth IRA where it will give you fewer problems. There is plenty of discussion of this sort of thing on various personal finance sites: https://www.bogleheads.org/forum/viewtopic.php?t=223701

Thanks Ben, especially the part about structuring the withdrawals post retirement. I am actually backwards there, the company I work for was bought last year, had to start a new 401K at new company and rolled old 401K into IRA at Vanguard, so IRA is much much larger than 401K. But still something to think about.

[Laura33]

Yes, max out your 401k to take full advantage of the deduction.

After that, the main point is that as between a backdoor Roth IRA and a taxable account, there is no downside to putting cash in a backdoor Roth IRA, so max that out first rather than simply putting everything in taxable. All your dividends and capital gains will come out of the backdoor Roth IRA tax-free, whereas in a taxable account they would attract tax. You can also pull principal out of a Roth IRA tax and penalty free whenever you like. About the only downside to having such investments in a Roth IRA is that you cannot access any gains on the investment before retirement age without paying an additional tax or penalty -- but if this is retirement savings, it's probably very unlikely that you'll try to grab that cash early.

If you could have deducted the IRA contribution that would probably have been better, but without the deduction the backdoor Roth IRA is at least superior to the taxable account.

Given that you are fairly close to retirement at a traditional retirement age, it is also worth looking up advantageous withdrawal strategies. If your retirement living expenses are, for example, $40,000 per year, you might consider withdrawing that from the 401k, and then converting an additional $10,700 of 401k money into Roth IRA money, which in total will give you a paper income of $50,700 for the year (assuming you have no other sources of income in retirement). The reason for doing such a conversion is that the 12% tax bracket maxes out at around $50,700 of income ($12,000 standard deduction plus $38,700 of bracket size), and getting money out of the 401k at such a cheap tax rate is usually a good deal. This is particularly true if you have a very large 401k -- so large that by the time you reach 70.5 years old you will likely be stuck with required minimum distributions well in excess of your $40,000 living expenses budget, pushing you involuntarily into a higher tax bracket. Better to get the money out early when you have spare headroom in cheap tax brackets, stick it in a tax advantaged account which does not have required minimum distributions, and allow it to grow in the Roth IRA where it will give you fewer problems. There is plenty of discussion of this sort of thing on various personal finance sites: https://www.bogleheads.org/forum/viewtopic.php?t=223701

Thanks Ben, especially the part about structuring the withdrawals post retirement. I am actually backwards there, the company I work for was bought last year, had to start a new 401K at new company and rolled old 401K into IRA at Vanguard, so IRA is much much larger than 401K. But still something to think about.

If you have a large existing rollover IRA from an old 401(k), if you do the backdoor Roth, the IRS will treat your Roth conversion as coming proportionately from the existing and new IRA.  Usually you open a nondeductible IRA and then convert it to a Roth very quickly (the next day).  Because it is a nondeductible IRA, you owe taxes only on the growth in the account since you opened it -- meaning if you convert it right away, that is practically nonexistent.  OTOH, anything you convert from your existing rollover IRA will be treated as income to you, meaning you will pay taxes on that entire portion at your marginal tax rate.  So if you have $95K in the IRA you rolled over from your 401(k), and start a new nondeductible IRA for $5K, the IRS will treat your Roth conversion as if 95% of the $$ came from the rollover IRA (and is fully taxable), and only 5% comes from the nondeductible.

I am a huge fan of the Backdoor Roth and have one myself.  But it works only because I had no other IRAs I had.  In your situation, if your new 401(k) is good and accepts rollovers, I would roll the existing IRA into the new 401(k) and then do the backdoor Roth.  OTOH, if the 401(k) has high fees or poor choices, or if it doesn't take rollovers, I'd skip the backdoor Roth given your current high marginal tax rate.

[MDM]

Hi all. looking for some guidance from the community. I am having difficulty deciphering steps 4-6 in the US Investment order plan noted in the Investor Alley sticky. My situation is my income is too high (yeah, I know) for Roth IRA, and for deducting a traditional IRA. Knowing this, why would I not just keep maxing out 401K beyond the company match (only $3000) to the $24,500 limit (old guy), then do taxable account with money left for saving? Is it better to max t-IRA even without deductibility? My assumption is that when I retire in ~4 years, I will be in a lower tax bracket so I am thinking backdoor Roth would not be optimal for me. I think I can continue to put away about $2,800 a month total. I think I have a good-sized stache and will be able to pull trigger in 4 years. I would like to maximize the stache as much as I can tax-wise and growth-wise. I have been 90/10 all along but am now starting to morph to 70/30 with current contributions.

Thanks for reading and please be kind.  :-)

Good question.  The general theme of the investment order is "minimize taxes and fees so you keep more of your money".  In many cases, the fees in an IRA are lower than in a 401k, so the default is "use IRA before using 401k."  But if one has a particularly good 401k plan (e.g., funds with institutional-class fees) then swap that order.

For most, the only reason to contribute to a non-deductible tIRA is as the first step in a backdoor Roth.  Roth, either normal or backdoor, will almost always be better than taxable.

Does that make sense?

The what and why for steps 4-6 are reproduced below.  If there are specific parts that could be clearer, please advise - rewording may help others as well.

4. Max Traditional IRA or Roth (or backdoor Roth) based on income level            
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)            
6. Fund a mega backdoor Roth if applicable.         

4. Rule of thumb: traditional if current federal marginal rate is 22% or higher; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise. 
   For those willing to expend a little more energy than it takes to flip a coin, consider comparing current marginal tax saving rate vs. predicted marginal withdrawal tax rate.
      If current > predicted, use traditional.  Otherwise use Roth.
   See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
   See Traditional versus Roth - Bogleheads for even more details and exceptions.  State tax (or lack thereof) should also be considered.
   The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals*.
5. See #4 for choice of traditional or Roth for 401k.  In a 401k there are no income-based limits for deductions or contributions.      
6. Applicability depends on the rules for the specific 401k

[Ben Kurtz]

Thanks Ben, especially the part about structuring the withdrawals post retirement. I am actually backwards there, the company I work for was bought last year, had to start a new 401K at new company and rolled old 401K into IRA at Vanguard, so IRA is much much larger than 401K. But still something to think about.

As Laura33 points out, if you have "pre-tax" money in a traditional IRA account (meaning tIRA contributions for which you took deductions in the past, or a rollover IRA containing pre-tax 401k dollars), IRS rules prevent you from successfully using the backdoor Roth IRA strategy. A disclaimer to that effect is usually baked into articles and posts about executing the backdoor Roth strategy. Call your new 401k provider and inquired about "reverse rolling" the rollover tIRA back into your new 401k, to clear out any pre-tax IRAs. Again, as Laura33 points out, it's only worth bothering with this if your new 401k plan has reasonable investment choices and low fees.

Another point to consider in the future is that most 401k plans will not require you to rollover into an IRA after separation from the sponsoring employer, at least if your balance is above a relatively modest floor (often $10,000 or $25,000). I have two 401ks from prior employers that I've left exactly in place, because both had good investment options and fee structures -- and it keeps the decks clear for my annual backdoor Roth.

On the post-retirement withdrawal side, there isn't much of a difference between tIRAs and 401ks when it comes to the required minimum distribution issues I discussed earlier. If the combined balance of all your 401ks and tIRAs is large enough to create the threat of excessive RMDs when you reach age 70.5, it is usually worth paying taxes early at a modest 12% tax rate to get some of the investments (and subsequent gains) into more advantageous Roth space.

[rxmurphy]

Okay, so the company I was with and had a large 401K at dissolved, and dissolved their 401k. We had to either roll it into the new parent company's 401k or into an outside IRA. I put it all in Vanguard IRA and started new 401K from scratch a year ago. As I mentioned, the IRA is very large and the 401K is very small right now. Here is how I am invested:

401K (small)    at Fidelity Net Benefits                                    exp ratio      % invested
FidelityŽ Extended Market Index Fund - Premium Class FSEVX     0.07                 32%
      
FidelityŽ 500 Index Fund - Institutional Class  FXSIX                   0.03                 32%
      
FidelityŽ International Index Fund - Premium Class FSIVX           0.06                 22%
      
FidelityŽ U.S. Bond Index Fund - Institutional Class FXSTX          0.035                 14%
=======================================================      
IRA - (large)   at Vanguard   
Vang Total Stock Market Index Fund Admiral Shares  VTSAX            0.04                 65%
      
Vang Total International Stock Index Fund Admiral Shares  VTIAX    0.11                 30%
      
Vang Total Bond Market Index Fund Admiral Shares  VBTLX             0.05                 5%

I am in the process of shifting more to bonds over the next couple of years. I will check with Fidelity to see if I can roll the whole IRA over to them. The IRA is totally pretax dollars, except for $6,500 i contributed in 2017, plus of course all of the growth that has occurred. If Fidelity accepts roll over, then I can start new IRA at Vanguard and do back door, correct? After I max the 401K, HSA etc. Sounds like a plan?

Thanks for all of the comments.

[MDM]

I will check with Fidelity to see if I can roll the whole IRA over to them. The IRA is totally pretax dollars, except for $6,500 i contributed in 2017, plus of course all of the growth that has occurred. If Fidelity accepts roll over, then I can start new IRA at Vanguard and do back door, correct? After I max the 401K, HSA etc. Sounds like a plan?

A fine plan indeed (except, leave the post-tax $6500 in the IRA - maybe that's what you meant - and do a backdoor Roth with that amount).  Good luck!

[Ben Kurtz]

Agree with MDM.

I take it you contributed directly $6,500 to your tIRA in 2017 and then figured out that you couldn't take the deduction on the tax return you are about to file?

For roll-overs between 401ks and tIRAs, I believe the tax rule is that you can move your pre-tax dollars and earnings first (for tax purposes, pre-tax contributions and all earnings are basically the same), and selectively leave behind the after-tax $6,500. Which you can then convert to Roth in a backdoor Roth maneuver.

If I recall correctly, the rule is quite confusing: Partial conversions from tIRA to Roth IRA are analysed proportionately, while rollovers between 401ks and tIRAs are treated as earnings-out-first. That is, if you have $50,000 in pre-tax dollars / earnings in an IRA, and $25,000 in after tax dollars in an IRA, a conversion of $6,000 of your account will be treated as $4,000 of pre-tax dollars (which will be included in income in the year you convert for tax purposes) and $2,000 will be treated as after-tax dollars. But if you reverse-rolled $50,000 of that into a 401k, all of that would be pre-tax and then you'd be left with $25,000 in pure after tax dollars in your tIRA, which could then be converted to Roth without income tax consequences.

Also worth remembering is the fact that for the Roth conversion rule, all your separate tIRAs are lumped together as if you had one big tIRA. So it doesn't help to have a tIRA with Vanguard with all your 401k rollover money, and then a new tIRA at Fidelity in which you just put new non-deductible contributions, and then just convert the Fidelity tIRA into Roth each year.

Finally, Vanguard makes it very easy to convert from tIRA to Roth at the push of a button. I use them for my backdoor Roth strategy because it is a very user-friendly experience.

[rxmurphy]

I take it you contributed directly $6,500 to your tIRA in 2017 and then figured out that you couldn't take the deduction on the tax return you are about to file?

Exactly right Ben. Hindsight is 20/20.

Many thanks to all for the guidance, I still have a lot of homework to do, especially deciding if Roth IRA is appropriate for me based on current and expected tax brackets, amount of $$ being converted, etc.

[rxmurphy]

A fine plan indeed (except, leave the post-tax $6500 in the IRA - maybe that's what you meant - and do a backdoor Roth with that amount).  Good luck!

Yes MDM, exactly what I meant.

Thanks for the feedback.

[Ben Kurtz]

I still have a lot of homework to do, especially deciding if Roth IRA is appropriate for me based on current and expected tax brackets, amount of $$ being converted, etc.

If you are maxing out all your other tax-advantaged space, and the only choice is between (i) backdoor Roth IRA, (ii) non-deductible tIRA and (iii) taxable, I think it's a no-brainer to fill up the backdoor Roth IRA, and then taxable after that.

However, if you are not otherwise going to be able to fill up all your other tax-advantaged space (e.g. you have $18,000 to save and its a question of whether you put that all in the 401k or split it $5,500 into backdoor Roth IRA and $12,500 401k), then yes, you need to do some homework and take a view as to current and expected future tax rates, etc.

Again, if you are in the former category, don't make things needlessly complicated -- just fill up the backdoor Roth IRA before putting more in taxable. Good luck!