Don't qualify for Roth IRA - how to utilize them?

[lifeplus]

My wife and my combined income exceeds the limit for Traditional and Roth IRAs. I've been looking at the IRA conversion ladder and was hoping to utilize this strategy from my 401k at FI, but am thinking that looks grim.

Questions:
1. Can one roll over a 401k into a Traditional IRA even if the income level exceeds the income limit?
2. Where are other high income earners putting their money aside from 401ks? And, if you cannot leverage the IRA conversion ladder strategy, then what is your strategy to pay the least in taxes? Take the 10% penalty? Curious. Thanks. 

[ILikeDividends]

According to this article, you can make a non-deductible contribution to a tIRA, and then use the backdoor Roth conversion method to move it into a Roth account without any tax consequences (with a caveat). *

https://www.cnbc.com/2018/07/23/high-income-savers-use-this-tax-friendly-strategy-for-retirement.html

* To your first question, you can definitely roll your 401K into an IRA rollover account when you leave your job.   If you do already have a tIRA funded with pre-tax dollars, there's a little gotcha called "the pro-rata rule" that you need to be aware of when converting a non-deductible IRA to a Roth.  I'm not entirely sure whether your 401K might also be subject to that gotcha, so you should read the whole article, and proceed with caution.  If your 401K isn't subject to the pro-rata rule, then it seems you'd be better off keeping it in a 401K rather than a tIRA; at least until the next tax year after doing the backdoor Roth conversion from a non-deductible IRA.

[secondcor521]

1.  Yes.
2.  Taxable account is what I did.  Although I would point out that if you roll your 401(k) into a traditional IRA, there are absolutely no restrictions on converting money from that traditional IRA to a Roth IRA and using the Roth conversion strategy.  (Well, you do have to pay income taxes on the converted amounts, and you can no longer recharacterize conversions, but there are no income limits or anything like that.)

Regarding @ILikeDividends comments above about the pro-rata rule, if your 401(k) is all funded with pre-tax dollars (I'm guessing it is), then you can roll that to a traditional IRA without any concerns about the pro-rata rule.  If you have after-tax money in your 401(k), I am less certain how that works but I believe you can roll the pre-tax amounts (plus any earnings) into a traditional IRA and the after-tax money into a Roth IRA, again without concern for the pro-rata rule.

[lifeplus]

1.  Yes.
2.  Taxable account is what I did.  Although I would point out that if you roll your 401(k) into a traditional IRA, there are absolutely no restrictions on converting money from that traditional IRA to a Roth IRA and using the Roth conversion strategy.  (Well, you do have to pay income taxes on the converted amounts, and you can no longer recharacterize conversions, but there are no income limits or anything like that.)

Regarding @ILikeDividends comments above about the pro-rata rule, if your 401(k) is all funded with pre-tax dollars (I'm guessing it is), then you can roll that to a traditional IRA without any concerns about the pro-rata rule.  If you have after-tax money in your 401(k), I am less certain how that works but I believe you can roll the pre-tax amounts (plus any earnings) into a traditional IRA and the after-tax money into a Roth IRA, again without concern for the pro-rata rule.

Thank to both of you.

Yes, the 401k is all pretax dollars so good to know I don't have to worry about pro-rata rule.

@secondcor521 , when you say "Taxable account is what I did..." What taxable account type did you choose? An individual (or joint) VTSAX mutual fund account like this: https://investor.vanguard.com/investing/joint-account-individual-account? Curious. Thanks for your help.

[Indexer]

I think there might be some confusion about the pro-rata rules. ILikeDividends was talking about the pro-rata rules on a backdoor Roth strategy, not whether there is after-tax money in the 401k. That is a completely separate matter, and since you don't have any after-tax money in the 401k you don't need to worry about it.

If you want to do a backdoor Roth strategy, which is what ILikeDividend's linked article is describing, then you want to be aware of any current pre-tax IRAs. If you have an existing pre-tax IRA and you try to use the backdoor strategy then the IRS will look at all of your pre-tax IRA's and apply the pro-rata rules across the conversion.

Example1: No existing IRAs. Put 6k in a pre-tax IRA without taking the deduction and then convert it to a Roth. You avoid the Roth income limits and there are no tax implications. This is nice and clean, and the ideal scenario when using the backdoor Roth strategy.

Example2: You have 94,000 in a Traditional IRA. Now you put 6k in a pre-tax IRA without taking the deduction and convert to a Roth. You avoid the Roth income limits BUT the IRS will apply the pro-rata rules including your 94,000 Traditional IRA. From the IRS's point of view you converted 6k of a 100k IRA, and 94% of that IRA was pre-tax. Now you will owe taxes on $5,640 of additional income. This is what ILikeDividends was warning you about. If that $5,640 is taxed at a high tax bracket, which is the likely scenario if you are over the Roth income limits, then this was likely a terrible decision.


Very important note: your 401k is NOT included in the pro-rata calculation for the backdoor Roth strategy. You could have $1,000,000 in your 401k, $0 in Pre-tax IRAs, and complete Roth conversions without having to worry about the pro-rata rules. In other words, if you plan on using the backdoor Roth strategy you probably don't want to roll your 401k into a Traditional IRA because as soon as you do that you subject yourself to the pro-rata rules. This is what ILikeDividends was warning you about when they said, "(with a caveat)*"

[secondcor521]

1.  Yes.
2.  Taxable account is what I did.  Although I would point out that if you roll your 401(k) into a traditional IRA, there are absolutely no restrictions on converting money from that traditional IRA to a Roth IRA and using the Roth conversion strategy.  (Well, you do have to pay income taxes on the converted amounts, and you can no longer recharacterize conversions, but there are no income limits or anything like that.)

Regarding @ILikeDividends comments above about the pro-rata rule, if your 401(k) is all funded with pre-tax dollars (I'm guessing it is), then you can roll that to a traditional IRA without any concerns about the pro-rata rule.  If you have after-tax money in your 401(k), I am less certain how that works but I believe you can roll the pre-tax amounts (plus any earnings) into a traditional IRA and the after-tax money into a Roth IRA, again without concern for the pro-rata rule.

Thank to both of you.

Yes, the 401k is all pretax dollars so good to know I don't have to worry about pro-rata rule.

@secondcor521 , when you say "Taxable account is what I did..." What taxable account type did you choose? An individual (or joint) VTSAX mutual fund account like this: https://investor.vanguard.com/investing/joint-account-individual-account? Curious. Thanks for your help.

I simply have a Vanguard brokerage account with VTSAX inside it.  I'm single, so it's an individual account.  Since I'm FIREd, I follow the usual advice and have the quarterly dividends paid out to me as an ACH to my checking account.

https://www.vanguard.com/pdf/vbcfaq_062013.pdf

[lifeplus]

I think there might be some confusion about the pro-rata rules. ILikeDividends was talking about the pro-rata rules on a backdoor Roth strategy, not whether there is after-tax money in the 401k. That is a completely separate matter, and since you don't have any after-tax money in the 401k you don't need to worry about it.

If you want to do a backdoor Roth strategy, which is what ILikeDividend's linked article is describing, then you want to be aware of any current pre-tax IRAs. If you have an existing pre-tax IRA and you try to use the backdoor strategy then the IRS will look at all of your pre-tax IRA's and apply the pro-rata rules across the conversion.

Example1: No existing IRAs. Put 6k in a pre-tax IRA without taking the deduction and then convert it to a Roth. You avoid the Roth income limits and there are no tax implications. This is nice and clean, and the ideal scenario when using the backdoor Roth strategy.

Example2: You have 94,000 in a Traditional IRA. Now you put 6k in a pre-tax IRA without taking the deduction and convert to a Roth. You avoid the Roth income limits BUT the IRS will apply the pro-rata rules including your 94,000 Traditional IRA. From the IRS's point of view you converted 6k of a 100k IRA, and 94% of that IRA was pre-tax. Now you will owe taxes on $5,640 of additional income. This is what ILikeDividends was warning you about. If that $5,640 is taxed at a high tax bracket, which is the likely scenario if you are over the Roth income limits, then this was likely a terrible decision.


Very important note: your 401k is NOT included in the pro-rata calculation for the backdoor Roth strategy. You could have $1,000,000 in your 401k, $0 in Pre-tax IRAs, and complete Roth conversions without having to worry about the pro-rata rules. In other words, if you plan on using the backdoor Roth strategy you probably don't want to roll your 401k into a Traditional IRA because as soon as you do that you subject yourself to the pro-rata rules. This is what ILikeDividends was warning you about when they said, "(with a caveat)*"

@secondcor521 Thanks. That is super helpful.

@Indexer So go from 401k directly into Roth IRA and no penalties or pro-rata applies? I'm sure I'm missing something there. I was going to go from 401k to Traditional IRA then to Roth IRA per the Mad FIentist's article here: https://www.madfientist.com/how-to-access-retirement-funds-early/.

If I can go from 401k directly to a Roth on say $94k, as you mentioned above, could I do that all at once or would I have to do it in chunks to avoid penalties or limits?

[ILikeDividends]

This is what ILikeDividends was warning you about when they said, "(with a caveat)*"

Yes.  Excellent clarifications.  Thanks @Indexer.

If I were to summarize this into a strategic plan, it would be as follows:

1) Never rollover your 401K(s) into an IRA until you are certain you won't want to use the backdoor Roth conversion ever again (both you and your spouse).

2) If either of you change jobs, consider rolling your old 401K plan into your new employer's 401K plan, subject to rule #1, and if your new employer's plan accepts rollovers.

3) W.R.T. rule #2, if your new employer doesn't accept rollovers, consider keeping your 401K with your old employer.

4) Option W.R.T. rule #2, even if your new employer does accept rollovers, compare features and investments available in both plans.  Based on that qualitative comparison, you might want to keep your old employer's 401K plan for the funds that are already in it.

Remember that whenever you do roll any tax deferred accounts into an IRA, you will be subject to the pro-rata rule for any backdoor Roth conversions done after that.

So it seems that the longer you can delay creating a tIRA, the better off you'll be in terms of keeping the option of a backdoor Roth conversion open without incurring other entanglements.

[lifeplus]

@ILikeDividends that is super clear. Thank you for taking the time to explain it so clearly.

[secondcor521]

I like @ILikeDividends explanation and I think it is clear.

As a practical matter, though, I sort of have a question.  If one is FIREing and leaves their job, it seems that in many cases they could roll over their 401(k) into a traditional IRA, because the backdoor Roth becomes irrelevant.  One either has no earned income, in which a contribution to an IRA is not allowed, or one usually has low enough income to where a normal IRA contribution (to either Roth or Traditional) would be allowed.  Right?

[ILikeDividends]

If one is FIREing and leaves their job, it seems that in many cases they could roll over their 401(k) into a traditional IRA, because the backdoor Roth becomes irrelevant.  One either has no earned income, in which a contribution to an IRA is not allowed, or one usually has low enough income to where a normal IRA contribution [or conversion] (to either Roth or Traditional) would be allowed.  Right?

Correct, but only with the minor technical correction to terminology noted above.  Such conversions, tIRA->Roth, can be done piecemeal, over years (to avoid getting into a higher tax bracket than you want), or all at once.

I employ the piecemeal method of rolling my tIRA into a Roth to keep my AGI low enough to remain eligible for VA health benefits; and, of course, to keep my tax bill as low as is acceptable.

Rolling entire 401Ks into an IRA does not affect your AGI, so the piecemeal method is only a meaningful tactic for tIRA->Roth conversions; might as well roll 401Ks into a tIRA wholesale if you don't plan on using the backdoor Roth conversion ever again.

ETA: If your post-FIRE earned income is low enough, it doesn't really make a lot of sense to contribute to a tIRA; might as well contribute to a Roth.

[secondcor521]

I was in the process of writing a reply but then you edited your post! ;-)

I'm familiar with the difference between conversions and contributions.

My line of thinking was simply this:  the reason I think we were talking about backdoor Roths is that the OP is above the income limits for a traditional deductible IRA contribution and regular Roth contributions.  Once OP retires, OP's income may drop enough to where they don't need to use the backdoor Roth method - they can just contribute to their Roth IRA directly.  And in that case, they can roll their 401(k) into their traditional IRA, with no taxes and no worries about the pro-rata rule.

And yes, I agree one can do partial conversions.  I do partial tIRA to Roth conversions yearly for AGI management also (although for ACA and tax bracket reasons, not VA benefits).

I also agree with your comment (that I think you may have deleted) that contributing to a Roth IRA in retirement makes sense if the person has low income and still wants to or needs to shelter growth from taxes.

Finally, I will point out that there are no income limits on conversions (other than you have to pay taxes on them).  Your edit to my post could be construed to suggest that there are income limits on conversions.

[ILikeDividends]

Your edit to my post could be construed to suggest that there are income limits on conversions.

I actually was trying to make the distinction between contributions (which have income limits) and conversions* (which have no income limits); more so for the OP, than for you (I assumed you already knew the difference).

However imperfectly I may have done that, we are on the same page now.  ;)

* "conversion" being an exclusively distinct term from a "backdoor Roth conversion."  Thank you IRS for making it nearly impossible to even have a coherent conversation about this.  ;)

[secondcor521]

Your edit to my post could be construed to suggest that there are income limits on conversions.

I actually was trying to make the distinction between contributions (which have income limits) and conversions* (which have no income limits); more so for the OP, than for you (I assumed you already knew the difference).

However imperfectly I may have done that, we are on the same page now.  ;)

* "conversion" being an exclusively distinct term from a "backdoor Roth conversion."  Thank you IRS for making it nearly impossible to even have a coherent conversation about this.  ;)

Ah.  It sounds like we both understand but I feel sorry for the OP and others who may be trying to learn this stuff.

And we haven't even discussed rollovers, distributions (QCDs and RMDs), recharacterizations... ;-)

[lifeplus]

OP Here. No, really, it's great to follow along and I appreciate the clarification. I'll re-read this thread a another time through to make sure I follow. But the deeper discussion is welcomed.

[FIreSurfer]

Can I piggyback on this thread and ask my personal version of this question, as despite reading the thread and links I still don't quite understand and am looking this in the face this very week? Thanks in advance!

Situation:
-DW and I make enough to not qualify for RothIRA for at least the next year or so-hopefully not for a long time!
-I just pulled about $15k that was my 401k from my old company (the 401k plan had been shifted from one holder to another holder, there were just big layoffs at the old company not that the matters) with the intention of consolidating to Vanguard where I have my taxable investments account and an existing Roth w about $6k in it.  I just received the check and was going to send it on to Vanguard today, having already set up a rollover IRA to receive it.  I currently have no traditional IRA account, but my wife has one with Vanguard with about $5k in it in addition to her taxable brokerage ...

Question:
Is there any way I can take advantage of a RothIRA in my present position, or am I basically too late because I already pulled the funds, and I should have left the money with the crappy 401k holder and just kept tabs if they shifted it again?

Question 2: Does that mean the only way to benefit (assuming DW and I continue to top out yearly income wise)  is to leave a trail of small 401ks around and then at one point when you are sure you are done earning, collect them all and put them in the Roth together as you can only do this once?

Any help appreciated, I've got this check sitting on my desk, gonna wait to mail it ---

Thanks!

TTFILA

[robartsd]

Can I piggyback on this thread and ask my personal version of this question, as despite reading the thread and links I still don't quite understand and am looking this in the face this very week? Thanks in advance!

Situation:
-DW and I make enough to not qualify for RothIRA for at least the next year or so-hopefully not for a long time!
-I just pulled about $15k that was my 401k from my old company (the 401k plan had been shifted from one holder to another holder, there were just big layoffs at the old company not that the matters) with the intention of consolidating to Vanguard where I have my taxable investments account and an existing Roth w about $6k in it.  I just received the check and was going to send it on to Vanguard today, having already set up a rollover IRA to receive it.  I currently have no traditional IRA account, but my wife has one with Vanguard with about $5k in it in addition to her taxable brokerage ...

Question:
Is there any way I can take advantage of a RothIRA in my present position, or am I basically too late because I already pulled the funds, and I should have left the money with the crappy 401k holder and just kept tabs if they shifted it again?

Question 2: Does that mean the only way to benefit (assuming DW and I continue to top out yearly income wise)  is to leave a trail of small 401ks around and then at one point when you are sure you are done earning, collect them all and put them in the Roth together as you can only do this once?

Any help appreciated, I've got this check sitting on my desk, gonna wait to mail it ---

Thanks!

TTFILA

You can convert the funds to Roth, but they will then be taxed as income for 2019 (no penalty tax). Be aware that you must get the check deposited into an appropriate account within 60 days or it will be considered a withdraw (taxed as income with penalty tax). I'd deposit in your rollover IRA then work out any Roth conversion you want to do with Vanguard. If you have several years of potential back door Roth contributions ahead, you might want to bite the bullet and convert your pre-tax IRAs to Roth. In rare cases, 401(k) plans allow pre-tax IRA funds to be rolled into the plan which would open the door to backdoor Roth IRA contributions without converting existing tIRA funds.

[FIreSurfer]

Thanks @robartsd    ---
So let me parrot back to you -
I can send the check to Vanguard - rollover the $$ into the RothIRA, pay the tax this year, and then we are good and tax free when the time comes down the road, and this is definitely better than just putting it in a traditional IRA?

Thanks again!

[robartsd]

and this is definitely better than just putting it in a traditional IRA?

I can't say it's definitely better than just putting it in a tIRA - that requires considering your whole financial situation (and a bit of predicting the future).

Generally people are better off with tax deferred accounts vs Roth (particularly people aiming for early retirement) because they don't realize as much income in retirement as they do in their working years putting them in a lower tax bracket (it's more complicated than that due to effective tax rate vs marginal tax rate). However, if you want to execute a backdoor Roth, the pretax money in a tIRA gets in the way of the loophole and must be dealt with in one way or another - converting it to Roth is the most straightforward way to do this. If you are going to convert it while in a high tax bracket, you might as well do it before it has a chance to grow much.