How Does One Backdoor Roth?

[Penn42]

Maxed my IRA a few weeks ago and I am now contributing $11 an hour to my union's 401k.  Despite knowing nothing about it yet and harboring fears of terrible ER's (as I have chronicled here already), I think this first year I'm simply planning on maxing it because it's an easy way to save and I'm unsure of my other options at this point.  My contribution will get bumped when I get a raise in August and I'm on track to max the 401k out as well. 

However, I still have more money coming in each paycheck than I need.  About 600 big ones a month over my expenses.  Looking at the investment order thread I think I'm getting to the point of opening a taxable account.  I'm not eligible for an HSA and my only other potential option is a backdoor Roth, but I'm a little confused by it.  Everywhere I look it up there's always talk about not being eligible for Roth contributions.  My income isn't nearly that high, but since I've maxed my IRA already this year I can still do it, right? The process seems straight forward enough: make non-deductible contributions to a tIRA, ASAP do a Roth conversion, and you can do that up to some number that's way out of my range. 

The big downside is that I'll have more complicated taxes since I'd have to report each non-deductible tIRA contribution on form 8606, correct?  I'd be happy having to deal with that if I don't have to pay taxes on the dividends.  These first couple years I don't think the dividend taxes would make much difference because I'll be in the 12% bracket, which I think puts my dividend income bracket at 0%.  Later, though, I won't be able to stay out of the 22% bracket.  Adding insult to injury my dividend income will be higher then too, so it'd be a double whammy.

Am I good to go hitting up some Backdoor Roth opportunities?

[MDM]

You may be mistaking the Mega Backdoor Roth for a Backdoor Roth IRA.

Does your 401k offer the former?

[Penn42]

I knew they were two different things, those links cleared them each up some more though.  The Backdoor Roth IRA is even more complex than I thought.  This was all new info to me.

For example: If your nondeductible contribution is only 25% of all the money in your Traditional, SEP, and SIMPLE IRA accounts, then only 25% of your Roth conversion amount will be tax-free. The remaining 75% of your Roth conversion amount will represent the deductible (pre-tax) money across all of your Traditional, SEP, and SIMPLE IRAs

I have no clue what my plan offers, but I seriously doubt it offers in service transfers. .  I know all my co-workers are financially illiterate enough to not be able to answer my questions and I know when I call the union HR the only thing they know is how I can sign up.  I called John Hancock directly several times, but they can't tell me anything either.  It's a mess. 

[MDM]

The Backdoor Roth IRA is even more complex than I thought.  This was all new info to me.

If you are eligible to deduct a tIRA contribution, you have no need for a backdoor Roth.

See IRA Deduction Limits and IRA Contribution Limits.

Good luck with the 401k questions.  Sorry to see that John Hancock is the provider - their fees are often atrocious.

[Penn42]

I have heard that is often the case with JH.  I am eligible to deduct my tIRA contributions.  So I guess I don't meet the qualifications for the back door Roth.  I think I understand this less than I do! 

Really trying to figure out how to shelter more than just 5500 a year as my income keeps growing if the 401k is that bad. as my   

[MDM]

I am eligible to deduct my tIRA contributions.  So I guess I don't meet the qualifications for the back door Roth.  I think I understand this less than I do!

Replace the struck-through phrase with "need" and you have it correct.

The maximum total contribution to IRAs for someone under 50 is $5500/person/yr.  By "total" that means "adding traditional and Roth together."

Really trying to figure out how to shelter more than just 5500 a year as my income keeps growing if the 401k is that bad.

See To 401k or not to 401k? That is the question. for more on that topic.

[Penn42]

Thanks for the link and helping out tonight.  I had found that thread through the investment order thread and it hasn't made me too optimistic.  Reason being there's no match offered and I'll be with this union for a long time so no rollover opportunities.  I've got that spreadsheet from the finance buff blog bookmarked so when I actually know some specific numbers I'll be able to see the potential for damage.

[MDM]

Thanks for the link and helping out tonight.  I had found that thread through the investment order thread and it hasn't made me too optimistic.  Reason being there's no match offered and I'll be with this union for a long time so no rollover opportunities.  I've got that spreadsheet from the finance buff blog bookmarked so when I actually know some specific numbers I'll be able to see the potential for damage.

Just noticed the other spreadsheet referenced there had a bad link.  It's MMM Case Study Spreadsheet '401k vs Taxable' tab and that has also been corrected in the other thread - thanks for the assist!

[jjandjab]

I was reading through this and hope you've gotten out of it what you need to know. But to summarize and add my thoughts:

An individual can only put away $5500 a year into an IRA, whether a traditional or Roth. Under ceratin income levels, you can choose to do either

- you have chosen to contribute to the traditional IRA, which in your tax bracket means that you can deduct the $5500. Just know that in the future, you withdrawals will be taxed at your then current tax rate...
- you could also choose to contribute to a Roth IRA instead. If you do this, you still pay taxes on that $5500, but it will never be taxed again.

So if you are really in the 12% bracket now and are young and you are managing to save extra, you might want to just contribute to the Roth IRA instead. You pay some money now, but you could save a lot of money on taxes in the future.

As far as the backdoor Roth IRA - these are used for people with high incomes, around $200k for a married couple this year. The reason for this is that at that income level, a person cannot contribute directly to a Roth IRA (make too much money). They can contribute to a traditional IRA, but cannot take the tax deduction (again, make too much money). But due to a strange loophole, you can contribute your non-deductible money to a traditional IRA, wait until the money clears, and then transfer it to a Roth IRA, and that is allowed. It can be more complicated than that, but that is the general gist of the "backdoor IRA".

[Penn42]

I was reading through this and hope you've gotten out of it what you need to know. But to summarize and add my thoughts:

An individual can only put away $5500 a year into an IRA, whether a traditional or Roth. Under ceratin income levels, you can choose to do either

- you have chosen to contribute to the traditional IRA, which in your tax bracket means that you can deduct the $5500. Just know that in the future, you withdrawals will be taxed at your then current tax rate...
- you could also choose to contribute to a Roth IRA instead. If you do this, you still pay taxes on that $5500, but it will never be taxed again.

So if you are really in the 12% bracket now and are young and you are managing to save extra, you might want to just contribute to the Roth IRA instead. You pay some money now, but you could save a lot of money on taxes in the future.

As far as the backdoor Roth IRA - these are used for people with high incomes, around $200k for a married couple this year. The reason for this is that at that income level, a person cannot contribute directly to a Roth IRA (make too much money). They can contribute to a traditional IRA, but cannot take the tax deduction (again, make too much money). But due to a strange loophole, you can contribute your non-deductible money to a traditional IRA, wait until the money clears, and then transfer it to a Roth IRA, and that is allowed. It can be more complicated than that, but that is the general gist of the "backdoor IRA".

Thanks for an additional walk through.  I think my mix up was that I was under the assumption that the Backdoor Roth allowed you to go over the 5500 annual limit in a similar way that the Mega Backdoor Roth allows you to go over the 18,500 401k individual contribution limit.