Author Topic: Non-deductible IRA questions  (Read 5173 times)

muckabout

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Non-deductible IRA questions
« on: April 01, 2014, 09:08:41 AM »
Hi all!

I've maxed out my 401k contribution and was considering maxing out $5k to my IRA contribution as well. Given the circumstances I cannot contribute to my Roth and the IRA contribution will be non-deductible. It seems like this is a good point to contribute to the non-deductible, then do a Roth IRA conversion.

The catch is that I already have $15k in a rollover IRA. As I understand, this will bring my tax liability on the conversion of the $5k to $15k / ($5k + $15k) -> 75%. However, I anticipate doing this non-deductible conversion for the next many years.

My options are:

1. contribute to non-deductible and do nothing else
2. contribute to non-deductible, convert the $5k to roth, and take the tax hit this and subsequent years
3. contribute to non-deductible, convert the entire IRA to roth, then take the tax hit only this year and not in subsequent years
4. do something else

Would be great to get feedback from the community on this!
Cheers

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #1 on: April 01, 2014, 09:18:13 AM »
Make the $5500 contribution then convert the whole $20,500 to a Roth IRA and pay the $4000 or so in tax out of other money (if you have enough reserves to be able to do this).

If the markets just tank over the next year and your $20,500 Roth turns into a $10,000 Roth, convert it back to a traditional IRA and don't pay any tax (then reconvert the next year if you want).

I would do the whole conversion *if* you plan on at least 5 or more years of high income and backdoor Roths.  If you are going to be retiring before then, I would not pay conversion tax at this time.

Cromacster

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Re: Non-deductible IRA questions
« Reply #2 on: April 01, 2014, 09:35:00 AM »
I would leave your 15k rollover where it is.  There is really no reason to pay taxes on that right now.  Consider rolling it over when you are looking to start your Roth pipeline.

As far as the non-deductible.  Is the money you are putting in here already taxed?  If so, the way I understand it is you just roll it over into a Roth.  There aren't additional taxes, it's just more of a paperwork thing.

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #3 on: April 01, 2014, 09:56:19 AM »
I would leave your 15k rollover where it is.  There is really no reason to pay taxes on that right now.  Consider rolling it over when you are looking to start your Roth pipeline.

As far as the non-deductible.  Is the money you are putting in here already taxed?  If so, the way I understand it is you just roll it over into a Roth.  There aren't additional taxes, it's just more of a paperwork thing.

Unfortunately it doesn't work that way.  All IRA balances are considered when calculating basis and converting to Roth.

Cromacster

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Re: Non-deductible IRA questions
« Reply #4 on: April 01, 2014, 10:01:55 AM »
I would leave your 15k rollover where it is.  There is really no reason to pay taxes on that right now.  Consider rolling it over when you are looking to start your Roth pipeline.

As far as the non-deductible.  Is the money you are putting in here already taxed?  If so, the way I understand it is you just roll it over into a Roth.  There aren't additional taxes, it's just more of a paperwork thing.

Unfortunately it doesn't work that way.  All IRA balances are considered when calculating basis and converting to Roth.

I think you are mistaken.  The whole premise of the Roth pipeline is that you only rollover what you plan to withdraw after the 5 years are up.  Taking advantage of the taxes where you can.  If you had to rollover everything all at once you lose major tax advantages that the Roth pipeline provides while FIRE.

Edit:  I do not know where in the tax code to find this, but reading madfientist and other posts on the forum about this strategy, this is how I understand it to work.  If you can show me otherwise please do.
« Last Edit: April 01, 2014, 10:04:37 AM by Cromacster »

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #5 on: April 01, 2014, 10:17:53 AM »
Maybe we are talking about two different things.

The OP already has a traditional IRA that was created from a rollover from a 401K at a previous employer.  That IRA has a balance of $15,000 and a basis of $0.

If he creates another separate IRA (at Vanguard, Etrade, wherever) and funds it with $5500 of post tax money, it will have a basis of $5500.

If he chooses to convert that $5500 IRA to a Roth, he will owe tax because of the $15000 IRA that has zero basis.  This is not speculation by me, this is hardcore IRS fact.

I was suggesting maybe he choose to take the pain now and convert everything to a Roth while the $15,000 IRA is relatively low balance if and only if he plans to do backdoor Roths for quite a few years.

The caveat is that they could stop the ability to do a backdoor Roth in the future, although I  have my doubts that they will because it gives politicians money now (from the tax on some conversions).

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #6 on: April 01, 2014, 10:26:24 AM »
Note there are some extreme lengths you can go to and avoid tax on conversion even in the case where you have a traditional IRA with zero basis, but it requires mowing lawns or something to generate self employment income.  You then set up a self directed 401K and roll the traditional IRA into that, thus hiding the lack of basis from your other post tax traditional IRAs you are now funding.  It sounds like a lot of trouble to me for saving  $3000 to $4000 in one time tax but I might consider it if I had a larger balance in a zero basis IRA.

Cromacster

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Re: Non-deductible IRA questions
« Reply #7 on: April 01, 2014, 10:26:56 AM »
Maybe we are talking about two different things.

The OP already has a traditional IRA that was created from a rollover from a 401K at a previous employer.  That IRA has a balance of $15,000 and a basis of $0.

If he creates another separate IRA (at Vanguard, Etrade, wherever) and funds it with $5500 of post tax money, it will have a basis of $5500.

If he chooses to convert that $5500 IRA to a Roth, he will owe tax because of the $15000 IRA that has zero basis.  This is not speculation by me, this is hardcore IRS fact.

I was suggesting maybe he choose to take the pain now and convert everything to a Roth while the $15,000 IRA is relatively low balance if and only if he plans to do backdoor Roths for quite a few years.

The caveat is that they could stop the ability to do a backdoor Roth in the future, although I  have my doubts that they will because it gives politicians money now (from the tax on some conversions).

Ah ok.  We're on the same page now.  Thanks for the explanation.

Aeth

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Re: Non-deductible IRA questions
« Reply #8 on: April 01, 2014, 10:28:06 AM »
Note there are some extreme lengths you can go to and avoid tax on conversion even in the case where you have a traditional IRA with zero basis, but it requires mowing lawns or something to generate self employment income.  You then set up a self directed 401K and roll the traditional IRA into that, thus hiding the lack of basis from your other post tax traditional IRAs you are now funding.  It sounds like a lot of trouble to me for saving  $3000 to $4000 in one time tax but I might consider it if I had a larger balance in a zero basis IRA.

Would he be able to rollover the funds from his current IRA into his current 401K?  The OP stated that he has maxed out his 401K contributions, so I assume that he has an active 401K account.

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #9 on: April 01, 2014, 10:37:40 AM »
Would he be able to rollover the funds from his current IRA into his current 401K?  The OP stated that he has maxed out his 401K contributions, so I assume that he has an active 401K account.

I am not 100% sure but I do not think any employer 401K plans allow you to roll in a outside IRA into their plan.  You can do it with a self employed 401K at brokers like Fidelity (who would be the manager of the 401K).

Maybe there are some though?  I don't know all of those rules.  I just found out recently that our employer lets us do a post tax 401K contribution in excess of the pre tax $17,500 and they will convert the post tax portion to a Roth 401K up to four times a year for us for free.  Too bad this was available for several years previous to this year and I just discovered it.

muckabout

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Re: Non-deductible IRA questions
« Reply #10 on: April 01, 2014, 10:43:35 AM »
Make the $5500 contribution then convert the whole $20,500 to a Roth IRA and pay the $4000 or so in tax out of other money (if you have enough reserves to be able to do this).

If the markets just tank over the next year and your $20,500 Roth turns into a $10,000 Roth, convert it back to a traditional IRA and don't pay any tax (then reconvert the next year if you want).

I would do the whole conversion *if* you plan on at least 5 or more years of high income and backdoor Roths.  If you are going to be retiring before then, I would not pay conversion tax at this time.

Thanks for the advice. To be clear, the "convert back" option is really just undoing the Roth conversion in the case that the market tanks and I could later switch back to Roth with lower taxes, right?

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #11 on: April 01, 2014, 10:59:38 AM »
Thanks for the advice. To be clear, the "convert back" option is really just undoing the Roth conversion in the case that the market tanks and I could later switch back to Roth with lower taxes, right?

Yes, exactly.  It is called re-characterization.  I forgot what the limits are on timeframes but you should look that up before making any decisions.

Aeth

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Re: Non-deductible IRA questions
« Reply #12 on: April 01, 2014, 11:08:48 AM »
Would he be able to rollover the funds from his current IRA into his current 401K?  The OP stated that he has maxed out his 401K contributions, so I assume that he has an active 401K account.

I am not 100% sure but I do not think any employer 401K plans allow you to roll in a outside IRA into their plan.  You can do it with a self employed 401K at brokers like Fidelity (who would be the manager of the 401K).

Maybe there are some though?  I don't know all of those rules.  I just found out recently that our employer lets us do a post tax 401K contribution in excess of the pre tax $17,500 and they will convert the post tax portion to a Roth 401K up to four times a year for us for free.  Too bad this was available for several years previous to this year and I just discovered it.

Does the conversion from post-tax 401K monies to Roth 401K monies have the same tax implications that converted non-deductible IRA monies to Roth IRA monies does?  In other words, when you do the 401K conversion, are you converting both the pre-tax and post-tax monies in a proportion equal to the pre-tax and post-tax contributions?  Or are you able to isolate the post-tax monies from the pre-tax monies?

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #13 on: April 01, 2014, 11:15:11 AM »
Does the conversion from post-tax 401K monies to Roth 401K monies have the same tax implications that converted non-deductible IRA monies to Roth IRA monies does?  In other words, when you do the 401K conversion, are you converting both the pre-tax and post-tax monies in a proportion equal to the pre-tax and post-tax contributions?  Or are you able to isolate the post-tax monies from the pre-tax monies?

You are able to isolate (they isolate it for you) so you don't pay any tax on the post-tax contributions that are converted to a Roth 401K (you may pay a little tax if the contributions have had gains in the short timeframe but I plan to convert every 3 or 6 months).

It is a killer deal to get an extra $20,000 Roth each year and I am bummed that it has been allowed for at least 3 years previous and I missed it.

Aeth

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Re: Non-deductible IRA questions
« Reply #14 on: April 01, 2014, 11:28:00 AM »
Does the conversion from post-tax 401K monies to Roth 401K monies have the same tax implications that converted non-deductible IRA monies to Roth IRA monies does?  In other words, when you do the 401K conversion, are you converting both the pre-tax and post-tax monies in a proportion equal to the pre-tax and post-tax contributions?  Or are you able to isolate the post-tax monies from the pre-tax monies?

You are able to isolate (they isolate it for you) so you don't pay any tax on the post-tax contributions that are converted to a Roth 401K (you may pay a little tax if the contributions have had gains in the short timeframe but I plan to convert every 3 or 6 months).

It is a killer deal to get an extra $20,000 Roth each year and I am bummed that it has been allowed for at least 3 years previous and I missed it.

That is a very interesting proposition.  I see that my plan allows me to contribute after-tax dollars.  However, I do not see any information about converted those dollars to a Roth 401K.  I guess I need to make some phone calls.  Also, strangely, my plan limits my after-tax contributions to 10% of my salary.

Roland of Gilead

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Re: Non-deductible IRA questions
« Reply #15 on: April 01, 2014, 11:49:55 AM »

That is a very interesting proposition.  I see that my plan allows me to contribute after-tax dollars.  However, I do not see any information about converted those dollars to a Roth 401K.  I guess I need to make some phone calls.  Also, strangely, my plan limits my after-tax contributions to 10% of my salary.

Tell them you are interested in contributing after tax money to your 401K and want to find out if they keep track of that money separately (it is ok if it is in the same investments).  Ask them if they allow a "in plan" conversion to a Roth 401K and how frequently you can do that.  It is possible you have the same deal we do but with slightly reduced limits (although 10% of a $200,000 salary would be $20,000, ie, our limit.

Undecided

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Re: Non-deductible IRA questions
« Reply #16 on: April 01, 2014, 02:41:44 PM »
Would he be able to rollover the funds from his current IRA into his current 401K?  The OP stated that he has maxed out his 401K contributions, so I assume that he has an active 401K account.

I am not 100% sure but I do not think any employer 401K plans allow you to roll in a outside IRA into their plan.  You can do it with a self employed 401K at brokers like Fidelity (who would be the manager of the 401K).

Maybe there are some though?  I don't know all of those rules.  I just found out recently that our employer lets us do a post tax 401K contribution in excess of the pre tax $17,500 and they will convert the post tax portion to a Roth 401K up to four times a year for us for free.  Too bad this was available for several years previous to this year and I just discovered it.

Mine does. It's an important part of the process of making after-tax contributions to a 401(k), then rolling those contributions and earnings to an IRA, then returning the earnings to the 401(k) so that the conversion of the contributions to a Roth IRA is tax free.