Author Topic: Prioritizing backdoor Roth vs. House Downpayment  (Read 3705 times)

NorCal

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Prioritizing backdoor Roth vs. House Downpayment
« on: March 15, 2015, 08:10:18 AM »
So here's the scenario.  Both my wife and I are set to max out our pre-tax 401k's this year.  I expect to have a marginal tax rate of 46.3% this year (fed + state), so it would be stupid not to.  We are still generating a decent amount of after-tax savings.

So far, we are using the after tax savings to grow our house downpayment fund.  We already have enough to put 20%+ down on a house.  However, I would like to put enough down that our monthly payments would be low enough where we could comfortably cover the mortgage with only one of our incomes.  We are still a few years away at our current pace.

Of course, I would also like to get as much money into tax sheltered accounts as possible, given the annual limits on them.  My only remaining unused option is the backdoor Roth.

How would you prioritize savings between the downpayment fund and the backdoor Roth, and why?

As a follow-up question, has anyone done the backdoor Roth?  How easy are the logistics?

zurich78

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Re: Prioritizing backdoor Roth vs. House Downpayment
« Reply #1 on: March 15, 2015, 09:54:17 AM »
I do the backdoor Roth every year.  It's very simple.  I'm not sure how it works through anyone other than Fidelity, but I use that since I had an old traditional IRA account there to use as my conversion vehicle.  Here's the basic steps I take.

First, you have to make sure you don't have a balance in ANY traditional IRA account.  If you do, you can still do the conversion but you'll be taxed on it (pro rata).  401K accounts are exempt from this.  So, you move all of your traditional IRA funds in to your company 401K.  Once you've established a zero balance in your traditional IRA accounts (all of them), you're ready for the Roth conversion.

I make a non-deductible contribution (via a savings account) to my traditional IRA of the full maximum amount of $5,500.  Then, within Fidelity, there is a menu option in my traditional IRA account to "Convert to Roth IRA".  I convert the full amount over to my Roth.  That's it. 

As for whether you should do one or the other ... IMO, and I'm not an expert but, I would think from a purely financial perspective, the Roth contribution is preferred if you can't do that and put a down payment down.  You get tax free growth and it should grow at a faster rate than a property.  Since the Roth is capped at $5,500/year anyway, it sounds like you can do both, it'll just take you a little longer to pull the trigger on the house.

Another thing to consider is that interest rates are historically ridiculously low right now.  If your goal is to get a low monthly payment, I think the safe assumption is that rates are going to go up from here.  If it does, you may be borrowing less (good), but paying a higher interest rate and so net-net, your monthly payment could be the same.  I'm sure there are experts here who would know best, but, have you thought about pulling the trigger on the house, and then, if interest rates stay low, refinancing later?  So you'd buy the house, keep saving your "down payment" and Roth, and then if you've built up a nice chunk later, you can refinance and put that down to get your payment down.
« Last Edit: March 15, 2015, 10:00:39 AM by zurich78 »

patricles

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Re: Prioritizing backdoor Roth vs. House Downpayment
« Reply #2 on: March 15, 2015, 09:59:10 AM »
I haven't done a backdoor Roth myself.  One consideration is that after a Roth account has been open for 5 years you can withdraw the contributions tax- and penalty-free, and if the money is used for a primary house downpayment you can pull up to $10k of earnings tax and penalty free. 

HOWEVER each time you make a rollover contribution (such as a backdoor Roth) the 5 year timer starts again on that rollover amount, so Backdoor Roth contributions would not help you build a downpayment but could be a way to replenish your Roth if you already have one and drain most of it for a downpayment in the way I described above.

zurich78

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Re: Prioritizing backdoor Roth vs. House Downpayment
« Reply #3 on: March 15, 2015, 10:09:31 AM »
I haven't done a backdoor Roth myself.  One consideration is that after a Roth account has been open for 5 years you can withdraw the contributions tax- and penalty-free, and if the money is used for a primary house downpayment you can pull up to $10k of earnings tax and penalty free. 

HOWEVER each time you make a rollover contribution (such as a backdoor Roth) the 5 year timer starts again on that rollover amount, so Backdoor Roth contributions would not help you build a downpayment but could be a way to replenish your Roth if you already have one and drain most of it for a downpayment in the way I described above.

Well, it's only tax free because you would have already paid taxes on it =)  Also, I don't think it is allowable for "primary" house down payment.  I think the stipulation is if you are a first time homebuyer then you can do that penalty free. 

Personally, I would not advise withdrawing the $10K for a down payment.  You can't put that back in and you lose out on all of that tax free growth. 

NorCal, here's a basic article on Backdoor Roth process: http://www.forbes.com/sites/ashleaebeling/2012/01/23/the-backdoor-roth-ira-advanced-version/

NorCal

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Re: Prioritizing backdoor Roth vs. House Downpayment
« Reply #4 on: March 16, 2015, 07:38:19 AM »
Thanks for the replies.  I had missed that part about having to roll IRA's into 401k's.  That will change my plans somewhat, as I'm just changing jobs, and was about to roll my 401k into my old IRA.  Looks like I'll be reversing that.

I don't plan to use a ROTH as part of a home purchase.  The value of having money in a ROTH in the first place is long term tax savings on earnings.



patricles

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Re: Prioritizing backdoor Roth vs. House Downpayment
« Reply #5 on: March 17, 2015, 08:10:44 PM »
My reasoning was if you werent sure whether to make additional backdoor Roth contributions or additional contributions to a brokerage you should do the backdoor Roth and then you are covered in two scenarios:  if you decide to wait on a house then you took advantage of tax sheltered space you would have lost by contributing to a brokerage, and if you do want the house after all then you could draw the downpayment from your Roth IRA and use the backdoor contributions to replenish it. Obviously if you have enough just in your brokerage for a downpayment then don't touch the Roth.

Someone please let me know if my reasoning is off, obviously a Roth is best untouched until retirement but to me this would be a hedge for saving up for a downpayment while still taking advantage of sheltered space.

Rein1987

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Re: Prioritizing backdoor Roth vs. House Downpayment
« Reply #6 on: March 18, 2015, 09:40:06 AM »
My DH and I are doing backdoor roth. It's very easy, just a few clicks at Vanguard. Our companies also offer mega backdoor roth (aftertax 401k -> roth). We also do that.

For my family, we prioritize backdoor roth more, because there's a time limit how much you can put into the roth. If you miss this year, you can not make it up. If you do need to buy a house, you can withdraw your contribution freely, or 10k. I do not advise to withdraw from roth though, because the interest rate on mortgage is very low at this point, and your roth potentially save you more.

From your tax rate, I guess you are in the bay area. If so, one thing to consider is the housing price trend. It is possible that the housing market is so crazy that if you wait a few years it might cool down and save you a lot of money. It might also be possible like, my colleague can afford a nice house 2 years ago but not now...In other words, I mean, the house price in some area matters more than your downpay saving/grow rate.

jmusic

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Re: Prioritizing backdoor Roth vs. House Downpayment
« Reply #7 on: March 19, 2015, 01:04:16 AM »
From your tax rate, I guess you are in the bay area. If so, one thing to consider is the housing price trend. It is possible that the housing market is so crazy that if you wait a few years it might cool down and save you a lot of money. It might also be possible like, my colleague can afford a nice house 2 years ago but not now...In other words, I mean, the house price in some area matters more than your downpay saving/grow rate.

This.  I was talking to a realtor a few months ago and he said that housing prices went up by about 35% in San Diego in 2014!!!  If you're watching the news you'll know that the Federal Reserve is discussing raising the interest rates later this year (though just from Ridiculously low to still pretty low), which should also have the effect of slowing the real estate market (most people buy on payment, not on price).