Backdoor Roth IRA with Rollover

[mtnman125]

I have a year end dividend coming from employer "Incentive Units" later in the month that could push us over Roth Income limits (I dont know the amount yet).

So, I've been researching the Backdoor Roth IRA for first time- and have a couple questions.

Since I've already maxed out Roth IRA for 2018 (for myself and spouse)- do I somehow remove those funds?

2nd, my wife has a small ($10k) Rollover IRA from previous employer, my reading says backdoor roth is "easier" without any other IRA's.  Would we need to convert that Rollover to Roth first?

It's a good problem to have, just nervous as Im up against end of year clock.

For reference, we already max out 2x 401k, HSA, and Dependent care FSA.

[ericbonabike]

1) you will have to recharacterize the roth contributions that exceed whatever your income cap is.  I had to do this with fidelity and it was relatively straight forward.  Although it kind of jacked up my taxes a bit.   If you've invested that money, you'd have to pay the taxes on the appreciation.  After the money has been "moved" to non-roth aftertax IRA, then you recharacterize that money back into the roth. 

2) The 10k Rollover IRA would affect your ability to do a backdoor roth conversion.
The IRS has some rule called "proportional conversion" or something.
I think the way it works is something like:   
your wife contributes 5000 to your backdoor roth IRA, and your wife has 10k in the rollover IRA.
Which means that you could only convert 1/3 (5000/10000) of your wife's roth IRA.  The other 2/3rds has to come from the traditional rollover IRA.  Which means you'd have to pay taxes on that.  Not just the appreciation, but the 2/3rds that you pulled from your traditional IRA. 

I was in the exact same situation as you, except I had a MUCH larger amount of money in the rollover, but my wife didn't.  So, we fully funded her backdoor roth.  I had already funded mine (incorrectly) and I had to do something like outlined above.  Except, that my ~250k rollover screwed my backdoor conversion. 

Make sense?

[mtnman125]

Thanks ericonabike!

That mostly makes sense.  I know it sounds awful on this site, but I'm hopeful to sneak in under the cap this year and deal with it next year :-)

Does the recharacterization have to happen this calendar year, or possible to do before April 15 during tax prep?

That rollover sounds like a pain, but I think I'll have to graduate from TurboTax to a pro this year, so i can have them help me walk through it.

[dandarc]

1) you will have to recharacterize the roth contributions that exceed whatever your income cap is.  I had to do this with fidelity and it was relatively straight forward.  Although it kind of jacked up my taxes a bit.   If you've invested that money, you'd have to pay the taxes on the appreciation.  After the money has been "moved" to non-roth aftertax IRA, then you recharacterizeconvert that money back into the roth. 

Fixing the language slightly.

OP -

Normally, you can recharacterize before your tax filing deadline. However, you want to also do a conversion for tax year 2018. Conversions have to be done in the same calendar year. So your perfect execution looks like this:

1) transfer existing IRA money into a 401K so as to not screw up your backdoor Roth contribution
2) recharacterize your Roth IRA contributions to non-deductible traditional
3) convert the non-deductible IRA contributions to Roth

1 and 2 can be done in any order, but both must be done before 3 and that has to be done by 12/31.

If rolling existing tIRA money into your 401K isn't an option, I'd convert all tIRA money and pay tax on the 10K to get yourself better set up going forward. Unless this is an unusually high income year, setting yourself up for an easier time next year would be worth the tax on $10K.

The other thing you could do is just request a return of the excess contribution, pay tax on any earnings, and forget about your 2018 IRA.

Edited to strike anything related to having a 12/31 deadline - for what OP needs to do, that is wrong.

[dandarc]

Hit send without really thinking it through - a common mistake - actually, you could do the conversion in 2019. Order is right, but there really isn't a 12/31 deadline.

You can do conversions any time, so you could do this all in 2019. Normally, you want to minimize any gains when doing a backdoor Roth, so you want to do the conversion as close as possible to the non-deductible contribution. And you have until 4/15 (10/15 if you file an extension) to do the recharacterization. So there isn't a looming deadline as I had thought.

Basically you can do this at any time, but it might behoove you to do that recharacterization soon to lock in any gains and stop them from growing further. Or not - paying tax on the gain when you convert isn't that big of a deal.

[mtnman125]

Thanks dandarc

I sent a note to Vanguard about the possibility of transferring rollover IRA into 401k (both accounts are already at Vanguard).

As I mentioned, I don't know exact amount of dividend, but if it does push us above limit- it would likely be within phase-out range still.  So I should just be able to recharacterize the amount over the reduced Roth limit, and then convert.

Hard to say if future years will be the same situation, as it can be dependent on overtime and bonuses.

Our hope is for my wife to go down to part time (still eligible for benefits at 24hr/week) in the next few years, so also considering just forgoing Roth and put that money in taxable.

[ericbonabike]

My takeaway from last year:

1) Don't fund Roth IRA until my taxes for that year are pretty well finalized.  So, that means I need to have about 11k in the bank sometime in March.  That 11k goes either into last years roth ira via normal contribution (if my income is low enough) or I pursue backdoor conversion. 
My wife and I both reduced our work down to 75% so our AGI has been cut by 25%, and we should both be under the cap this tax year.

2)   If my income begins to exceed or approach the income cap, I might pursue rolling over my Traditional Rollover IRA from previous employer to my current employers 401k.  I believe that would allow me to do a backdoor conversion.


good luck!

[mtnman125]

Thanks everyone for the help.  Heard back from Vanguard- my wife's 401k will accept rollover from rollover!

Will get that sorted, then see where dividend lands, then I'm all set up for Backdoor if I need to