Backdoor Roth IRA (pay, taxes, rate, transfer)

[hello321]

Hello everyone,

I'm 28 years old, and have been putting money into my traditional IRA (don't qualify for roth) for the last two years (now at around 13K) , but have just learned about the backdoor roth IRA. If I decide to do the backdoor roth IRA now, I would have to sacrifice the tax penalty on my earnings, am I correct? Do you think it would be better in the long run to just sacrifice the tax hit now and convert it into a roth, rather than waiting to do it later? Or should I just keep everything as it is in a tradition IRA. (making the assumption that I will be making the same/more than what I do now). Thanks for your help!

[volk2k]

If you aren't eligible for a ROTH due to the income limit, you probably make too much to deduct any contributions to a traditional IRA anyway. So it should be a no-brainer to do the ROTH conversion/backdoor.

Are you maxing out your 401K or employer plan? I might think about doing that first unless you believe you will be earning more in retirement than while you are working.

[Lowexpectations]

My wife and I don't qualify for a roth, well that is until we both max out our 401ks. This year we still might qualify so we will go with the back door option. Make sure you don't have money in any other qualified Ira though Ira/sep etc

[purpleprincess22]

Originally Posted by volk2k

If you aren't eligible for a ROTH due to the income limit, you probably make too much to deduct any contributions to a traditional IRA anyway. So it should be a no-brainer to do the ROTH conversion/backdoor.

+1

I also like doing the backdoor Roth IRA since I already have a traditional 401k. I like the variety.

[00molavi]

My understanding is that for you not to get hit with a tax bill, you have to transfer your traditional IRA to a 401K before using it for back door ROTH.

[Petunia 100]

Originally Posted by 00molavi

My understanding is that for you not to get hit with a tax bill, you have to transfer your traditional IRA to a 401K before using it for back door ROTH.

It depends. A traditional IRA can hold either deductible or non-deductible contributions, or both. Tax will be due on any gains. No tax is due on converted non-deductible contributions.

[UntilTheNDofTimE]

Hello,

I have a question about a traditional IRA to Roth IRA conversion.

The last 4 years I've always contributed the max to a Roth IRA. This year I have some extra untaxed income that I'll have to pay tax on at the end of the year so I went ahead and funded a traditional IRA for the max this year to offset that tax burden. My plan was in the future I'd convert it to a Roth but not in the immediate future because I'm only 25. I'm starting to think this wasn't the wisest choice.

I'm saving around $1200 this year by making this traditional IRA contribution. I was under the assumption that you only had to pay tax on the deductable amount ($5500) during a conversion. After researching, it seems I'll pay tax on the deductable amount AND any proceeds. So if this $5500 appreciates to let's say $20,000 in 10 years I would then have to pay tax on $20,0000 (around $5000) to convert when my original tax savings was only $1200. Is this right? If you have any advice on this situation please let me know. I'd rather not pay $1200 out of pocket come this tax season but if it would cost me a lot more down the line I'll just convert to a Roth now and pay the $1200.

[mathjak107]

roth conversions are far less effective down the road for most of us as opposed to doing a roth upfront early on in your career and it has nothing to do with compounding.

unless you are going to jump tax brackets when rmd's kick in or get your social security taxed you may be ahead not doing a conversion later on especially late in your career.

the problem is folks look at only the final years of their careers and try to judge whether they will be in a higher or lower tax bracket after retirement. but they are not looking at their total average tax rate ramping up to those final years.

the logic here is quite wrong.


the fact is roth's done early in your career are very powerful because you have decades of ramping up to those final years income ahead of you. doing roths all along while average tax rates are lower can woirk great and make a big difference down the road..

your long term effective average tax rate is far lower over decades spent ramping up than just looking at your final years and deciding whether to do a conversion at that point.

odd are most retirement tax brackets will be higher than the average tax brackets of a 40 year career that took decades to ramp up.

folks only compare their retirement tax brackets they think they will be in to their highest earning years not the average effective rate they saw for decades of working.

a study by t.rowe showed doing roths early on can give you 20% more spending cash in retirement than either a traditional or conversion would down the road even if tax rates stayed the same..

[Petunia 100]

Originally Posted by UntilTheNDofTimE

Hello,

I have a question about a traditional IRA to Roth IRA conversion.

The last 4 years I've always contributed the max to a Roth IRA. This year I have some extra untaxed income that I'll have to pay tax on at the end of the year so I went ahead and funded a traditional IRA for the max this year to offset that tax burden. My plan was in the future I'd convert it to a Roth but not in the immediate future because I'm only 25. I'm starting to think this wasn't the wisest choice.

I'm saving around $1200 this year by making this traditional IRA contribution. I was under the assumption that you only had to pay tax on the deductable amount ($5500) during a conversion. After researching, it seems I'll pay tax on the deductable amount AND any proceeds. So if this $5500 appreciates to let's say $20,000 in 10 years I would then have to pay tax on $20,0000 (around $5000) to convert when my original tax savings was only $1200. Is this right? If you have any advice on this situation please let me know. I'd rather not pay $1200 out of pocket come this tax season but if it would cost me a lot more down the line I'll just convert to a Roth now and pay the $1200.

Remember, you have the option of converting part of your traditional IRA, you do not have to convert it all, and certainly not all the same year.

Here is something to think about that we don't often see brought up: if you retire with nothing but SS benefits and monies in a Roth, you have paid too much income tax along the way. You want to have at least enough money in tax-deferred that you are filling up your 0% and 10% brackets. Some people have pensions, or rental income, or some other source of taxable income. If that describes you, this is a non-issue. If it does not describe you, definitely just leave the traditional IRA alone.

In future years, keep in mind you can split your IRA contributions between traditional and Roth if you choose. It does not have to be one or the other.

[mathjak107]

I can see doing a deferred ductable ira or traditional 401k towards the tail end of ones earnings history when income is the highest. Early on though i think not doing it and going all roth would be a better choice.

Those low average tax rates in ones ramping up years would leave a traditional ira or 401k behind.

The higher years earnings would pay off since you can deduct them at fairly high rates hopefully , and take them out tax free using up your standard deductions and exemptions.

but you have to be careful doing that ,depending on when you take ss and the amounts involved. it may still be better to have the roths tax free since if need be you can apply those exemptions and deductions against your ss income possibly preventing taxes on that.

taking ss early or not and the amount you get is going to be the wild card as far as which is a better choice.

had roths existed during my early career they would have payed off far better now than my deferred accounts will tax wise.

not only because of getting my ss taxed but the rmd's are a factor too. in fact the roths still have the edge since as of now all gains after 70-1/2 are tax free.

remember ,at 70-1/2 i have to start drawing money out and if i don't spend it i have to reinvest it in my taxable accounts.

all future gains and earnings are now taxed as well as the money i had to take out.

the roths still grow all tax free on future earnings after 70-1/2.

all in all it can be very difficult to come out a head with deferred accounts once zero rmd's and zero future taxes in a roth are considered as a factor down the road.

in fact i bet in most cases the average long term tax rates one saw over a 30 or 40 year career still leave you in a lower bracket than the cxurrent one you retire at.

there is talk of taxing gains after 70-1/2 in a roth too but so far it is still all systems go for the roths in that respect.

according to t.rowe's study:

Most investors remain in the same tax bracket during retirement. However, if an investor’s tax bracket happens to drop by at least 9% and they are over 50 years old, the Traditional IRA becomes more valuable.

A 65-year old would only need a 6% drop in their tax bracket for a Traditional IRA contribution to be more advantageous than the Roth IRA in retirement.

https://www2.troweprice.com/rms/rps/...4_Roth_IRA.pdf