IRA/Roth/Backdoor Roth?

[wemberly]

I'm trying to figure out our roth set up and I'm so confused. We've always maxed out 401K but never contributed to an IRA before, but do have a rollover IRA. Can anyone help with a couple of my points of confusion?

So IRAs are pretax...but they become post tax if you make over the income limit? 

Is this why people do backdoor conversions? Because you already paid taxes on the money? Does this mean I wouldn't owe any more taxes on the money?

Would doing a backdoor roth have any effect on the rollover IRA? Are those totally separate accounts? 

I want to contribute right now for 2020 before I file taxes. I'm assuming I can just transfer money right to fidelity once I have the account set up, is that correct? 

For 2021 I'd like to set up automatic withdrawals. How does that work if you are over the income limit? I can set up my husbands through his work, I can't figure out if it will be pre tax or post tax.

Hopefully this makes sense, thank you for your help!

[ohgillian]

Hi. I cannot answer all of this but I can answer a few points.

It's helpful to remember that there are different kinds of IRAs, and each different kind is a different account. So you commented about IRAs being pretax, but that's not true as a blanket statement. There are Traditional IRAs (pre-tax) and Roth IRAs (post-tax)*. You can open either kind, or both. Your current rollover IRA could be either kind, it depends on whether the 401k that rolled into it was funded with pre- or post-tax dollars.  At least at Vanguard, mine are specifically labeled in their account names (eg. Traditional IRA blah blah whatever or Roth IRA blah blah whatever). So you should be able to figure out that way which kind you already have. 

But, you're kind of on the right track - they don't just "become" post-tax if you make over a certain limit, but after a certain income limit, you are no longer eligible to contribute directly to a Roth IRA; you are only eligible to contribute directly to a Traditional IRA. And that's why people backdoor -- because they're over the income limit to contribute to a Roth, but they still want their money in a Roth. So they contribute to a Traditional, then do the conversion into a Roth.

If your rollover is a Traditional, I am guessing that you would make an additional contribution to that same account, then convert part of it. I don't know if that answers the question about whether it affects that account. 

Hopefully someone can chime in on some of the other parts; i've never done auto withdrawals to an IRA, and I don't use Fidelity. 



* and other kinds not relevant here

[cc111]

Traditional IRA can be pre-tax or post-tax contribution. If your income is under a certain income threshold (link), then you can do pre-tax contribution. If your income is above that threshold, then you can only do post-tax contribution. Roth IRA is only post-tax contribution. And eligibility for the Roth IRA contribution is income dependent.  The reason you do backdoor Roth conversions is if your income disqualifies you from contributing to a Roth IRA directly but yet you want to have post-tax retirement allocation.

You'll need to check rollover IRA and determine if the amount in it is pre-tax or post tax. If all contributions or most contributions are pre-taxed, then when you do Roth conversions, you'll need to pay taxes. I've found a link containing the tax formula. Here's the paragraph containing that information:

But the tax calculation becomes more complicated if you have other money in traditional IRAs that is a mix of pretax contributions – say, rollovers from a 401(k) -- and after-tax contributions. Your tax liability on a conversion will be based on the percentage of your overall balance that hasn’t been taxed yet. And you can’t pick and choose which money to convert. Say you have $10,000 total in all of your traditional IRAs and $8,000 of that is from rollovers, tax-deductible contributions or earnings, while $2,000 is from nondeductible contributions. Under the formula, 80% of the money converted to a Roth would be taxable, and 20% would be tax-free.

If let's say your current rollover IRA is all post-tax contribution. Then you can open a traditional IRA account at Fidelity, transfer the amount in. After the money is settled, you can go through the Roth Conversion instructions right on their website to convert the $$ to Roth IRA account. 

If your income is over a certain level (link), you can only contribute post tax to traditional IRA. If your income is under the income threshold, then you can decide if you want to contribute pre-tax to Traditional IRA or post-tax to Roth IRA. You and your husband will have to do some rough estimates and check your AGI. You can potentially base it on your 2020's AGI/W2 and just account for any expected increases for 2021.

By automatic withdrawals, do you mean you want to setup a monthly contribution to Roth for 2021? Then you'll have to set up an automatic transfer to the traditional IRA (if you don't qualify for direct Roth contribution), but you can't do the Roth conversion automatically though. Also, with the automatic transfer to traditional IRA, you don't want to invest the funds in the traditional IRA. Because when you do eventually get to Roth conversions, any earnings will be taxed at your tax rate. Hope that helps.

[ribollita]

Is there money in your rollover IRA?

[wemberly]

Mar 13, 2021 8:13:57 GMT -5 ribollita said:

Is there money in your rollover IRA?

Yes, we rolled over every single one of my husband's 401Ks into it. I do not have a traditional ira or roth, so mine might be a bit easier.

[wemberly]

I think I may have figured out a solution, but please chime in with advice. I have no iras, so I should be able to contribute to the ira and then do a conversion. I think we can do a reverse rollover with my husbands rollover ira into his current 401k, and then contribute to the ira and do a conversion. I'm still a bit worried about doing both the reverse rollover and the roth conversion in the same year, but hopefully Fidelity could help us make sure we do it correctly. I'm also guessing that I'd have an issue doing it for my husband for 2020 since the reverse rollover would occur in 2021, but I think I could do 2020 and 2021 for myself without issue.

[ohgillian]

Mar 13, 2021 20:58:00 GMT -5 wemberly said:

I think I may have figured out a solution, but please chime in with advice. I have no iras, so I should be able to contribute to the ira and then do a conversion. I think we can do a reverse rollover with my husbands rollover ira into his current 401k, and then contribute to the ira and do a conversion. I'm still a bit worried about doing both the reverse rollover and the roth conversion in the same year, but hopefully Fidelity could help us make sure we do it correctly. I'm also guessing that I'd have an issue doing it for my husband for 2020 since the reverse rollover would occur in 2021, but I think I could do 2020 and 2021 for myself without issue.

Have you talked to Fidelity? There's no reason you need to do a reverse rollover just to empty out the IRA just to use it for a backdoor conversion. There's also no limit to the number of IRAs you have, so at a minimum it would be much easier just to open an additional IRA for your H and use it for this purpose. Fidelity should be wiling to walk you through this process, though. 

[wemberly]

Mar 14, 2021 18:20:31 GMT -5 ohgillian said:

Mar 13, 2021 20:58:00 GMT -5 wemberly said:

I think I may have figured out a solution, but please chime in with advice. I have no iras, so I should be able to contribute to the ira and then do a conversion. I think we can do a reverse rollover with my husbands rollover ira into his current 401k, and then contribute to the ira and do a conversion. I'm still a bit worried about doing both the reverse rollover and the roth conversion in the same year, but hopefully Fidelity could help us make sure we do it correctly. I'm also guessing that I'd have an issue doing it for my husband for 2020 since the reverse rollover would occur in 2021, but I think I could do 2020 and 2021 for myself without issue.

Have you talked to Fidelity? There's no reason you need to do a reverse rollover just to empty out the IRA just to use it for a backdoor conversion. There's also no limit to the number of IRAs you have, so at a minimum it would be much easier just to open an additional IRA for your H and use it for this purpose. Fidelity should be wiling to walk you through this process, though. 

That would be awesome. I thought I read that the IRS considers all iras when taxing even if one was at fidelity and one was at vanguard. I’m in over my head, definitely calling fidelity tomorrow.

[froggy76]

Based on your questions, I think you understand the issues pretty well. You need to be careful doing the backdoor Roth, because any pre-tax traditional IRA contributions will be taxed when you convert to a Roth. Even if you think you are taking post-tax IRA contributions and converting them, the IRS would look across all your IRAs to determine what % was pre-tax vs post-tax.

My simple understanding in an example:
Assume you have a $5,000 rollover IRA (prior pre-tax contributions)
Now you make a $5,000 contribution to a traditional IRA on a post-tax basis (because you're not eligible for pre-tax)
You convert the $5,000 in that second IRA to a Roth --> the IRS would say 50% of your IRAs are pre-tax, so you have to pay tax on 50% of the Roth conversion

I think your workaround ideas of doing the Roth in your name or doing a reverse rollover of your husband's IRA *might* work to solve the issue - please update on what you find out!

[gt7301b]

Mar 14, 2021 18:20:31 GMT -5 ohgillian said:

Mar 13, 2021 20:58:00 GMT -5 wemberly said:

I think I may have figured out a solution, but please chime in with advice. I have no iras, so I should be able to contribute to the ira and then do a conversion. I think we can do a reverse rollover with my husbands rollover ira into his current 401k, and then contribute to the ira and do a conversion. I'm still a bit worried about doing both the reverse rollover and the roth conversion in the same year, but hopefully Fidelity could help us make sure we do it correctly. I'm also guessing that I'd have an issue doing it for my husband for 2020 since the reverse rollover would occur in 2021, but I think I could do 2020 and 2021 for myself without issue.

Have you talked to Fidelity? There's no reason you need to do a reverse rollover just to empty out the IRA just to use it for a backdoor conversion. There's also no limit to the number of IRAs you have, so at a minimum it would be much easier just to open an additional IRA for your H and use it for this purpose. Fidelity should be wiling to walk you through this process, though. 

But she might want to do the recharacterization for tax reasons.  The original poster needs to consider the rollover value because of the impact of the prorata rule on the taxes from the conversion. 

"The pro-rata rule. The IRS requires rollovers from traditional IRAs to Roth IRAs to be done pro rata. Here's how it works: When determining your tax bill on a conversion from a traditional IRA to a Roth IRA, the IRS is going to look at all of your traditional IRA accounts combined. If all of your traditional IRAs combined consist of, say, 70% pre-tax money and 30% after-tax money, that ratio determines what percentage of the money you convert to a Roth is going to be taxable. In this example, no matter how much money you convert or which IRA account you pull the money from, 70% of the amount you convert to the Roth will be taxable. You can't choose to convert only after-tax money; the IRS won't allow it. And a word about timing: the IRS applies the pro-rata rule to your total IRA balance at year-end, not at the time of conversion."

www.nerdwallet.com/article/investing/backdoor-roth-ira-high-income-how-to-guide-2

[sicilygirl]

Yes to what gt7301b said. You do not want to do a Roth conversion if you have any pre-tax money in any type of IRA (Traditional, Rollover, SEP). Or if you choose to anyway, understand that the conversion will be partially taxed.

[wemberly]

Mar 15, 2021 15:19:52 GMT -5 sicilygirl said:

Yes to what gt7301b said. You do not want to do a Roth conversion if you have any pre-tax money in any type of IRA (Traditional, Rollover, SEP). Or if you choose to anyway, understand that the conversion will be partially taxed.

Thank you guys, this is really helpful. That also clears things up as to the order I do things in and it not mattering too much if they’re looking at end of year balances. So if I do a reverse rollover to 401k and add 6,000 to the traditional ira/then convert the balance we will end the year at 6,000 in all iras. It looks like on my husbands plan I can add post tax money and have it converted automatically once we’re ready.