Finance: Backdoor Roth!

[iDumb]

this will be my series of threads time to time on at most income level to be a better saver and better prepared for future.

A portfolio needs to be diversified. This diversification is not only among stocks you hold but among investments that you have. Meaning at some point later in your life you should have money in tax deferred account (ie 401k), tax exempt account (roth ira), pension (if available), real estate. These are MUST for everyone at most income level.

Roth IRA is a post tax investment where any gain can be drawn tax free at retirement. Young ppl are always encouraged to contribute to roth as early as possible. Maybe you can look into buying cryptocurrencies in your roth and all the gain would be TAX FREE!!! you can buy whatever the hell you want in it....

Now the limits:

amount: 5500 USD per year you can contribute.
income: you can not contribute if you are single and make >135k usd, or if you are married and make >199k USD.

This income limitation prevents many single or certianly a lot of dual income couple to miss out on this great tax free wealth creation.

Loophole: Back door ROTH if you fall into those income level

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How to do it:

1. contribute 5500 USD to traditional IRA (at that income level these are nondeductible contributions meaning post tax)
2. Convert that tradional IRA to Roth IRA (there are no tax implication because your money is already post tax)
3. invest
4. Repeat every year.

5500 usd may seem like nothing but trust me over time with the right investment it will be significant tax free money later in life.


Things to keep in mind:
When you do this conversion, you can not have any PRE-TAX money in any of your ira (tradional ira, sep ira, etc). So if you have any pretax ira account you need to either convert them to roth and take a tax hit or preferably roll them over to any 401k/b that you have.

if anyone interested in the process I can further provide step by step guidance.

until my next thread...

[zman]

Originally Posted by iDumb
if anyone interested in the process I can further provide step by step guidance.

Please provide the steps.

[Ajfar]

^ I think you just call your brokerage and tell them you want to convert your traditional IRA to roth IRA. This will be beneficial only if you have small gains from your post-tax contributions, assuming it’s an existing account not a new one.

[iDumb]

you don't have to call anyone. Everything can be done online. But each step needs to happen properly not to mess up come tax time and get subject to pro rata rule.

Backdoor roth is a nice little loophole that is used by those who can not directly contribute to roth due to higher income. While there is income limit for contribution to roth, there is no income limit to contribute to traditional IRA.

the most important step you have to do is first get rid of any of your pre-tax ira money. (tira, sep ira). Either you roll them over to a 401k or if the amount is very low you can convert it to roth and take the tax hit. If you don't have any then it's as simple as clicking few boxes.


1. Open a traditional account
2. Open a Roth Account
3. Contribute 6K to traditional account (2019), you can also contribute 5.5K for 2018 up until april 2019. The website gives u option which year u are contributing for.
4. Crucial step: Make sure there are no pre-tax money in any IRA anywhere under your name. If yes then roll that over to a 401k/403b/457. Or if the amount is very low and u don't mind, u can convert it to roth and tax a tax hit. <-- this would be the first step if you already have a traditional IRA account.
5. Convert traditional to Roth (not transfer) before they start making any money. Since ur contributions were post tax (nondeductible contribution) there is no tax consequences for this conversion.
6. Report it during filing tax: form 8806. Keep track of the year as there are two separate things: one is contribution, another is conversion. It gets a little confusing since you have up until april 2019 tax file day to contribute for the year 2018. So you would report contribution of 2018 for 2018 tax return even if the contribution was done in 2019. But if you convert in 2019 (anytime from Jan 1st) - you have to report the conversion next year (2020) when 2019 tax is due.

If you are married you can also open one for your wife. giving u a potential 5.5 (2018) + 6 (2019) for you and 5.5 + 6 for your wife. A total of 23K of roth money just to start- all growing tax free for years. <--- just dont lose everything in the market like we been having lol. You can buy whatever u want.. no restrictions like in 401k.

[zman]

Very informative. Thank you!

[mufi_02]

informative. two ques --

1) what are the rules for withdrawing from IRA (Traditional or Roth). I heard you can withdraw penalty free in certain instances such as buying first home?

2) so this is your post tax money. the real savings is that you are not paying tax on your capital gains. is that correct?

[iDumb]

^
1) Traditional IRA and Roth IRA are dictated by different rules. Roth is always better and favorable. you can withdraw money from roth that you have contributed ANYTIME without penalty or tax.

2) that's correct. You are not paying any taxes on your EARNINGS if you withdraw after you are 59.5 years old.

these yearly 5 to 6 k looks very small but over long term by the time u can withdraw earnings, I can easily see it being a million dollar portfolio with zero tax liability.

[zman]

1) if you have only 401K and SEP IRA and no traditional or Roth account, and you intend to take advantage of backdoor Roth, can you open a traditional IRA account and roll it over to backdoor Roth while maintaining SEP IRA account?
2) Do you happen to know the steps to allocate some portion of your Roth to crypto?

[iDumb]

Originally Posted by zman
1) if you have only 401K and SEP IRA and no traditional or Roth account, and you intend to take advantage of backdoor Roth, can you open a traditional IRA account and roll it over to backdoor Roth while maintaining SEP IRA account?
2) Do you happen to know the steps to allocate some portion of your Roth to crypto?

1. No. SEP IRA is an IRA that has pre-tax money. You need to roll that over to your 401k before you can do a conversion from traditional to roth. Otherwise you will be subject to pro rata rule and will end up owing taxes on some portion of money in ur sep ira. I know u probably wrote it by mistake but the term needs to be clear not to make any mistakes. You would be doing a convertion not roll over of a traditional IRA (that u funded with non deductible fund due to ur high income) to a Roth IRA. The process is called a backdoor roth. There is no such a entity as backdoor roth. It's simply roth ira.

2. I havent done it so i can't help you. I have done back door roth via fidelity and vanguard. So I can pretty much do anything that I am able to do with a regular brokerage account.. buying/selling/shorting individual stocks, options, bond, mm, funds etc etc. If the brokerage do not offer any cryptos - which none does then the process is a bit complicated where u can open self directed IRA - and have alt investments like crypto, business, real estate etc. I don't have first had experience on how to go about doing that. Previous Presidential candidate Mitt Romeny using this likely ended up having some millions of dollars in roth ira money for his family members - escaping taxes.

[iDumb]

^bascially the year in which you do a nondeductible (post tax money) traditional to roth conversion , you can not have ANY PRE TAX money in ANY IRA under ur name till dec 31 of that year if you want to avoid being subject to pro rata rule.

[zman]

Thanks again! Good to know deadline isn't until April. Hard to get hold of accountants this time of the year.

[zman]

It's that time of the year again when I come back to BC for this thread

Originally Posted by iDumb
6. Report it during filing tax: form 8806. Keep track of the year as there are two separate things: one is contribution, another is conversion.

Form 8806 has to do with changing capital structure of the corporation. Is this the correct form? if so do you need to convert the monetary amount to stocks?

Originally Posted by iDumb
1. No. SEP IRA is an IRA that has pre-tax money. You need to roll that over to your 401k before you can do a conversion from traditional to roth. Otherwise you will be subject to pro rata rule and will end up owing taxes on some portion of money in ur sep ira. I know u probably wrote it by mistake but the term needs to be clear not to make any mistakes. You would be doing a convertion not roll over of a traditional IRA (that u funded with non deductible fund due to ur high income) to a Roth IRA. The process is called a backdoor roth. There is no such a entity as backdoor roth. It's simply roth ira.

If you have separate 401K and SEP accounts, and want to convert only the SEP account to Roth IRA, will you be able to maintain both accounts separately?
From what I understood you'll have to roll over the SEP account into 401K and then convert 401K to Roth IRA. So you will no longer have 401K. Is that what you're doing?

[iDumb]

Originally Posted by zman
It's that time of the year again when I come back to BC for this thread

Form 8806 has to do with changing capital structure of the corporation. Is this the correct form? if so do you need to convert the monetary amount to stocks?

At work but I had to reply to this.

That was a typing mistake form is 8606 but when u file in turbo tax ..it should automatically generate it.

If you have separate 401K and SEP accounts, and want to convert only the SEP account to Roth IRA, will you be able to maintain both accounts separately?
From what I understood you'll have to roll over the SEP account into 401K and then convert 401K to Roth IRA. So you will no longer have 401K. Is that what you're doing?

No man no.
If u want to convert sep ira to roth ira. Just do the conversion . You will have to pay taxes on the whole amount for it that's all. 401k shouldnt be involved .

But If u want to avoid paying taxes then u can roll over ur SEP IRA to 401k.

Then put NEW MONEY into a traditional account and then convert that traditional account to roth if u are ineligible to directly put money to roth due to high income . This is called backdoor.


But it sounds to me like u just want to convert ur SEP IRA to roth . Then u just convert and pay taxes . And yes 401k remains separate .

[bujhee kom]

Couldn't they come up with a better name than this? Sounds very Osslil!

[iDumb]

Btw this is for relatively high income ppl - back door. If your income falls where you can contribute directly to roth. Please put money in roth. YOu can also put money for your wife whether or not she works. Do not waste the years not putting money in. this is really a gift. It forces savings, you have protection, and all returns are tax free.

you can also withdraw your principal like you would from a bank after 5 years. Every year you don't do is a year you miss out on because the cap is so low... 6K for 2019(still time till april 2020)

[bujhee kom]

^^^Thank you for the explanation, iDumb bhiaya!

[zman]

Originally Posted by bujhee kom
Couldn't they come up with a better name than this? Sounds very Osslil!

oh no BK da getting ideas of "pechon theke shojore japte dhora"

[zman]

Originally Posted by iDumb
But If u want to avoid paying taxes then u can roll over ur SEP IRA to 401k.

Then put NEW MONEY into a traditional account and then convert that traditional account to roth if u are ineligible to directly put money to roth due to high income . This is called backdoor.


But it sounds to me like u just want to convert ur SEP IRA to roth . Then u just convert and pay taxes . And yes 401k remains separate .

I think I understand what you are saying. If you roll over your SEP IRA to 401K you won't pay pre-tax but you'll eventually pay taxes when you retire. I guess I was being too greedy, trying to avoid paying taxes altogether, pre-tax/post-tax and after retirement.

[patriot]

What the hell is an IRA? Irish Republic Army?

And what is a 401? An HTTP status error code?

Why should the non US members care about this thread. Perhaps change the thread title?

[zman]

Originally Posted by iDumb
1. No. SEP IRA is an IRA that has pre-tax money. You need to roll that over to your 401k before you can do a conversion from traditional to roth. Otherwise you will be subject to pro rata rule and will end up owing taxes on some portion of money in ur sep ira. I know u probably wrote it by mistake but the term needs to be clear not to make any mistakes. You would be doing a convertion not roll over of a traditional IRA (that u funded with non deductible fund due to ur high income) to a Roth IRA. The process is called a backdoor roth. There is no such a entity as backdoor roth. It's simply roth ira.

1) So for my SEP IRA I'll need to do a "roll over" to "Traditional IRA" which is within 401K, before converting to Roth IRA, is that correct?
2) When you do the roll over or conversion you do not need to sell any stocks do you?

[zman]

Ignore the above post. My procrastination cost me a lot but I'm glad I finally took care of it.