[My] Backdoor Roth IRA: near the end of the year

NOTE: Based on Bichon Frise’s comments and some research on Publication 590 from the irs.gov website, as well as the link to fairmark.com in the comments from Bichon Frise, I’ve decided to make my 2014 Backdoor Roth IRA contribution at the very beginning of 2014. Since it’s so late in 2013 already, I’m going to continue with my existing plan for my 2013 contribution. You’ll see an update on both of these in one of my remaining net worth updates for the year. I’m still leaving the content of the post here because I feel that my concerns and wonderings are still valid. Just please read the first few comments as well.

 

Many people who can make the maximum contribution to their Roth IRA at the very beginning of the year, in January. Some people even make a game (?) of trying to do this as early as possible in the year. Me? I try to do this as close to the end of the year as possible. I’m not against setting aside the cash to make the contribution throughout the year so that I could technically do it at any point.

Why do I do this? Well if you read line 6 on form 8606, you need to enter the value of all your traditional, SEP, and SIMPLE IRAs as of December 31, 2013. I want to be confident that there will be no money in a traditional IRA at the end of the year before I make the Roth IRA contribution when I’m making it through the back door. Why?

My employer charges a fee to keep money in my 401(k) once I’m no longer an employee. The difference in expense ratios between admiral shares and what I can get through my employer is not worth paying this fee, so I plan to roll my 401(k) into a Rollover IRA or the next employer’s 401(k) as soon as the plan administrator will let me. I don’t want to be caught with having money in a Traditional IRA at the end of the year, so I’d rather wait on making the Roth IRA contribution. If the new employer doesn’t let me contribute to the 401(k) for some period of time or their plan isn’t as good as admiral shares at Vanguard, I would rather use the Rollover IRA, even though it would make me ineligible for a Backdoor Roth IRA that year.

With the current balance in my 401(k), most of my conversions from Roth IRA to Traditional IRA would have been taxable, which would be expensive in my 28% bracket. That would be approximately a $2,500 mistake. I’d rather pay the fee to leave money in my 401(k) than the income tax on the conversion. Honestly, looking at form 8606 now, I should have waited until the end of the year to make the conversion from Traditional to Roth on my 2012 contribution. Or I should have just made it in 2012 itself.

In conclusion: my assumption that some day I will have a Rollover IRA instead of a 401(k) is also part of why I am doing the Backdoor Roth IRA for now, even though I was originally against it. Since I hit the income cap for direct Roth IRA contributions so young (at 24), I would like to build up some Roth space while it’s still possible. I’m hopeful that I will at least get to contribute to a Roth IRA through the backdoor this year, in 2014, and in 2015, which would give me $35,000 to $40,000 in the account. My Roth account will almost always be dwarfed by my eventual Traditional IRA from my 401(k) and my taxable account, but it’s still valuable space to have, to diversify on future taxes, especially since I otherwise would have invested the money in a fully taxed investment account.

Readers, when do you make your Roth IRA contribution for the year?

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13 thoughts on “[My] Backdoor Roth IRA: near the end of the year

  1. With how simple a re characterization or an “undo” is in terms of IRA’s, I don’t think any of what is said above has any substance. If one has the money, they should make their move as soon as practical. The rules are very generous and flexible in the contribution year.

    • So if I was to:
      1) Contribute $X to a Traditional IRA.
      2) Convert $X from my Traditional IRA to Roth IRA.
      3) Leave my employer and the new employer’s 401(k) isn’t very good, so I roll my old 401(k) over to a Rollover IRA at Vanguard.
      4) Now I need to recharacterize the conversion in 2) before the end of the year because it is now largely taxable and I don’t want to pay my full income tax rate on it.

      Is 4) correct? Would that not result in having non-deductible contributions in my Traditional IRA? Or could I just withdraw the contribution entirely since it’s still the contribution year? (I don’t want non-deductible contributions in my Traditional IRA for various reasons.) If I can just withdraw the contribution with no penalties, I would definitely make the contribution earlier in the year.

      • Some small changes in terminology….

        1) Contribute $x to non-deductible IRA
        2) Convert $x from non-deductible IRA to Roth IRA
        3) somehow take in additional IRA funds the same year making the conversion not within the rules to avoid additional taxes and penalties.
        4a) recharacterize back to non-deductible IRA before tax filing deadline (4/15 or 10/15, whatever you setup).
        4b) withdraw contribution and income attributed to the contribution before tax filing deadline (4/15 or 10/15, whatever you setup). you will have to take any gains as income, but there are worse problems in the world….like a loss.

        Here is a helpful page from fairmark.com.

        http://www.fairmark.com/rothira/undoing.htm

  2. Usually we make it in October. This year, however, we’re waiting for the end of the year to see if we qualify for the regular Roth or if we have to do a backdoor Roth. All of our traditional IRAs are currently Roth IRAs because we converted as soon as we could (also took losses rather than gains, so didn’t have to pay taxes on the conversion– so um, yay recession?)

    • Why October? From what I read last year, it’s simpler if you make the contribution and do the conversion in the same tax year. I really wished I hadn’t made my 2012 contribution in January-April 2013 and instead made it in December 2012, but I knew I was going to be in the phaseout range and wanted to make as much of a normal contribution as I could, which I couldn’t do until I’d filed my income tax return. In hindsight, I wish I’d just put $5,500 in Traditional in December 2012 and converted that.

      • Because on average October is a good month to do a lump-sum contribution in terms of returns. (“In May go away…”) It also happens to be when I get my first paycheck after the unpaid summer (when we both did when DH was also at the Uni), so there’s no reason to start summer savings yet.

        • Ah okay, so similar to my pattern to make the contribution with my last bonus for the year. Based on Bichon Frise’s comments, I may start using the last bonus for the year to set aside the $ to make the following year’s contribution in early January since I really doubt my income will dip below the phaseout range anytime soon, considering how close just my MAGI is to the cutoff for MFJ.

  3. you said, “so I plan to roll my 401(k) into a Rollover IRA or the next employer’s 401(k) as soon as the plan administrator will let me. I don’t want to be caught with having money in a Traditional IRA at the end of the year, so I’d rather wait on making the Roth IRA contribution.”, and it strikes me that a rollover of a 401(k) to Rollover IRA is not taxable because it is a qualified account to qualified account transfer. I don’t believe the resulting Rollover IRA in this case gets reported on Line 6 of Form 8606.

    • You are correct – the rollover of a 401(k) to a Rollover IRA is not taxable. However, the balance of all of your traditional IRAs (includes Rollover IRAs) at the end of the year is taken into account when determining how much is in your Traditional IRAs to calculate how much of the conversion from Traditional to Roth is taxable. In order to convert from Roth to Traditional, it is better if you only have non-deductible contributions in your Traditional IRA: http://thefinancebuff.com/the-backdoor-roth-ira-a-complete-how-to.html

  4. I made the contribution 1/2 and the conversion 1/3 this year (past 3 actually, though in 2010 it was 2 days later).

    With regard to traditional dwarfing your Roth IRA/401K, – who knows, maybe your next employer’s plan will be structured so you can take advantage of the 415c limit (52k next year) using a Roth, in which case you could put 40K-match in your Roth IRA each year while putting 17500+match in your pretax 401k. At match< $11,250 could be putting more in your Roth IRA. Personally, my Roth IRA and 401k are currently about the same size.

    Oh and for your info, if your future employer's plan is structured so you can put in up to 415c limit – money in a regular IRA will not block it (though it would in a sense block the 5500 backdoor Roth if you didn't move the money back into the 401k). Your max total in your Roth IRA each year (while maxing out 401k) could then be 34500-match.

    • Contribution 1/2 and conversion 1/3 is now looking like what I’ll do for 2014! My employer’s stock price would have to lose 75% of its value for me to be able to contribute to a Roth IRA in 2014. That happening could also cause job loss, so I’m reasonably hopeful that won’t happen! I was a bit less confident in that for this year though I’m not quite sure why when I’m forecasting my total compensation to drop by $10-30k from 2013 to 2014.

      One of my friends can do the 415c thing and I must admit that I’m slightly jealous! I would absolutely be doing that over mortgage payoff, if I could.

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