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Relatively high income DINKs, both already maxing 401k accounts. Income is too high for a direct Roth IRA contribution.

I plan on doing a backdoor Roth contribution of $5500 for 2018, and $6k for 2019. My wife, on the other hand, has a large balance in a traditional IRA (from a former 401k rollover), so she's effectively blocked by the pro rate rule. Which has me thinking...

We have some room in the 24% bracket still. Is it better for me to make backdoor Roth contributions, or should I consider using that money to pay for a Roth conversion instead? The vast majority of our assets are in the tax deferred 401k/IRA accounts, if that makes any difference. The major difference as I see it is that conversions get me to a larger Roth balance more quickly. But I'd just be paying taxes today on future retirement funds, not exactly the same as adding to them. Or does it make sense to do the backdoor Roth first, and then only convert what I can afford beyond that? Or is it best to just delay paying the tax man as long as possible?

We're 40/41, so retirement is still 15+ years off. I get that tax brackets are subject to change, but I expect us to be in a similar range in retirement.
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My wife, on the other hand, has a large balance in a traditional IRA (from a former 401k rollover), so she's effectively blocked by the pro rate rule.

Does your wife's current 401(k) allow rollovers into the 401(k)? If so, your wife could roll her entire IRA into her current 401(k) and then she wouldn't have any issues with the pro-rata rule. Or she could just roll some of the IRA into the 401(k), with the intention to do conversions on what's left in the IRA, so that the pro-rata rule wouldn't be as impactful.

We have some room in the 24% bracket still. Is it better for me to make backdoor Roth contributions, or should I consider using that money to pay for a Roth conversion instead?

Because you have no traditional IRAs, and you've already paid taxes on the money that you contributed to the Traditional IRA in order to do the back door Roth, you aren't generating any additional income to be taxed by doing a back door conversion. If you, instead, convert Traditional funds to a Roth, you will be adding additional income to be taxed. Because of that, doing a back door Roth conversion that's not impacted by the pro rata rule is always favorable compared to conversions where you do generate additional income.

The major difference as I see it is that conversions get me to a larger Roth balance more quickly. But I'd just be paying taxes today on future retirement funds, not exactly the same as adding to them. Or does it make sense to do the backdoor Roth first, and then only convert what I can afford beyond that? Or is it best to just delay paying the tax man as long as possible?

Well, it probably makes sense to do the back door Roth either way, since you already have paid the taxes on that income, and you have the chance to shelter it from future taxes. The question is - what do you want your strategy on her Traditional account to be? Understanding that when the money was initially put into the accounts it probably saved you 28% (or more), are you willing to take the 24% tax hit now, because you think it's likely to be taxed at a higher rate later? It's still a tax savings of at least 4% compared to what it saved you. But if you end up in the 15% bracket (based on current law, the rates will return to prior rates in 2026) in 15 years, you will have paid 9% more in taxes than you could have paid then. If you think that there's no chance that you will be in the 15% bracket, but will, instead probably be in at least the 25% bracket, then it probably makes sense to do conversions at 24% if you can afford the taxes.

However, you should be aware, if there's another new tax law passed between now and when you retire, you could be making a mistake. People who did Roth conversions in 2017 and prior probably paid higher rates than they would have if they'd waited until 2018. On the other hand, if a new tax law with higher rates is passed, then you could end up with a huge win.

AJ
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Does your wife's current 401(k) allow rollovers into the 401(k)? If so, your wife could roll her entire IRA into her current 401(k) and then she wouldn't have any issues with the pro-rata rule. Or she could just roll some of the IRA into the 401(k), with the intention to do conversions on what's left in the IRA, so that the pro-rata rule wouldn't be as impactful.

It does all roll-ins, but the expense ratios are on the high side - not crazy high, but even a cheap index fund is charging over .6%. Over time, I think the money could do better in the IRA than the 401(k). DW has roughly $350k in this account.

Because you have no traditional IRAs, and you've already paid taxes on the money that you contributed to the Traditional IRA in order to do the back door Roth, you aren't generating any additional income to be taxed by doing a back door conversion. If you, instead, convert Traditional funds to a Roth, you will be adding additional income to be taxed. Because of that, doing a back door Roth conversion that's not impacted by the pro rata rule is always favorable compared to conversions where you do generate additional income.
Agreed, and this is why I'll definitely do my backdoor Roth before worrying about DW's traditional IRA.

The question is - what do you want your strategy on her Traditional account to be? Understanding that when the money was initially put into the accounts it probably saved you 28% (or more), are you willing to take the 24% tax hit now, because you think it's likely to be taxed at a higher rate later? It's still a tax savings of at least 4% compared to what it saved you. But if you end up in the 15% bracket (based on current law, the rates will return to prior rates in 2026) in 15 years, you will have paid 9% more in taxes than you could have paid then. If you think that there's no chance that you will be in the 15% bracket, but will, instead probably be in at least the 25% bracket, then it probably makes sense to do conversions at 24% if you can afford the taxes.

However, you should be aware, if there's another new tax law passed between now and when you retire, you could be making a mistake. People who did Roth conversions in 2017 and prior probably paid higher rates than they would have if they'd waited until 2018. On the other hand, if a new tax law with higher rates is passed, then you could end up with a huge win.


Historically we've been in the 28/33% range, under prior tax law. Today we do get the benefit of the expanded 24% bracket, but I know that's temporary (unless they change it). Based on the deficit explosions we've seen, I think it's quite likely that tax rates will need to go back up somewhere down the line. Our retirement income should be less than today's income, but will still be in the 24 or 28% range.

Looking forward, we're getting close to the top of the 24% bracket, even after deductions, and I don't think future conversions would EVER make sense at 32%. This seems to make a strong case for rolling the trad IRA into the 401(k) to clear a path to a backdoor Roth.

On the other hand, DW's 401(k) documents do state that they allow in-service withdrawals of post-tax contributions after 3 years of service, potentially giving her the opportunity to do a mega-backdoor Roth in future years. My understanding is that those funds can be rolled directly to a Roth IRA, with no concern for the pro-rata rule?
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On the other hand, DW's 401(k) documents do state that they allow in-service withdrawals of post-tax contributions after 3 years of service, potentially giving her the opportunity to do a mega-backdoor Roth in future years. My understanding is that those funds can be rolled directly to a Roth IRA, with no concern for the pro-rata rule?

Yes, if her plan allows in-service withdrawals of after tax contributions, she can roll those directly to a Roth IRA. There are no issues with the pro-rata rule because she is not converting from an IRA, she's rolling from a 401(k).

AJ
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jeffbrig,

You wrote, On the other hand, DW's 401(k) documents do state that they allow in-service withdrawals of post-tax contributions after 3 years of service, potentially giving her the opportunity to do a mega-backdoor Roth in future years. My understanding is that those funds can be rolled directly to a Roth IRA, with no concern for the pro-rata rule?

Side question: Does DW's 401(k) offer in-plan conversions as well?

My employer (Microsoft) offers both. I understand that it's not uncommon for an employer that offers in-service distributions to also offer in-plan conversions. And her in-plan conversions might not be time-limited.

Still, if your DW has to make after-tax contributions for 3 years, you should be aware that it's possible to split the after-tax contributions from the earnings when you make the distribution. Both have to be distributed at the same time, but you are allowed to send the cost basis to a Roth IRA and the earnings to a Traditional IRA. This avoids any immediate tax liability, which could be substantial if she accumulates 3 year's worth of contributions.

And aj485 is right - the 401(k) after-tax to (mega-backdoor) Roth IRA option isn't affected by the prorata rule.

BTW, I max-out my after-tax contributions ($27,500/year) and use our in-plan conversion option. But I'm on a distribution list that discusses these things in-house and I know there are a number of other employees that do the Roth IRA distribution option. I also do a regular backdoor Roth IRA contribution as I've rolled my traditional IRA into my employer's plan.

<boasting> This year (including my employer match) I will shelter $77,000 from future taxes... </boasting>

- Joel
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Does DW's 401(k) offer in-plan conversions as well?
Reading the docs, it doesn't appear to.

Still, if your DW has to make after-tax contributions for 3 years
It's not contributions for 3 years, it's just being an employee for 3 years to be eligible. She's been there just over 2 years already, so this option becomes available in 2020.
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