Roth error

Submitted by Anthony Romano on Sat, 2020-03-28 01:27

My wife and I file married separately because she has student loans and if we file jointly she will pay a higher interest rate. I opened a Roth with Vanguard this year not realizing the married separately 0-$10,000 restriction. Both my wife and I have employer retirement plans and 403b so we will not get a tax deduction on IRA contributions. Our thought was to start a Roth so at retirement so we would have both taxed and tax free income should we need it.

If I rollover my Roth to a traditional IRA at Vanguard will I be taxed only on the growth of investments since this money was already taxed?

Is it wise for us to continue to make contributions to a traditional IRA if we are not eligible for a deduction? Is this equivalent to being taxed twice?

I think the way a Vanguard Traditional IRA works is I make a contribution after taxes. When I have to take an RMD I will only be taxed as ordinary income on the gains and not the initial contribution. Is this correct?



Submitted by Alan - IRA critic on Sat, 2020-03-28 01:40

If you report your contributions and distributions correctly you are never double taxed.For a spouse that has no TIRA balance now, the solution is to either recharacterize the Roth contribution as a non deductible TIRA contribution, then immediately convert it to a Roth IRA tax free. This strategy is called a “back door Roth contribution”.  Another option since you likely have losses on your Roth contribution is to have the contribution returned to you. You will get back less, but you can then make a new TIRA contribution equal to the contribution limit, then convert it. There will be no current taxes due. If a spouse already has a pre tax IRA balance (eg a rollover IRA), please advise.



Submitted by Anthony Romano on Sat, 2020-03-28 02:12

Both of us set up a roth. We can have the contribution returned but I think  we will get hit with a 10% penalty.  If I do the “back door Roth contribution” this year, will I have to do the same thing every year we file separtely? Or should we leave it in two TIRA’s and use the back door later in life. We think we we be able to file jointly in about 7 years.



Submitted by Alan - IRA critic on Sat, 2020-03-28 02:52

If the contribution is requested returned, if there is a loss there are no earnings subject to either tax or penalty. So there are two ways to get your funds into a TIRA account. You can do the back door every year, and it is the only way to get your contributions into a Roth IRA, but if you ever file jointly again, you might then be eligible for direct Roth contributions if your modified AGI is not too high (over 200k). If you make the ND contributions but do not convert, once there are gains on your contributions your conversion will be partly taxed. Therefore it is best to convert immediately after making the ND contribution. Further, if you ever need to tap your Roth IRAs, you can withdraw these conversions tax and penalty free, since the conversion 5 year holding period only applies to taxable conversions. In your situation, it is clearly the only reasonable choice if you do not have any pre tax IRA values already.



Submitted by Anthony Romano on Sat, 2020-03-28 14:08

Thanks Alan. If you would be so kind to give your opinion as you are prpbably not allowed to give advice.Opinion: My wife and I are recently married and both in our early 30’s. She is a social worker and I am an ESL teacher so we both make under $100,000. I read somewhere that the Roth is a good strategy if you make over $200,000. Both of us have a retirement with NYS teachers retirement system and both have a 403b. Do you think it is wise for both of us to have a Roth.My original thought process was when we retire we would have income that is taxed and income that is tax free but now I’m thinking maybe we should just put as much as we can in the 403b and forget the roth.Also Vangaurd did recharcterize my Roth to a TIRA.   



Submitted by Alan - IRA critic on Sat, 2020-03-28 14:33

Yes, in your case where you are likely to pile up large pre tax retirement balances by the time you retire, along with a pre tax pension. That will result in a relatively high federal marginal rate in retirement even though I believe most of this income will be non taxable for NYS taxes. It would be nice to have Roth IRAs to provide some tax diversification and Roth IRAs are not subject to RMDs at age 72. You would both have to use the back door Roth method by making non deductible TIRA contributions and immediately converting them. Further, tax rates are expected to rise in the future as the currently low rates expire in 2025, and govt debt at all levels is snowballing with this crisis. Again, I assume that neither of you has pre tax amounts in traditional IRAs.



Submitted by Anthony Romano on Sat, 2020-03-28 18:11

Thank you Alan. I have a CPA that is also a CFP but couldn’t get a straight answer. Your direction is much appreciated. 



Submitted by Anthony Romano on Sat, 2020-03-28 18:35

Actually I do have two more questions. I was going to let is sit in the TIRA for about 7 more years and then do the back door Roth and pay the taxes on the gains. But if I understand you correctly I can avoid paying any taxes if I do the back door Roth every year. If I do that -Do I have to open a new Roth account every year or can a make a contribution to my TIRA and immediately back door it to the same Roth?We were doing monthly deposits into the original Roth but thinking your strategy through I probably have to make one contribution to the TIRA and immediately roll it over to the Roth so there is no growth. Is that correct?



Submitted by Alan - IRA critic on Sat, 2020-03-28 23:04

  • Yes, converting immediately will avoid taxes and if you are going to do that you would place your TIRA contribution into a money market fund to avoid any instant gains or losses on your contribution. After the conversion is done you can invest as you see fit in the Roth IRA. 
  • You do not have to open a new Roth every year. Just add each year’s conversion into the existing Roth.
  • However, your TIRA will only hold the funds for 1 day and be empty for 364 days a year. Most custodians will not close your TIRA for quite awhile, and you can tell them that you plan to make your annual IRA contribution to the TIRA every year. If your custodian indicates they have to close it after a period less than 1 year, then simply leave $10 in the IRA. You would convert the balance less that $10. This way all you need is one TIRA and one Roth account (but double that if your spouse will be doing the same).


Submitted by Anthony Romano on Sat, 2020-03-28 23:27

That’s amazing Alan. Your advice is invaluable. Thank you.



Submitted by Anthony Romano on Sun, 2020-03-29 23:13

Just thinking this through and trying to figure out the timeline. If I am interpreting the tax law correctly, I can not make a Roth contribution when filing married and separetly if I make over $10,000 in the tax year I am filing. It’s OK if I have the Roth but can not make a contribution.  I am correcting my 2019 contribution before my taxes are filed this year. After they are file and I get my return then I can do the conversion or recharacterize (not sure which) to the IRA. For 2020 I can not make a Roth contribution. So can I make my TIRA contribution Jan 1 and back door it on Jan 2 or do I wait to file my taxes in 2021.



Submitted by Alan - IRA critic on Sun, 2020-03-29 23:56

  • Yes, your existing Roth IRA is fine, but you cannot make a regular contribution to it while filing separately. Therefore you are recharacterizing your entire 2019 Roth contribution as a TIRA contribution. Once the funds are in the TIRA, convert them back to Roth ASAP. Best to recharacterize now, then file your 2019 return showing a non deductible TIRA contribution on Form 8606, and an explanation for the recharcterization. The conversion to Roth should be done right after the recharacterization since that will not be reported until you file your 2020 return next year. 
  • If you last sentence addresses your 2020 contribution, you can make it anytime, but no later than 4/15/2021. Be sure to flag it showing the year it is for (2020).  In fact, if you have the funds, you could make your 2020 non deductible contribution to the same TIRA where you recharacterized 2019 contribution is transferred to, then convert both the 2019 and 2020 contributions in a single conversion. The only contribution you must recharacterize is your 2019 contribution because starting this year you will make your contributions to a TIRA to begin with. You do not need to wait for your 2020 return to be filed to make the contribution and convert it. You could do it now or anytime you want to before 4/15/2021.


Submitted by Anthony Romano on Tue, 2020-03-31 01:58

I think I finally got it. The only catch I see is -Don’t I have to wait until my taxes are filed in 2021 in order to convert the TIRA to the Roth? I thought I couldn’t put money into the Roth while filing married but separate. I thought the IRS was OK with the ND contributions to theTIRA then after I filed my taxes I could convert it to the Roth 



Submitted by Alan - IRA critic on Tue, 2020-03-31 04:21

No need to wait to file your taxes. You can convert anytime. In fact, you can also make a regular IRA contribution in January even though you don’t find work until October. You just have to come out OK by the end of the year. Best to convert as soon as you make a non deductible contribution, before any gains or losses occur on your non deductible contribution.



Submitted by Anthony Romano on Wed, 2020-04-01 02:43

this is from the IRS website, Can I do multible coversions to the same Roth Beginning in 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own (Announcement  2014-15 and Announcement 2014-32). The limit will apply by aggregating all of an individual’s IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs, effectively treating them as one IRA for purposes of the limit.

  • Trustee-to-trustee transfers between IRAs are not limited
  • Rollovers from traditional to Roth IRAs (“conversions”) are not limited

 



Submitted by Alan - IRA critic on Wed, 2020-04-01 03:11

Yes, that is correct. Rollovers between IRAs and qualified plans are also unlimited.



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