(Not) Oops!…I Did It Again

I just did it again. And it’s not an “Oops”.

Yes, I made my annual IRA contribution and backdoored it into a Roth again. If you are able to backdoor your Roth, then you can avoid the IRA versus Roth conversion debate. Are the upfront taxes for the conversion worth the tax-free status on the withdrawals in the future? Etc.

Brittany or Christina?

The IRA debate is like the age-old Brittany or Christina conundrum. Those of you who lived through the 90’s know what I’m talking about. Were you a Brittany Spears fan or Christina Aguilera fan? One had hits like Oops!…I Did It Again, Stronger, and Baby One More Time. The other had hits like Genie in a BottleWhat a Girl Wants, and featured vocals on more contemporary stuff like Maroon 5’s Moves Like Jagger. They both had their legions of fans and there was really no clear winner.

Anyways, if you can backdoor your Roth, you get the benefits without the costs and avoid the debate.

Backdoor Roth Strategy

We’ve been doing this strategy since 2014 (with a 2013 catch-up) as a way to turn some of our taxable brokerage assets into tax-free assets for our retirement in the future. This is what we do:

  1. We make an IRA contribution every year ($5,500 per person) even though we don’t get a current tax deduction due to income limits. Because we don’t get a tax deduction for the IRA, it is considered after-tax dollars.
  2. For my wife’s account, we immediately convert the IRA contribution into a Roth. Here’s the backdoor. When you convert an IRA to a Roth, you have to pay taxes on the gains. But since our IRA contribution is after-tax dollars, the cost-basis of the contribution is also $5,500. When we convert the account valued at $5,500 into a Roth, the gain is zero (value of $5,500 – cost basis of $5,500 = $0 gain). So we have a tax-free conversion. Now that $5,500 can grow into a tax-free nest egg for our retirement.
  3. For my account, we simply make an annual IRA contribution. We don’t do the Roth conversion because I have a lot of gains from my other existing IRA accounts. You don’t get to cherry pick which amounts or accounts you are converting. You have to pay a proportionate share of the gains across all of your IRAs. So in my situation, it didn’t make sense to do the Roth conversion for my account.
  4. If you haven’t made your IRA contribution for 2016, you still may be able to squeeze it in before the tax deadline. That’s what we did in January 2014 when we first started this plan. We made both a prior year contribution of $5,500 for 2013 and contribution of $5,500 for 2014. It sounds like a lot, but we’re just transferring assets from one account into another (from our regular taxable brokerage account into a tax-sheltered IRA account).
  5. Here’s the research and full details I posted in the Backdoor Roth post I made a year ago.

Conclusion

Like the Brittany or Christina conundrum, nothing is ever really that clear-cut. The backdoor Roth worked for my wife, but it didn’t make sense for my situation. However, in either case, making that additional IRA contribution every year is still a benefit.

For the record, I was always partial to Christina.

 

Note – Always consult with your tax advisor about your personal situation.

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