How to report a backdoor Roth IRA contribution on your taxes

How to report a backdoor Roth IRA contribution on your taxes

Updated June 25, 2019

By: Geoff Curran & Jeff Barnett

When you are thinking about how to put your hard-earned dollars to work, it’s important to consider every avenue for tax-advantaged savings. Backdoor Roth IRA contributions are great tools for high earners to take advantage of Roth IRAs even after passing the income limits for standard contributions, and the steps for making backdoor Roth IRA contributions are pretty simple. However, the documentation and tax forms for the process can be confusing, and you may run into trouble when it comes time to report everything to Uncle Sam. Whether you work with a professional tax preparer, use tax software such as TurboTax or complete your taxes by hand, understanding the mechanics of the money movements can help ensure you file your taxes correctly. 

Let’s walk through each step in the backdoor Roth IRA process to illustrate the moving parts. You got here by making too much money to deduct Traditional IRA contributions or to contribute to a Roth IRA normally. However, there is no income limit on converting a Traditional IRA to a Roth IRA, which is the crux of the backdoor Roth IRA.

Step one of the Backdoor Roth IRA is making a non-deductible contribution to your Traditional IRA. It’s your responsibility to report the non-deductible contribution to your Traditional IRA at tax time on IRS form 8606, Nondeductible IRAs. Form 8606 helps track your basis and avoid paying additional tax on your non-deductible contribution as you convert the balance to a Roth IRA.

The second step after making your non-deductible Traditional IRA contribution is converting your Traditional IRA balance to a Roth IRA. You will owe tax on any earnings in the Traditional IRA before converting, but from that point on, those dollars are now Roth IRA assets and aren’t subject to future tax. Use Form 8606 for calculating the taxable amount from the conversion if you had any earnings in the Traditional IRA.

Around tax-time, you’ll receive a 1099-R from your custodian showing the distribution from your Traditional IRA that was converted to your Roth IRA the previous year. Later in the year you’ll also receive an information reporting Form 5498 that shows the contribution you made to the Traditional IRA and the amount that was converted to Roth. We recommend keeping Form 5498 for your records, but you don’t need to report Form 5498 in your tax filing.

Now that we have walked through the steps, let’s look at an example of how to report a backdoor Roth IRA contribution. Tom, a 35-year-old physician in the Pacific Northwest and diehard Seahawks fan, is working on his Married Filing Jointly tax return after making a $6,000 non-deductible Traditional IRA contribution last year that he converted to his Roth IRA. Tom didn’t have any other Traditional IRA assets aside from his non-deductible contribution in 2018, and he didn’t have any earnings in his Roth IRA conversion. Part 1 of Tom’s Form 8606 is filled out below.

Next let’s look at Part 2 of Tom’s Form 8606, where the conversion portion is reported. If line 18 is 0, as it is in this example, none of the conversion ends up being taxable.

 

 

 Note: Our example uses the increased 2019 IRA contribution limit ($6,000 for individuals under age 50) on the 2018 tax year forms. The 2019 tax year forms won’t become available until January 2020.

Tom won’t end up owing any taxes on his Backdoor Roth IRA, and his correct reporting of the contribution and conversion will avoid running afoul of the IRS. However, tax forms and reporting can be a daunting challenge. If stressors like tax law changes, new forms and confusion around the whole process keep you from sleeping soundly, reach out to a Merriman advisor to discuss whether a backdoor Roth IRA makes sense for you. You might even have other options available for tax-advantaged savings that you haven’t considered. Check out Mega Backdoor Roth Explained to see how you might be able to do a backdoor Roth in your employer 401(k) plan. We love navigating complex issues like these and giving guidance to elevate your finances.    

 

 

References:

Internal Revenue Service. (2018, November 1). About Form 5498, IRA Contribution Information (Info Copy Only). Retrieved from https://www.irs.gov/forms-pubs/about-form-5498

Internal Revenue Service. (2019, February 27). About Form 8606, Nondeductible IRAs. Retrieved from https://www.irs.gov/forms-pubs/about-form-8606

Internal Revenue Service. (2019, April 18). About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.. Retrieved from https://www.irs.gov/forms-pubs/about-form-1099-r

Mega Backdoor Roth Explained!

Mega Backdoor Roth Explained!

By: Geoff Curran & Jeff Barnett

Everyone thinks about saving for retirement, and not many people want to work forever. However, have you thought about the best way to save for the future? If you are setting aside the yearly max in your 401(k) and channeling extra savings to your brokerage, you might be missing out on powerful tax-advantaged saving opportunities. In this article, we will show you how we help clients maximize savings, minimize taxes and secure their future using the Mega Backdoor Roth IRA.

 

Most people know they can contribute to their employer’s retirement plan from their paychecks through pre-tax and Roth contributions up to $19,000 a year ($25,000 if age 50 or older; IRS, 2018). What people miss is whether their retirement plan allows for additional after-tax contributions beyond this limit. Enter the supercharged savings!

It turns out that some company plans permit you to contribute up to the IRS maximum for total contributions to a retirement plan, which is $56,000 in 2019 ($62,000 with catch-up contributions; IRS, 2018). The IRS maximum counts contributions from all sources, including pre-tax employee deferrals, employer matching contributions, and even after-tax contributions for the Mega Backdoor Roth. That means you might be able to contribute an additional $20,000 or more after-tax each year after maxing your elective deferral and receiving your match. You can then convert the extra after-tax savings to Roth dollars tax-free. This more than doubles what most individuals can contribute to their retirement plan, and you won’t have to pay taxes on your Roth account distributions in retirement. This benefit is even greater when both spouses have this option available through their employers, so be sure to check both plans.

Retirement plans like those at Boeing, Facebook, and Microsoft permit easy conversions of after-tax to Roth dollars within the retirement plan. Other companies offer a variation where you can make in-service distributions and move after-tax dollars into a Roth IRA. Make sure to check with your benefits team to find out if your company’s retirement plan supports after-tax contributions and Roth conversions, the steps involved and the maximum amount you can contribute to the after-tax portion of your retirement plan. It’s important not to run afoul of plan rules or IRS requirements, so also be sure to consult experts like your accountant or financial advisor if you have any questions.  

Why contribute extra after-tax?
Now that we have covered the high-level view, let’s hammer down the why. The benefit of contributing to your employer’s after-tax retirement plan is that those contributions can subsequently be converted to Roth tax-free. This is sometimes called a ‘Mega Backdoor Roth,’ whereby you can contribute and convert thousands of dollars per year depending on your retirement plan. Once converted, these Roth assets can grow tax-free and be distributed in retirement tax-free. After several years of Mega Backdoor Roth contributions, you can amass a meaningful amount of wealth in a tax-free retirement account

How do I contribute?
1. Log in to your employer’s retirement plan through their provider website, such as Fidelity.

2. Find the area where you change your paycheck and bonus contributions (i.e., deferrals).

3. Find “after-tax” on the list showing how much you elected to contribute pre-tax, Roth, or after-tax to your 401(k).

4. Enter a percentage to have withheld after-tax from your upcoming paychecks and bonuses that works for your budget.

5. Select an automated conversion schedule, such as quarterly (Microsoft’s retirement plan even offers daily conversions!). If your plan doesn’t offer automated periodic conversions, contact your retirement plan provider regularly throughout the year to convert the assets.

6. Remember to select an appropriate investment allocation for your retirement account that aligns with your overall investment plan.

Is any part of the conversion taxed?
For retirement plans that don’t convert after-tax contributions to Roth daily, there may be growth in the account prior to conversion. This growth is subject to taxation at ordinary income tax rates. For example, if you converted $22,000 ($20,000 contributions + $2,000 investment growth over the period), you’ll owe income tax on the $2,000.

We suggest speaking with a Merriman advisor to determine if your retirement plan allows additional after-tax contributions, how to fit it within your budget and its impact on your retirement savings goals.


References: Internal Revenue Service. (2018, November 2). Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits. Retrieved from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits

Should I Rent Out My Home on Airbnb?

Should I Rent Out My Home on Airbnb?

Written by: Geoff Curran, CPA/ABV, CFA, CFP® and Alex Golubev, CFA

The last few years have seen tremendous growth in the short-term rental housing economy. Services like Airbnb and VRBO connect homeowners and travelers around the world. While vacation rentals aren’t anything new, home-sharing platforms make it more convenient than ever for homeowners to earn extra money on their personal residence or vacation home. Airbnb fosters accountability and transparency by inviting hosts and guests to review and rate each other on criteria like cleanliness, following house rules, and ease of communication. A whole ecosystem of services has also sprung up to streamline and improve host operations (Smartbnb, AirDNA, NoiseAware, Vacasa, Evolve and many more). However, vacation rental remains a highly competitive and regulated industry.

Hosts in the Airbnb space face many challenges for success. Setting up homes for vacation rental, optimizing rental rates and cleaning properties between guests eats into time and money. Once rentals are rolling, even successful properties can hit speed bumps. Tourist demand is often seasonal or focused on appealing properties in central locations. Low barriers to entry can also reduce profits as more hosts enter the market and/or authorities create regulations to raise the bar. Short-term rental earnings have curbed in highly-regulated tourist hubs like New York, LA, San Fran, Barcelona, Berlin, and Amsterdam.

Given the popularity and potential of Airbnb, clients have started asking whether it makes sense to rent out their homes. We always encourage our clients to consider how renting their property will affect their life. If renting out your home helps you support your lifestyle and travel more, then exploring AirBnB could be an exciting opportunity.

AirDNA is a great starting point for researching vacation rentals in your area. AirDNA can help you assess the earnings potential of your home, whether you’d like to rent out your entire place or just share a room. Dipping a toe in the water of home-sharing during your next trip out of town is a great way to start!

The checklist below provides helpful points to consider before renting out your property:

Home Insurance: Check with your home insurance provider to ensure that your insurance coverage is still adequate and will remain in force if your home is rented out. The strategy of doing nothing and asking for forgiveness later just won’t work with insurance companies if you have a claim. We reached out to Sue Greer from Propel Insurance for her perspective on managing liability. She emphasized watching out for “contract language that can limit, or void, coverage entirely when the property’s occupancy is other than what was noted on the signed application.” It’s also important to ensure that your other liability coverage like umbrella insurance will still cover any accidents that may happen on your property if it’s rented out.

Security: It’s important to make sure that your home is secure and that any irreplaceable valuables are properly locked up when others are in your home.

  • Locks: Digital locks are a great tool for avoiding sharing keys with guests, and they provide a simple way to setup new codes for each guest.

 

  • Alarm: You still need to actively use your alarm with guests coming and going. The good news is that alarm companies permit you to change codes digitally so that each guest has their own unique code.

 

  • Safe deposit box: Valuables that you won’t be taking with you, like jewelry and essential documents, should be stored in a safe deposit box at the bank.

 

  • Internet Network: It’s also important to maintain internet security. Remember to create a guest network, and change the wireless password when guests leave.   
  • Co-host: Since most people rent out their home when they are out of town, it can be very helpful to find someone local that can help if there’s a problem in your absence. This could be someone to clean the property between guests—or even to break up an unruly party! Airbnb can help you find a co-host for 7-20% of the revenues depending on the services provided. There are also many new short-term rental operators that offer co-hosting services.

  • Maintenance: With guests coming and going, wear and tear can accelerate, and accidents can happen. Having a high security deposit helps mitigate costs in case of accidents. Given that home maintenance costs anywhere from 2% to 5% of your home’s value each year, setting aside a portion of your rental income to cover maintenance is a good idea.

  • Tax reporting: If your home is rented out for greater than 14 days a year, you’ll need to include the income
    and expenses on your tax return. Make sure to keep track of all your expenses incurred throughout the year related to the rental activities. This includes repairs, supplies, cleaning costs, new appliances and lawn care, just to name a few. Importantly, you can also claim some of your utility costs as an expense, including cable TV and internet, in proportion to how much of the year the home was rented.

If you have questions about this checklist or any other parts of your financial life, we recommend reaching out to a Merriman advisor. We can help with the decision to rent your home and with managing all the moving parts. You’ll have to share all the adventures you’ll be able to take once you explore Airbnb!

Talking to your Parents about Health and Finances

Talking to your Parents about Health and Finances

With the arrival of our first child fast approaching, my wife and I in all of our excitement have been working through a to-do list to prepare for this lifechanging event. While we know we have many surprises ahead, taking the time to learn, ask questions and plan for what’s coming can only help us.

My focus has been planning for the next generation of our family, but this experience caused us to start asking our parents questions we hadn’t before. (more…)

How to Determine When You Need Trip Insurance

How to Determine When You Need Trip Insurance

A lot goes into planning a great trip – choosing flights and hotels, making sure you have all the necessities, finding a house sitter, etc. Personally, I’m never able to relax and enjoy the trip until I’m on the flight to my destination. I’m always worried something might go wrong, and some unforeseen circumstance may force me to cancel all or part of the trip.

By the time you get to the airport, you’ve usually spent a good chunk of money that’s not refundable. If you have to cancel last minute, you miss out on the trip you’ve been looking forward to for months, and you lose the money you spent so far. (more…)