How to choose between Roth IRA and Traditional IRA

Question

I have been contributing to Roth IRA for several years now. At this point my income have jumped up so I cannot contribute to Roth IRA anymore, unless I use the backdoor. Currently, my tax rate is 24%. I am already contributing to Traditional IRA for this year on monthly basis.

Should I convert my traditional IRA to Roth IRA? If so when should I do this since I am contributing on monthly basis. What if my income will be lower at the time of retirement, will it still makes sense to convert Traditional IRA to Roth using the backdoor?

UPDATE: If I convert my total balance of Traditional IRA to Roth IRA then I will have to pay taxes on the earnings (since this is NOT pre-tax). At this point, what will happen to the traditional IRA account. Can I still contribute monthly to the traditional IRA and then convert it by the end of the year.

ANOTHER QUESTION: I contributed to Traditional IRA $6000 max (NOT pretax). If I convert traditional IRA to ROTH then will I still have to fill out form 8606.

QUESTION 4: Here is my situation. I have the following types of account.

Roll Over IRA - $100K (Not paid taxes) Traditional IRA - $6K (Paid taxes) Roth IRA - $10K (Paid taxes)

According to the text "When the IRS determines your backdoor Roth IRA conversion taxes, they will regard all of your current IRA accounts as one entity. This is known as the aggregation rule – no IRA stands alone; instead IRAs are regarded in the aggregate."

Does that mean if I convert my Traditional IRA account to Roth IRA, the Pro-Rata rule with apply since I have another IRA (Roll Over IRA)? If that happens I will end up paying more taxes.

Answer 1

Yes, you should rollover your Traditional IRA into a Roth IRA.

If you can no longer contribute to a Roth IRA, that means that you cannot deduct contributions to a Traditional IRA either (if you or your spouse is covered by a 401(k) at work). So, you have two choices: to let your contributions grow in your Traditional IRA tax-deferred, or to have them grow in your Roth IRA tax-free. The latter is the better option here, since you won't get the pre-tax contribution benefit from your Traditional IRA anyway.

You should do the conversion as soon as possible. You have to pay taxes on the earnings inside the Traditional IRA when you rollover. The sooner you do the rollover, the less earnings you'll have to pay taxes on. You can do the rollover once right after your last contribution into the Traditional IRA at the end of the year, or right after each contribution throughout the year. The latter takes more work, but is more efficient tax-wise.

Edit: turns out the OP has another Traditional IRA with a $100k balance in pre-tax dollars. The pro-rata rule now applies and the decision to do the rollover or not is not as straight forward anymore since doing a complete rollover would incur a massive tax bill from those $100k.

Answer 2

Does that mean if I convert my Traditional IRA account to Roth IRA, the Pro-Rata rule with apply since I have another IRA (Roll Over IRA)? If that happens I will end up paying more taxes.

Correct. You effectively have "one IRA" with $100k of pre-tax contributions and $6K of after-tax contributions (you don't say how much of the 6K is contributions versus growth, but I'm assuming it's mostly contributions). So for every $6 of Post-tax IRA you want to convert, you have to convert $100 of pre-tax IRA money. (more precisely, if you roll over $100, then $94.30 (100/106) of it will be taxable, regardless of what account you roll over from). If you want to roll over the whole $6k you have to roll over the full $106k, $100k of which will be taxable.

Unless you have the cash to pay the tax on a $100k rollover, I would just leave them alone. The only drawback is that the growth of the $6k will not be tax-free, but it is still tax deferred. So even if it triples to $18k (meaning $12k is growth), you'll be paying tax on "only" $12k of growth.

It doesn't seem like a big enough benefit to pay tax now on $100k. If the account grows by X and your tax rate T is the same when you withdraw, there's no difference mathematically in paying tax on $100k now (leaving you 100*T) left now to invest or borrow versus paying tax on 100+X when you withdraw.

I would just max out you 401(k) and contribute to either your traditional or Roth IRAs after that. Again, the decision point for Trad vs Roth is whether you think your tax rate will be higher or lower in the future. If you think it will be higher, it's better to pay a lower tax rate now by contributing to a Roth. If you think it will be lower, it will be better to get the tax deduction now by contributing to a Trad. If they are the same it doesn't matter.

---- EDIT ----

I just noticed this comment:

Last year 2021, I contributed $6000 to traditional IRA. All that money was after tax, meaning I already paid taxes on my contributions. I have yet not filled taxes for 2021.

I would check with your broker and see if you can get this reclassified as a pre-tax contribution, and take the deduction. It will simplify your IRA setup since now all of your money is pre-tax. Then take the tax refund and invest it for 2022 (or do something else with it).