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I have heard about backdoor Roth IRA conversions from traditional IRAs and am interested in pursuing this as a way to save some extra income. However, before I try it, I want to make sure I fully understand the mechanics. Are there any pitfalls with the following strategy?

  1. Continue making maximum contributions to my employer's 401(k) plan on a pre-tax basis ($18,500 annually for 2018).
  2. Open a traditional IRA in 2018 and invest some baseline amount of after-tax dollars (minimum allowed balance in some low-fee index fund tracking a major index).
  3. Open a Roth IRA in 2018 and fund it with the maximum allowed amount of after-tax dollars ($5,500 in whatever I choose)
  4. In 2018 and in subsequent years, contribute whatever after-tax money I choose to the IRA opened in step 2 above, and then within the same year convert some amount (likely the maximum allowable amount) to Roth, transferring to the account opened in step 3, and paying any applicable tax (hopefully small)?

Does having pre-tax savings in my or my wife's employer-sponsored 401(k) accounts create any problems, or are there problems with holding the funds in a traditional IRA for a short period of time (less than a year, likely less than 6 months or preferably even 6 weeks)?

Is the only benefit to the above scheme, compared to simply contributing directly to a Roth IRA, that it avoids income limits? Or does it have other advantages (or not even that one)?

I understand tax rules could change, maybe even retroactively, but there's no way to tell the future so I am not concerned about that real possibility.

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    You can only contribute $5,500/year total to IRAs (trad + roth; $6500 if you're old enough), so #2 won't work. I'm not sure what you're trying to achieve here, especially by #4—why wouldn't you just convert everything? – Kevin Jan 17 '18 at 23:50
  • @Kevin Does the $5,500 limit apply to all contributions, or only pre-tax contributions? If it matters, I was suggesting keeping the IRA open with some minimum balance to avoid having to open a new account each year. Perhaps the required amount is $0, that is, the seed is unnecessary, in which case smaller is better. – Patrick87 Jan 17 '18 at 23:54
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    All contributions. – Kevin Jan 17 '18 at 23:56
  • @Kevin I see, I had missed that. Glad I asked! I'll update the hypothetical to reflect this, although it makes it a lot less worthwhile. Is the only benefit to doing a backdoor conversion then to get around the income limits? Or if you're doing 401k conversions to Roth IRA? If you make that an answer I'll accept. – Patrick87 Jan 18 '18 at 0:08
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    Yes, AFAICT the only reason to do the backdoor is to circumvent the income limit. – Kevin Jan 18 '18 at 0:14
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The scheme your proposed, even after the edits, doesn't seem to achieve the goal that you want.

For this discussion I am assuming that you and your wife are under 50 years old. If not these numbers increase. I am also assuming that your company doesn't allow additional post-tax contributions to the 401K.

Each person can contribute 18.5K to a 401K, and 5.5 to IRAs in a year. Based on your income and your spouses income the question is do you want to make some or all of this potential 24.0K retirement contribution Roth or not. Regarding the IRA the question is it deductible or not? and can you make a Roth IRA contribution.

Once you know this, you construct your contributions to get you there. Knowing that you may have to use the backdoor Roth conversion to make a contribution to a non-deductible IRA and then convert the 5.5K plus gains to the Roth IRA account. If you will be near the income limits for the IRA it can benefit to do the IRA contribution near the end of the period to make sure you you do it correctly.

The backdoor Roth Conversion is only done when you want to contribute to a Roth but can't because of the income limits. If you can make the contribution directly, do so. There is less paperwork involved.

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