Excess cash and wildly varying incomes

[rick]

First off, thank you so much for putting all of this information out into the world. And apologies for the long post.

My wife and I were fortunate to make a combined gross of around ~$170k last year. We did not plan ahead and have many, many taxes to pay. I still have a lot to learn obviously.

This year, my income has dropped to $0. I'm starting a new company with a few partners. We are pre-revenue and incorporating this month. We are not sure at what point we'll be able to take salaries. The plan will be to build it to sell in 5-10 years. My wife still has the capability of making between $10k-$70k depending on how much she wants to work (half-burnt out nurse).

We have accidentally accrued around ~$100k in cash that we can invest while still having enough cash to get through this year (had a large purchase in mind that is now questionable).

Here are our current assets (A = me, B = my wife):

Betterment allocations (all 90/10 split except for emergency fund which is 50/50):
$145k - Traditional IRA A
$100k - Traditional IRA B
$25k - Roth IRA A
$25k - Roth IRA B
$25k - Emergency fund
$15k - Taxable account

Employer 401k's:
$10k - 401k A (I will be able to roll this over to an IRA once I officially leave my current position at the end of the month)
$15k - 401k B

Here is my plan for our funds:
Immediately contribute to our 2021 Roth IRA's - $12k
Immediately contribute to our 2022 Traditional IRA's - $12k
Dump the rest ($76k) in to our taxable accounts

It might be worth noting that we are in our late 30's, not having children, have zero debt or loans, live below our means, rent affordably, and our monthly burn rate last year was ~$5k.

My questions and concerns:
Backdoor roth conversions are very intriguing due to my new $0 income but I'm afraid of the prorata rule and am still trying to understand it, so I'm not sure if I should do one immediately, do a regular conversion at the end of the year, or not do one at all. Also we're not sure yet how much my wife will be earning.
Dumping the roth contribution into our taxable account instead makes sense based on the roth hypocrisy post, but we also have no idea how much we are going to make in retirement or have a clue when that is going to be, especially due to the new business.

PS. GGC, congrats on the new house and having the fortitude to adapt when necessary, all the while doing it in public. We've been fairly nomadic over the past five years and are looking to do more international travel soon, so thanks for outlining such a phenomenal blueprint for a satisfying life on the road. It's greatly appreciated!

[gocurrycracker]

Hi Rick, thanks for the kinds words, much appreciated.

So...

You can only contribute $6k total per person to IRAs - if you contribute $6k to a Roth you can't also contribute to a Traditional.

With a monthly burn rate of $5k and depending on spousal income, you may need some of that $100k to fund life expenses for 2022. That says leave excess cash in the taxable account for easy access.

There are 2 terms that are commingled in your question:
Backdoor Roth - something that high income people can do to get money into Roth accounts - you can just do Front door Roths this year assuming you have earned income of $12k+
Roth conversion - the act of moving funds from Traditional IRA to Roth IRA - it is taxable but advantageous when done during low income years

For Roth conversion, 100% of the conversion will be taxable (pro-rate is 100%) - the idea is you are happy to pay 0%, 10%, or 12% tax knowing that it saves you 22%+ later.

You can do a Roth conversion at any time in the year -

[rick]

Thanks for the reply.

Yes, aware of the IRA contribution limits. The $12k is between both of us. So it sounds like my current plan is accurate:

Immediately contribute to our 2021 Roth IRA's - $12k (we're phased out of traditional for last year and still need to contribute prior to filing taxes)
Immediately contribute to our 2022 Traditional IRA's - $12k (take advantage of the tax savings this year since we won't be phased out and contribute immediately)
Dump the rest ($76k) in to our taxable accounts

If my wife decides to not earn significant money this year and we stay under the standard deduction, wouldn't it be possible to do a conversion at zero tax with the difference?

I know that conversions can happen at any point - the real question I'm wondering about is if it makes sense to wait until the end of the year to see how much we earn, and if it's still very low then do a conversion up to a certain amount. There are so many variables in that sentence though I'm struggling with planning it out.

[gocurrycracker]

Yeah, accurate plan. I misread your initial post and was thinking you wanted to contribute to both Roth and Traditional IRAs in the same year, but you clearly labeled them 2021 and 2022.

If my wife decides to not earn significant money this year and we stay under the standard deduction, wouldn't it be possible to do a conversion at zero tax with the difference?

Yes. Or do more and pay a little tax at 10% / 12% if you think that is less than what you will pay in a few decades.

I almost always do Roth conversions in December - that is the first time I really know what annual income will be.
Exception - in 2020 when the market crashed in March(?) I did a Roth conversion at discount prices based on a guess for annual income.

[rick]

No worries! The post was verbose and that's on me. It was helpful to type it all out though but most importantly thank you very much for replying.

do more and pay a little tax at 10% / 12% if you think that is less than what you will pay in a few decades.

Correct me if I'm wrong, but the only way we pay higher taxes on a future conversion is if our earned income from wages, distributions, and social security is greater than ~$80k, yes?

Also, if we don't have any wages in retirement and our other income is under the standard deduction, we'll then have the room for the ~$80k LTCG at zero tax instead.

Both of those are assuming no significant changes to the tax code of course.

[gocurrycracker]

~$110k (Standard deduction + ~$85k, 2022 numbers)

Once RMDs get large (start at 72 but become significant after age 80 or so) it is quite easy to exceed $110k income, especially with SS

You can play with the numbers with this calc
https://www.gocurrycracker.com/federal-income-tax-calculator/

This post has some charts with rough 401k sizes to have RMDs push you into higher tax brackets
https://www.gocurrycracker.com/is-your-401k-too-big-part-2/