Roth IRA Conversions & Purchase of BAC

I usually try to max out my Roth IRA as early as possible each year in order to maximize the effects of compounding. Due to the high cost of living in Chicago this year, I was unable to contribute $5,500 until recently.

However, rather than contribute directly into a Roth, like I’ve done in the past, this year I chose instead to contribute to a non-deductible traditional IRA. The reason for this change is that in 2016 I’m anticipating being above the income limits for a direct Roth contribution. By doing a non-deductible contribution into a traditional IRA I was then able to do an (almost) tax free Roth IRA conversion. The “almost tax free” part will be explained below.

The reason I did this conversion is that this allows the retirement account to grow completely tax free and no taxes will be owed upon withdrawal. I’d also be able to pass the account down to any heirs tax free. A non-deductible traditional IRA contribution would have grown tax free but then would be subject to taxes on the backend (in addition to already paying taxes on the front as is the same with a Roth) and would have a required minimum distribution come 70 1/2 years old. See an earlier blog post: Why the Roth IRA is right for me.

There are two great websites that describe the process of a Roth IRA conversion and were very helpful in answering all my questions about the process:

1) How To Do A Backdoor Roth IRA (Safely) And Avoid The IRA Aggregation Rule And Step Transaction Doctrine
2) Backdoor Roth: A Complete How-To

A few things to consider that may possibly sway you against doing a backdoor Roth conversion is that you may owe additional taxes on the money set aside for conversion into a Roth if you already have deductible money in any other IRAs that you own. This is called the IRA Aggregation Rule and is explained well on the two above sites. For me this was not an issue since the only money in a traditional IRA was the $5,500 that I had just contributed.

There’s the possibility that keeping the contribution as cash and immediately (same day) converting to a Roth, could be seen by the IRS as abuse since this then is effectively the same as being above the legal income limit for a Roth contribution but then making the contribution regardless.

To avoid the question of this “Step Transaction Doctrine,” I elected to invest the $5,500 in the preferred shares ETF, PGX, which I have been using to hold cash since it pays around 0.5% per month. After the PGX transaction had a chance to settle, I initiated the conversion. PGX fluctuates a bit so I ended up making around $26 in gains, which I will owe taxes on in the 2016 tax season.

Once the money was in the Roth IRA I decided to invest it all in Bank of America (BAC). Banks have corrected a bit in the last couple of weeks but are still down from 6 months to a year ago. While I may be able to pick up BAC at a slightly better price a little while from now, in the long run, a couple percentage difference in share price now won’t make that much difference.

A value investor that I greatly respect, Tim at The Conservative Income Investor, has written quite a bit about the banking industry and BAC, in particular:
1) How Truly Long-Term Investors Should Approach Bank Of America
2) Bank of America’s Bright Dividend Future
3) Bank of America Stock: Getting Dirt Cheap
4) Wells Fargo vs. Bank of America Stock: Depends On Your Time Horizon

Current stats:
Annual dividend yield: 1.43%
Payout Ratio: 11.52%
Coverage Ratio: 868%
Forward PE: 10.37

While BAC does not pay enough dividend now to provide income to live on, that is not what I’m looking for in my current stage in life. BAC is back to being profitable, is well-positioned to sustain another 2008 crisis should that occur again, and has more than enough profit to easily cover the dividend. It should also be able to support multiple raises well into the future.

On 4/18/2016 I purchased 400 shares of BAC at $14.142/share, this purchase adds $80 in annual dividends at BAC’s current dividend amount.

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2 Responses

  1. DivHut says:

    Thanks for sharing your experience with an IRA to ROTH conversion. I am looking to do the same thing as long term I prefer a ROTH over an IRA. The only reason I have an IRA today is because of a legacy account that was set up many years ago. I have to discuss this with my accountant about converting my IRA to ROTH. I have a feeling that taxes will be owed but long term will benefit me more.
    DivHut recently posted…Dividend Portfolio Sector Allocation April 2016My Profile

    • scott says:

      Hey DivHut,

      Having a legacy IRA is definitely an issue to consider with a conversion. You’ll have to pay a percentage of taxes on any tax deductible IRA contribution that you have made into prior IRA accounts. I’m going to stick with the Roth because of the flexibility that it offers: Tax free withdraws during retirement, ability to pass it to heirs tax free, and no required minimum distribution.

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