By Dr. James M. Dahle, WCI Founder
I may not be the world's foremost expert on Backdoor Roth IRAs, but I'd be very surprised if I wasn't in the Top 10. I've been helping people with a Backdoor Roth IRA nearly since the beginning (i.e. 2010). I think at this point I've seen every mistake, certainly 99% of them. Most of those are demonstrated somewhere in the 1,300 post comments section on my Backdoor Roth IRA tutorial. I am continually amazed at how complicated people can make something that can be so simple. I mean, the only possible way it could be made simpler is if Congress would just allow high earners to contribute directly to a Roth IRA. Today, we're going to go through the most common ways to screw up the Backdoor Roth IRA. But first, a brief instruction on how to do it “right” in 2021.
How to Do a Backdoor Roth IRA
- Step #1 Contribute $6,000 ($7,000 if 50+) to a traditional IRA account during the calendar year, investing the money into a money market fund
- Step #2 Convert to a Roth IRA the next day, investing the money into your selected investment fund
- Step #3 Follow the written IRS instructions to fill out Form 8606 properly or double-check that your tax preparer did so
More information here:
How to do a Backdoor Roth at Vanguard
How to do a Backdoor Roth at Fidelity
17 Most Common Backdoor Roth IRA Errors
#1 Trickling in Contributions to Your Backdoor Roth IRA
To be fair, this isn't technically an error. I mean, you can do the backdoor Roth IRA this way if you really want to make your financial life more complicated. I think this error occurs from people trying to automate their financial life a la The Automatic Millionaire. They divide up their $6,000 contribution into 26 biweekly periods and every time they get paid, they put a little money into the IRA. If married, they do it for their spouse too. Maybe it makes their budgeting easier, I don't know. Perhaps they learned about the benefits of periodic investing/dollar-cost averaging and want to try to do that. Some of these people even do the conversion step each time they make a contribution. But by the end of the year, they've made over 100 transactions when they could have done four (halve those numbers if you're single).
I don't know about you, but I've got better things to do with my time than do an extra 100 transactions that I didn't have to do. Even if you put the contributions on auto-pilot and only do the conversion at the end of the year, you're still overcomplicating things (not to mention creating some tax drag). Save yourself some time and don't do this. If you make enough money that you have to contribute to a Roth IRA through the backdoor, you make enough to make the contribution all in one lump sum. Do your Roth IRA in January, your spouse's in February, and then move on to the 401(k) or 529s or whatever in later months.
#2 Not Making Your Backdoor Roth IRA Contribution During the Calendar Year
Here's another one that is super common, so common there's an entire post about how to fix it. Technically, it's not an error because you are allowed to contribute to a backdoor Roth IRA up until tax day in April of the next year. But don't do it if you can avoid it. The problem is that people learn about the Backdoor Roth IRA and realize it's already past the new year and they want to do a contribution for the previous year. Or they procrastinate. Or they do the first step and then forget to finish. So the very first time they do the Backdoor Roth, they've got to do a more complicated version. It's way easier to do the 8606 when it looks the same every year!
#3 Not Doing the Conversion During the Calendar Year
Here's a third one that isn't technically an error. I mean, it's not illegal or anything because there is no deadline for a conversion. You can do the conversion step now, later in the year, next year, or in 30 years without breaking any rules. But it makes your 8606 more complicated. And the longer you wait for the conversion step, the less tax-free growth you will see.
#4 Not Knowing the Pro-Rata Rule
Now we're starting to get into where you're actually breaking the rules. Line 6 of IRS Form 8606 (the form on which the Backdoor Roth IRA is reported) requires you to list the total you have in traditional IRAs, rollover IRAs, SIMPLE IRAs, and SEP-IRAs (but not Roth IRAs, 401(k)s, or any other type of retirement account) as of December 31st of that tax year.
You want this number to be zero. Make it zero.
#5 Choosing the Wrong Way to Deal with a Tax-Deferred IRA
So how do you make it zero? You have two choices. If the account is small, it is best to just convert it and pay the taxes. Not only does that require little hassle, but it also makes your Roth IRA bigger. If the tax-deferred IRA is large, you probably don't want to pay the tax bill on that. So you should roll it over into your employer's 401(k) or 403(b) or your own individual 401(k). Don't have a 401(k)? Go do some surveys online, get yourself an Employer Identification Number (free and takes 2 minutes online), open an Individual 401(k), roll the tax-deferred IRA in there, and get on with your Backdoor Roth IRA.
There's no minimum self-employed income required to open an Individual 401(k). I don't think you actually even have to have any income, but I'd try to get yourself at least $10 of profit for your “business”. Technically you don't have to do this step before doing the contribution and conversion, you have until the end of the year as long as you don't put your contribution into this same IRA. But don't put it off. The deadline is December 31st and things get really busy at investment companies the last week of the year.
#6 Open Your Individual 401(k) at the Wrong Place
I used to have an individual 401(k) at Vanguard. It had two problems back then. They didn't allow IRA rollovers and they used the slightly more expensive Investor Class shares. They have since changed both of those. They now take IRA rollovers and they use the less expensive Admiral Class Shares. Wherever you open an i401(k), make sure it has the features you need, particularly if you need to roll a traditional or SEP-IRA into it in order to facilitate the Backdoor Roth IRA process.
#7 Not Doing an 8606 Tax Form
During the Roth IRA process some people, including both those who prepare their own taxes and those who get help, simply don't include Form 8606 on their taxes. Not only is this illegal, but it will likely end up in you paying too much in tax. The good news? You can go back and file 1040Xs for the last 3 years. Include the 8606 this time, and fix it.
#8 Using a SEP-IRA or SIMPLE IRA Instead of a 401(k)
There are lots of resources out there that talk about the merits of using a SEP-IRA or SIMPLE IRA for your side gig or even your practice. That advice was probably fine pre-2010. It's fine for non-high-earners too. But it's not fine for you, because of the pro-rata rule.
An individual 401(k) is a little more paperwork, but it's not bad. It has to be opened before the end of the calendar year, unlike a SEP-IRA, but is that too much to ask? I mean, you don't even have to make the contributions before the end of the calendar year, you just have to open it. It has higher contribution limits than the SIMPLE IRA and you can max it out on less income than a SEP-IRA. What's not to like? Nothing.
#9 Fearing the Step Doctrine
Lots of people and their advisors are worried about The Step Doctrine. This is an IRS doctrine that says if the sum of all the parts is illegal, the transaction is illegal even if all the individual steps are legal. People have worried the IRS could apply this doctrine to the Backdoor Roth IRA, even though they never did to any single person in the last eight years, tens or hundreds of thousands did a Backdoor Roth IRA every year, you don't report the dates of the contributions or conversions to the IRS, and the most prominent financial publications in the land have written about it. “Too risky,” the misguided advisors said. They recommended you wait months or even years between the contribution and conversion steps so you could argue to the IRS that you really didn't contribute to a non-deductible traditional IRA just to convert it to a Roth. And then somehow did the same thing the next year. Give me a break. I practically dared the IRS to audit me on this point. No dice. At any rate, in 2018 Congress clarified that I was right, so consider this my victory lap. To be clear, you do NOT have to wait any period of time between the contribution and conversion. The next day is fine.
#10 Confusing a Backdoor Roth IRA and a Roth Conversion
Nothing confusing about this. Just one way down.
I know, I know. They both have the word Roth in them. They must be the same thing. The Backdoor Roth IRA even includes a conversion step, so I suppose it shouldn't be surprising that people get confused. But there is a key difference. When you do the conversion in the Backdoor Roth IRA process, there is no tax cost. With a Roth conversion, there is almost always a tax cost of some kind. A Backdoor Roth IRA is a no-brainer. Deciding whether to do a Roth conversion requires weighing a number of competing factors and often making assumptions about an unknown future. Don't confuse the two.
#11 Confusing a Backdoor Roth IRA and a Roth 401(k) Contribution
While we're on the subject of confusing stuff, here's another one. A Backdoor Roth IRA is not the same as a Roth 401(k) contribution. With a Roth 401(k) contribution, you're trying to decide which is better—tax-deferred or tax-free. That can be a difficult decision. With a Backdoor Roth IRA you're choosing between taxable and tax-free. That's not tricky. That's a no-brainer. Just do it.
#12 Forgetting the I in IRA = Individual
INDIVIDUAL Retirement Arrangement. That means one for you and one for your spouse. $6,000 each ($7,000 if 50+). That means you each fill out your own 8606 each year. That means if one of you can't do a Backdoor Roth IRA due to your employer using a SIMPLE IRA or you have some huge SEP-IRA you can't get rid of (online surveys are just too hard) your spouse can still do one. Your spouse doesn't even have to have any income, as long as you have enough income to “cover” him.
#13 Not Understanding What Basis Is
Line 2 of Form 8606 asks what your basis is.
Basis is money that has already been taxed, so if you convert it, there is no tax cost. The instructions for that line say:
Generally, if this is the first year you are required to file Form 8606, enter -0-. Otherwise, use the Total Basis Chart to find the amount to enter on line 2. However, you may need to enter an amount that is more than -0- (even if this is the first year you are required to file Form 8606) or increase or decrease the amount from the chart if your basis changed because of any of the following:
- You had a return of excess traditional IRA contributions (see Return of Excess Traditional IRA Contributions, earlier).
- You received part or all of a traditional IRA (see the next to last bulleted item under Line 7, later).
- You rolled over any nontaxable portion of your qualified retirement plan to a traditional or SEP IRA that wasn’t previously reported on Form 8606, line 2. Include the nontaxable portion on line 2.
This line confuses people more than any other on Form 8606. Here's a tip. Enter $0. That's probably right most of the time and certainly right if you're doing your Backdoor Roth IRA the way I recommend you do so (i.e. contribution and conversion steps both during the calendar year).
#14 Skipping Form 8606 Lines 4-13
See that little box there by line 3? The one that says skip most of the form (and which didn't use to be on the 8606)? That only applies to people who didn't do a Roth conversion during the calendar year. If you did your Backdoor Roth IRA the way I tell you to (contribution and conversion during the calendar year) you don't get to skip those lines. That's because you did a Roth IRA conversion during that tax year. Those lines aren't so bad. Just follow the instructions.
#15 One Divided by One Is One, Not Zero
Math time. See line 10 on Form 8606? It makes you do math. See?
Usually, line 9 is going to be $6,000. So is line 5, at least if you're doing your Backdoor Roth IRA the way I tell you to (contribution and conversion during the calendar year.) $6,000/$6,000 = 1. For some reason, a lot of people think $6,000/$6,000 = 0. Want to pay too much in tax? Put 0 on line 10.
#16 Worrying About Pennies and the Backdoor Roth IRA
Here's another thing that throws off so many people I wrote an entire post about it. These folks make their contribution, then a little while later do the conversion step. Even if they kept things really simple, doing the conversion shortly after the contribution and leaving the money in a money market fund while it was in the traditional IRA, there is likely a little more than $6,000 in the traditional IRA when it comes time to make the conversion.
So one of two things happens.
- Either you convert a little more than $6,000 and have to pay taxes on the amount above $6,000 or you leave the amount above $6,000 behind in the traditional IRA. If the amount is less than 50 cents, don't worry about it. Nobody cares. On your taxes, the IRS is perfectly fine with you rounding everything to the nearest dollar.
- If the amount is more than 50 cents, then try to include it in the initial conversion or do a second conversion if the IRA custodian will allow it. If they won't, no big deal, just fill out the 8606 right (there will be a few dollars on line 6) and convert it next year with your next Backdoor Roth IRA (and do it right this time so the amount left behind is < $0.50). Honestly though, even if it is a buck or two, if you only round to three places like line 10 tells you, it still rounds to 1.000.
#17 Not Checking Your Work on Form 8606
Whether you prepare your taxes yourself, or you pay somebody else to do it, you need to check Form 8606 before it is submitted. It is actually more complicated to fill out 8606 using Turbotax than to do it by hand (so if using Turbotax see Harry Sit's excellent tutorial). Either way, you need to check your work. So what do you check? You check lines 15c and 18. These lines should have $0 on them (not $6,000). If you're not doing your Backdoor Roth IRA the way I recommend (contribution followed rapidly by the conversion both within the calendar year), there may be something else on one of those lines, but it should be a whole lot closer to $0 than $6,000.
If you have $6,000 on either of those lines, you're going to be paying tax twice on the same money and you're throwing away a couple thousand bucks. Be sure to check your spouse's too.
That post ended up being longer than I expected, but I hope it is useful to those of you who are still becoming familiar with the Backdoor Roth IRA process. Don't worry, if you do it right all you have to do next year is copy the previous year's form. If you've made one of these errors, here's how to fix the mistake.
What do you think? What other ways do people screw up their Backdoor Roth IRA? Comment below!
I’ll disagree with one comment, just at the very beginning. I don’t know that doing a Roth IRA the very first time is as straight forward as outlined in your three steps. I ran in to several snags. That’s why I wrote a post on that specifici topic (doing a Roth IRA at Vanguard for the first time).
I know that after I have done it the first time, it’ll be easy as can be. However, it was not intuitive to me to “open a Roth IRA” and then fund it with zero dollars. There were also a couple other issues for people only the first time. Next year will be straight forward, though, I agree.
I made a few bucks because I waited for my money to clear (one week) at Vanguard and figured out the Roth IRA part being funded with zero dollars. Like you said, though, when I fill out 8606 the two bucks I made rounds to 1.000 and so it doesn’t matter.
Personally, I think the biggest mistake people make with a Backdoor Roth IRA is simply not doing it.
I also agree that the first time can be a bit painstaking, especially on step #5: Making it Zero. Once the Traditional IRA is cleared out, though, smooth sailing.
Great post WCI. I’ve been doing the backdoor Roth since 2011 so you’ve got me beat by a year! I agree that understanding “basis” was the thing that used to confuse me the most. I remember the first time I did it, my account was with T. Rowe Price at the time and I had to explain it to the guy on the phone. He then checked and said, “yes, this is legal”. Hardly anyone knew about it then.
And the good news for me is that this is the first year since 2011 that I won’t have to do one since going part time has cut my salary in half and I can now contribute to a Roth the good ole fashioned way!
This is the best post about backdoor Roth IRAs I have ever read. Thanks for the great work, Jim.
Mistake my accountant made this year; forgetting to put the 11k on line 15a IRA distribution on the 1040.
This ended up costing me a cp2000 form from the IRS and a hastle with me filling out more paperwork and writing a letter to the IRS.
Similar for me, but my “accountant” was turbotax. I had done the backdoor for several years without issue using Henry Sit’s template but just received a CP2000 for 2016. It looks like the program screwed up on problem #14 and I didn’t have the know-how to do issue #17 properly. I didn’t have to pay tax on the money the way the return was filled out, but now I have to fix 8606 and explain to the IRS that I don’t owe the extra 4k they are requesting.
Thanks for the timely post! Anyone have tips for forcing/making sure turbotax fills out lines 4-13?
Look at the 8606 in Forms mode before submitting.
My dad is actually a retired IRS agent so I had him look at my return and CP2000 when he was in town this past weekend. He said there was nothing wrong with the return and couldn’t exactly tell why the IRS computers had generated the CP2000. The only thing we could see was that TurboTax put an asterisk on the 8606 lines 13, 15 and 18 that had a small note: *From Taxable IRA Distribution Wkst (per IRS Pub. 590-B)
These worksheets were among the mass of forms produced by TurboTax for the return. They seem to cover everything in 8606 lines 6-12 plus a bit more and then direct you to transfer certain calculated numbers to lines 13, 15, and 18 of the 8606. Perhaps this is the source of the problem. If so I would call it a failure of the TurboTax return and the IRS computer to understand each other, but not necessarily a screw up by anyone.
I am curious how this was resolved for you and what you included in your response to the IRS. I received a CP2000 today for 2016 saying my 11k IRA contributions were taxable retirement income (~4k tax owed). I also used TurboTax and looked back at my 8606 forms and they are filled out exactly as past WCI tutorials lay out. I’m not sure how I’d fill out 8606 any differently for the IRS. Would I just write back saying these were non-deductible contributions were transferred to a Roth IRA and weren’t distributions? Apparently what prompted the IRS was receiving forms from Vanguard saying our 11k contributions were taxable. I’m a little nervous that the 1099-R form with Gross distribution (Box 1 = $5500) and Taxable amount (Box 2a = $5500) weren’t filled out correctly but I thought that was right.
Yes, that’s what I would do. If Vanguard screwed up their forms, request they correct them.
On my 1099-R it says 5,500 on line 1 and 2a.
Is this incorrect? Should line 2a say 0?
Line 7 also says Distribution code 2 early distribution. Is this also incorrect?
I did mine at Fidelity and there is a box when doing the conversion from traditional to Roth if the money is taxable or not. I remember checking that box because I thought that we had to based on a tutorial on this site (but maybe not).
What does the correct 1099-R say in these fields? I may need to contact Fidelity to correct.
There is often $5,500 in 2a, but 2b should be checked.
I don’t know about 7.
Yes mine has both boxes in 2b checked for “taxable amount not determined” and “total distribution”.
So you’ve had 5,500 in 2a and not run into problems.
In box 7 the code is 2 for early distribution, exception applies (under age 59 1/2). Whatever that means.
Also the IRA/SEP/SIMPLE distribution is checked. Technically it’s a conversion not a distribution I would think although maybe the conversion is still a distribution since money is leaving the account. First year doing the backdoor. Thanks for your input.
I think you’re fine. Just check your 8606 to make sure you didn’t pay tax twice on that money.
So far it seems like the letter and documents we faxed back addressed the issue. My dad emphasized that agents are looking to clear these forms quickly so encouraged me to keep the letter short and to the point. Maybe we attached more than was necessary (8606, turbotax worksheet, etc) but figured they could skim those if they wanted.
I guess your are ahead of me: also received a CP 2000 from IRS saying we owed almost 5 k due to discrepancy from Vanguard. The wording for form 1099-R says the same as you, then I “ discovered “ my accountant did not file 8606 these past years!!!, so I have a potential fine of 5 k along with a penalty of $780 per year all these past years por “excess contribution “: pretty picture, of course I am the fool for trusting blindly. Any help will be welcomed.
Time to file some 1040Xs with 8606s.
Wow. I had no idea there are so many ways to mess it up. I love Roth investing. I have a Roth 401K too.
I converted all my eligible traditional retirement funds to Roth and continue to contribute the max each year. All the work for both accounts (my wife and I) takes maybe 10 minutes a year at the most.
ALL your retirement accounts are Roth? That’s probably a mistake if that’s what you’re saying.
Well, not exactly. I did a mega-conversion in 2011 or 2012. I do an annual backdoor ROTH. I do also contribute to a traditional 401(K), SEP-IRA, and 457. I’m hedging my bets. I don’t have the level of certainty about the future, economy, tax rates etc that you seem to have. It isn’t all Roth but I’m not sure it would be a “mistake” to have tax-free growth and tax-free withdrawals for life. Avoiding the RMD nonsense might be reason enough to be in Roths.
The only certainty I see is change. But I don’t pretend to know what changes we will see. 3 years ago who would have expected lower tax rates in 2018? Nobody.
What I’m referring to is that there is no sense in paying ALL your taxes prior to retirement when you can “fill the brackets” with tax-deferred account withdrawals in retirement.
Thanks, WCI. Always double and triple check your accountant’s work. I fired mine back in 2013 for, among other things, messing up the basis on my 8606. And the accountant acted like the error wasn’t even a big deal.
I have a solo 401k. 19k goes to Roth portion this year. I was thinking of moving the employers contribution, (the remainder 37k going into trad solo 401k) , to a traditional ira and then converting this to Roth IRA Combined with using backdoor personal ira to Roth, leaving Roth IRA flush and the traditional ira zero every year. I already have a lot in trad 401k so eventually doing this would be pretty even between Roth’s and traditional. What do you think?
Can you do step 3 first? I have 3000 in a traditional IRA that I will need to covert to Roth.
Also are you opening a new Roth IRA every year or just adding money to the old one?
I know you said you can leave the.balance as zero in the traditional Ira? So that doesn’t have to be new every year. But do you open a new Roth IRA yearly? So that way the IRS can track it as a yearly contribution.
You mean fill out the tax form first? I guess, but why?
Just do your new contribution(s), convert the entire IRA to Roth and report it right on your 8606(s). This isn’t that complicated.
Same traditional and same Roth IRA every year. The IRS can handle tracking it in the same Roth IRA. The IRA provider reports it to them.
Next article:
“What to do when you skrewed up #4,” AKA “how to do an rechararcterization “
Now made harder, unfortunately.
Good point, I guess I learned this lesson just in time.
I was told that the recharacterization was done away with for 2018 and beyond…is this accurate info?
Yes.
I have a situtuation that I would love to get comments on. I have 100k in a self directed traditional IRA that i have invested in non standard investments (real estate). I cant roll it over into a 401k and still do alternative investments. I was left with a decision of either not doing backdoor roths, or paying additional tax because of the pro rata rule. I chose to pay the additional tax and get more money into a tax free ROTH. This is my thinking and I would love to hear how peopel feel about it. Im in a high income specialty so if I converted that entire 100k i would get a big tax hit which im not willing to take. I do the backdoor procedure as above, with the only difference being that I wind up paying taxes on most of the 5500. The way I look at it, if i was to convert 5500 fromthe traditional to roth annually, i would be paying the same tax, but this way, i pay the conversion tax but I am increasing the basis in my retirement accounts, i.e. instead of having 94500 in traditional and 5500 in ROTH, I now have 100,000 in the traditional and 5500 in ROTH, with paying the same amount of tax on the contribution as I would have if I had done a conversion.
This is what I had to do since the stinkers at Vanguard (otherwise I love them) got rid of small 401Ks briefly, converting mine into an IRA, so I can’t do the backdoor unless I hassle with turning that back into a 401K somewhere somehow (might’ve already spiked that well by mingling it with other IRA money). I figure the tax I was paying was nibbling away at the tax due on all my accounts in retirement. Now in retirement no backdoor for either of us, just nibbling away at my privately held traditional IRAs. Husband has all Roth since we backdoored and converted smaller traditional ones he had long ago. By the time I get mine all done without increasing our tax brackets over the years it’ll be time to decide if we should try to Roth our TSPs and other 401K equivalents held. I had calculated how much Roth:traditional to have based on RMDs but had forgotten about starting SS (hopefully) around the same time, so we’re getting more aggressive with conversions to avoid a huge rise in our tax rate at 70-71. Don’t think it’ll change my opinion on waiting until 70 for SS: working on convincing husband that the likely extra money earlier on is worth less than the higher annuity benefit aspect of waiting. If we aren’t hurting for money in our 60s I figure let’s lessen our risk of living into our 110s (who knows?) and hurting for money then.
If you’re (and your spouse is) retired without income you can’t have a Backdoor Roth IRA anyway. You need earned income to do the IRA contribution step. Your only question is whether to do Roth conversions or not.
Roth conversions are a great reason to wait on Social Security.
That sounds like a big pain to keep track of basis. Not sure I would have chosen that path. I would have either converted the whole $100K and paid the tax or just not done the Backdoor Roth IRAs.
But you can choose to just do the big conversion any time you want and end the hassle. Think of it as contributing an extra $40K to retirement accounts that year and it’ll be less painful.
its not that bad because the contribution is such a small amount relative to the total. I pay an accountant to do this anyway so its his pain, not mine. Is my logic flawed though????
It’s just not nearly as beneficial as it otherwise would be. You’re really doing two things:
1) A Roth conversion at a high tax bracket
2) Contributing to a non-deductible IRA
Neither is a particularly great thing or even a no-brainer, like a Backdoor Roth IRA is. If you’re investing in a taxable account this year, I’d argue you’d be better off converting that $100K instead. If you truly don’t have the money to do that, maybe I’d do what you’re doing, but I’m not 100% convinced it’s better for you than just investing in a taxable account. But what you’re doing is definitely NOT a Backdoor Roth IRA. A backdoor Roth IRA is in essence a Roth IRA contribution. That’s not what you’re doing.
Yeah, thats why im struggling to reconcile whether its really a smart move or not. My accountant basically echoes what you say but said because Im young (39) he thinks in the long run its probably not a big deal. Im probably making too much of it. I guess if it was a choice between saving an extra 5500 or not saving that money its worth doing but it might not be better than just putting 5500 in a taxable account. Oh well, i still can do it in my wifes name.
What about the idea of opening a self-directed 401k (you must have a self-employed business w/o employees). You can do surveys like WCI mentioned or moonlight.
Then rollover funds from the SD IRA into the SD 401K. This should take care of the pro rata rule AND you can still invest in alternative investments. The SD 401K is better than a SD IRA because you have no custodian to go through ,nickel and diming you for every transaction, and you have “checkbook” control. You’d serve as the trustee and once it’s set up, everything is under your control. Just a thought.
I don’t think i can do that because i already have a 401k, profit sharing plan with my private practice that i put the max 56k away per year in retirement accounts
I do too. That can be rolled over to a rollover IRA which can be rolled over to the SD 401k ( which is what I do). I think you can probably roll over that profit sharing directly to a SD 401k but I’m not 100% sure.
You still can, you just can’t do any personal contributions, only your business, online survey business etc., can contribute to it. Your really just looking for the rollover space, not another 401K to contribute to.
Can’t you have a checkbook IRA just as easily as a checkbook 401(k)? I would have guessed it would be less complicated.
Spiritrider is going to have a stroke when he reads #5….
I must have missed a conversation somewhere because I have no idea what you’re talking about. Link?
“Reckless” is the term he used for this advice.
https://www.whitecoatinvestor.com/forums/topic/can-i-set-up-an-individual-401k-just-to-roll-over-my-iras/
Ahhh….now I see it. I disagree with him. If you get paid $5 to do a survey, is that reportable income to the IRS? Absolutely it is. And where do you report it? You report it on Schedule C. What is Schedule C for? It’s for a business. What do you need to open an individual 401(k)? A business.
A hobby? Whose hobby is doing online surveys? Do you know anyone who would do that consistently if they weren’t paid for it? Of course not. It’s not a hobby. The IRS’s concerns about hobbies is so you can’t keep deducting losses for years and never turn a profit in a business. If you do that, they reclassify it as a hobby and you don’t get the deductions. I doubt the IRS would apply that issue to the ability to open a solo 401(k), but if you’re worried, go spend a weekend driving for Uber or better yet, moonlighting as a doc.
The $400 limit is if that is your ONLY income.
Also, if you use turbo tax to do your taxes, there are a few places you can trip up where the web program thinks you’re doing a traditional to roth conversion and makes you pay the taxes. There are a few blog posts on the internet (google-able) that walk through this. The good thing is that TT actually acknowledges the backdoor roth and has info in their help section as well to make sure you do it right.
I tripped up a few places when I did it (and went back and fixed):
1. I accidentally assigned the contributions to me for both roths instead of to my wife and I. So be careful about that.
2. BEFORE you import forms from your brokerage document the IRA contribution in the contribution section (If you go step by step you’ll see the investment section comes before the IRA contribution section). If you do it the other way TT logs the conversion but doesn’t realize you made the contribution and charges the taxes.
I agree. It’s actually trickier in Turbotax than on paper. Another dozen ways to mess it up I guess.
I do think some people over complicate things. I did my first backdoor Roth last year and it was pretty simple. All thanks to you for shedding light on this strategy and showing how its done.
Great post Jim!!! Thank you!
So I will be opening my Solo 401k this year. Last year I had to Last minute Open a SEP IRA and put in my 20% of profits. All fine and good. But I want to move to the 401k as I have $190K in tIRA money I want to get our of there for the pro-rata rules.
I was going to go with Fidelity as I hold an HSA and another small 401K there already. You are really leaning towards Etrade for that if you make a move in the future. Is it that much better.
I guess comparing apples to apples at today’s rates..
VTSAX has a ER of 0.04% – The Etrade route buying VTI ETF will have trade commissions attached to it.
FSTMX has an ER of 0.09% – The Fidelity route will eliminate the trade commissions.
Looks like the Fidelity route as an initial move I will be paying $75 more a year in Expense Ratio… Which does offset the $7 ETF trade fee a few times over the year.
Now that I’ve actually done the homework… I know my answer. Is it worth the extra ER to keep things consolidated with Fidelity??…
Thanks again Jim!
Fidelity would allow the rollover, unlike Vanguard, but doesn’t allow Roth contributions or 401(k) loans. Etrade allows it all. Both etrade and Fidelity will charge you commissions to buy VTI, but if you buy Fidelity funds you could eliminate those commissions.
If it helps your decision, if you have more than 10k invested in FSTMX at Fidelity, they automatically convert your shares to FSTVX which has an ER of 0.035%. Or if you’re buying more than 10k at once just purchase FSTVX to begin with and get the same index tracking at the lower ratio!
Thank you for the excellent article. If I have an inherited IRA, from what I have read, I have to include it in the fair market value of all my iRAs, therefore a Back door Roth would not be totally tax free. Is this correct?
No, inherited IRAs are not put on line 6 of Form 8606.
Thank you for this post! I get lots of questions about what to do if I did X, Y, or Z, and I say “Why didn’t you do A or B?”
It really is simple if you allow it to be.
Now I have a post to refer people to when their situation is not so simple instead of spending 20 minutes trying to figure out what needs to be done.
Cheers!
-PoF
How do I determine if I should convert some of IRA to Roths. 68yrs old and 4.3M in Iras between me and my wife
Probably in 22-24% tax bracket
This is a totally different issue from the one discussed in this post. But you’re a great candidate for Roth conversions for at least the next two years until you start Social Security.
Thanks for this article. I had done this for my wife last year but had been procrastinating on doing it for myself due to my existing IRA, and your article prompted me to get moving. Please confirm if my plan sounds good.
– I signed up for an EIN as you suggested
– I filled out the Fidelity docs to transfer my IRA to an i401K, with myself as the employer and my shiny new EIN
– I do work for my wife’s business, but so far for love and not for money
– She’ll pay me something in a 1099 this year, I’ll report it on schedule C, and I’m good to go for opening my i401K
– As a bonus, I can put 20% of what she pays me into my new i401K as the employer contribution (I already maxes out my employee part at my day job)
Did I get everything right?
(I know my wife could also make me an employee and include me in her i401K, but I think there will be fewer complications doing it this way.)
I’m not sure you can hire your spouse as an independent contractor and call it a separate business with its own 401(k). Better get some formal advice on that one, or at least read up on related businesses.
Is there an example for Roth Conversion vs. example for Backdoor Roth IRA for #10? I’m afraid it still seems confusing as it still seems like the same thing to me?
Is it just that for Backdoor Roth you don’t bother claiming a tax deduction on the traditional IRA you initially put it into (whereas with Roth Conversion you’ve already claimed the tax deduction on that initial traditional IRA)?
Roth conversion: You have an IRA, and convert some or all of it to a Roth IRA. You pay income tax on the amount converted.
Backdoor Roth: You have no regular IRA. You open a T-IRA, put in 5500, then convert it to a Roth IRA. You pay no tax assuming the value was still 5500 or less when you did the conversion. You once again have no regular IRA.
Excellent explanation.
When you say “you have no regular IRA”, you mean that I do not have a traditional IRA that I have already funded and reported to the IRS in previous years that has reduced my taxable income? ( in this circumstance a roth conversion would be a taxable event)
Because a Roth conversion for a T-IRA opened for the sole purpose of transferring money to a R-IRA is the definition of a backdoor Roth IRA isn’t it? The difference is that I’m doing the roth conversion on funds that haven’t already reduced my taxable income.
Semantics I know but something friends, including myself, have had questions on. Particularly since some banking institutions use the words “roth conversion” on their paperwork as the process to create a backdoor roth.
An indirect Roth IRA contribution or a Backdoor Roth IRA is a two step process. Step 1 is a non-deductible contribution to a traditional IRA. Step 2 is a tax-free Roth conversion.
Does that help?
1. Is it important that the IRA you use has been opened just for this transaction? I re-used the empty IRA from Vanguard that I had from my previous backdoor Roth. Will this screw things up somehow?
2. “When you do the conversion in the Backdoor Roth IRA process, there is no tax cost.” — Is there actually no tax consquence to me anywhere in the backdoor Roth process? I thought it was a means for a high-earner to get more money into Roth — I had thought I paid for it just like a Roth conversion, at my highest tax rate.
Thanks for all the help (in book and on site).
1. That’s fine. No problem.
2. Well, you paid for it when you earned the money. But after that, no tax cost.
So if we have all of our savings in traditional ira’s and sep ira’s $600k (since he became self Empl. we had been putting in the max into an sep as our “advisor” never told us the solo 401 existed. He rolled over our 403b from employment into 5 year ira’s and 7 year ira annuities!) That can’t be rolled over for 4 years without penalty , so what are our options? We cannot have any traditional Ira’s to do the Roth back door so wait 4 years than convert all of it to Roth to and pay all the taxes? Give up on the back door roth and just convert a portion. I could perhaps convert all of mine to Roth (stay at home spouse) to back door, only 80k.
I just opened a Vanguard solo 401k to get the over 50 catch up. I know that won’t work for rolling into. Now I’m wondering if we should start contributing the employee portion to a Roth 401k. And will I need to open another account. Should o do that with e trade?
I have gotten very unsound incomplete advice and am trying to do the research now.
Should I start contributing to non-deductible ira’s. I’m unclear on whether we can.
Thanks for all the info.
There is no such thing as a 5 year IRA. You can roll that over now. In fact, you can roll the annuities over too, but you’ll likely be paying a surrender charge. That’s often worth paying as it just represents the value now of all the fees you’ll pay from now until the surrender charge goes away-i.e. you’ve already agreed to pay that money, it’s now a sunk cost/water under the bridge.
To do Backdoor Roth IRAs effectively you would want to roll those IRAs into a solo 401(k). Unfortunately, the Vanguard one doesn’t accept incoming IRA rollovers.
The traditional vs Roth 401(k) question is totally separate. This post should help, but I suspect that isn’t the right move for you.
https://www.whitecoatinvestor.com/should-you-make-roth-or-traditional-401k-contributions/
You certainly can contribute to non-deductible IRAs, but you probably shouldn’t bother if you’re not going to do something with those IRAs to avoid the pro-rata issue.
Only the US tax code could come up with things that would have 17 ways you could mess it up. You would think they could get it all together by now.
Dr. Cory S. Fawcett
Prescription for Financial Success
It would be a lot easier if they’d just let docs contribute directly to a Roth IRA wouldn’t it?
What’s the implication if you backdoor and have a SEP vs a inidividual 401k?
You get “pro-rata’d”, that is you owe taxes on most of your conversion. If you want to work through just how much tax, put the SEP-IRA balance on line 6 of the 8606 and run through the form. Bottom line, better to roll it into a 401(k).
I was unable to find individual reports after a brief google search (ctrl+f on here) about the IRS auditing someone who has done a backdoor Roth and did or didn’t penalize them. I’ve read too much on Step Doctorine and wonder what the IRS precedent has been. Surely this scenario has been encountered by now (10+ years of these being done). Anyone here been audited having to review the conversion with the IRS and making it through the audit unscathed?
Nope. I have yet to find anyone in 8 years of looking for one. Let me know if you find one. The IRS put out a statement this year that said you didn’t have to wait between contribution and conversion.
Who cannot do a Backdoor ROTH IRA?
Thank you
Someone without income? Someone with a SIMPLE IRA at their practice? Someone with a $2M IRA they’re not willing to roll into a 401(k) due to higher expenses or inability to invest in their favorite investments? Not a lot.
“Someone with a SIMPLE IRA at their practice? ”
How about if a SEP IRA at the practice/ as the employer?
Thank you.
Same problem.
I always wondered about the 8606. Thanks for clarification and the pics helped a lot.
Re: Issue 16… is it worth contributing and converting $5499.00 to avoid any issue going over the limit in the off chance that the account gains too much in the short time between contribution and conversion?
There is no limit on conversions, just the contribution. So contribute $5500 and if you have to convert a few bucks more or less, no big deal.
I’m about to be a new attending and am going to have my salary pulled a lot of different ways. I posted my financial plan on here earlier. I know you say it is a mistake(-ish) to contribute less than annually, but it will make budgeting much easier for us. With us trying to save a large home down payment, start saving for retirement and build up an emergency fund, I want to put as much on auto-pilot as possible. Plus, I know that I will behaviorally be less likely to change it if it’s already in process. I know that if I pay myself first, I’ll never end up short.
We will have payroll deductions for the max on a 403b, 457 and HSA. It would make life easier to simply “set it and forget it” with my and my wife’s backdoor Roth’s.
I know I can set up an auto-deduct for $458/mo from my checking account into an ira x2 on the same day as my monthly paycheck comes in. My question is: is there any way to set up an auto-rollover?
Not that I know of. Are you sure you want to do a Backdoor Roth IRA at all right now? You have 12 months still to do it for 2018.It might not be your highest priority right now, and that’s okay.
Thanks. I’m not starting until August, but I think I want to mentally set myself up to think my salary is actually my salary less 18.5k 403b, 18.5k 457, 6.8k HSA, 11k Backdoor Roth and tithe. I’m worried if I put it off I may have lifestyle creep.
I know it’s simply a question of self-discipline, but the more external constraints I can place on myself early, the more likely I figure I am to succeed. I realize it’s training wheels, but considering I’m about to be playing with real money, I want to do everything in my power to ensure success.
I guess for now, I’ll probably just set up individual iras for my wife and I with auto-deduct for the first of the month, then rollover the second. Then, after buying a home and proving we can remain frugal, do it annually.
Thanks!
What if you pull the trigger to fast and convert an excess contribution to a Roth Ira. Since Roth conversions are finals, how do you fix the excess contribution ?
You will need to withdraw the excess contribution along with its earnings and pay any taxes and penalties (6% a year) due. The fact that you converted it is relatively irrelevant.
https://investor.vanguard.com/ira/excess-contribution
In Step #4 you list the ways to run afoul of the pro-rata rule. But I wondered: is a Backdoor Roth IRA still permissible if I have a cash-benefit pension plan funded with pre-tax dollars? I’m in the process of establishing one for my Schedule C income (a CBPP, that is) and seems that ought negate my ability to do continue doing Backdoor Roths, as I have in years past. But I haven’t found any info on this particular situation. Seems like one that MDs might occasionally run into.
Yes. You don’t report defined benefit/cash balance plan balances on line 6 of Form 8606.
Pine Creek? I can’t tell.
That’s a little place called Kaleidoscope Canyon, shortly before the Grim Section where two BYU students died from exposure when unable to get out of a pothole years ago.