By Dr. James M. Dahle, Emergency Physician, 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
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
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!
On “# 8 Using a SEP-IRA or SIMPLE IRA instead of a 401(k)”, as a US citizen residing permanently in Australia wanting to take advantage of investing in tax-deferred or tax free retirement accounts this is tricky when most providers disallow non-resident US citizens opening retirement accounts. So far only Interactive Brokers has allowed me to open up a Roth-IRA and/or SEP-IRA (they don’t have 401k’s). Given the higher tax rates in Australia (as I am exempt from paying US payroll tax, Medicare tax and state taxes) I can’t benefit from reducing my tax by contributing pre-tax funds to US accounts. So I only want to contribute after-tax or tax-paid funds to these accounts.
So my question is, can I contribute up to 25% of my net business income to a SEP-IRA then convert directly to a Roth IRA (given I will already be paying tax on this in Australia but no US taxes due to the tax credit for my Australian taxes already paid)? (NB Australia has already provided guidelines stating distributions and gains from these overseas retirement accounts are not tax assessable i.e. is excluded from tax reporting in Australia.)
You could if you lived in the US. I have no idea if that is legal while living in Australia.
Thank you for your speedy reply White Coat Investor. My Australian/US Accountant has indicated several times it is supposed to be legal for me even whilst living in Australia. So I guess I will try with a smaller amount.
I enjoyed reading your book. Your website has been very insightful and interesting. Keep up the great work.
They’re probably right. If your research indicates it is, it sounds like a great solution for you.
I have done a backdoor Roth every year since 2013 when I finished residency, at least I thought. I filed an 8606 only in 2014 tax year. Is there a way to check my return to see if I paid extra taxes? I was using Turbotax and it led me astray!
Sure. Go look at your 8606 for each tax year. What does it say the taxable amount is? If it is more than $0, you paid extra taxes.
Most of those years I didn’t file an 8606! I didn’t know I was supposed to! I have 1099-Rs from Fidelity, but no 8606 was filed…
Hello all,
I have been following white coat investor and applying all the principles. Have been very happy with all the advise and recommendations.
I am hospital employed and get paid with W2. I also do some side gig and earn tiny bit, get 1099.
My wife is a consultant and gets 1099.
Last year I opened SEP IRAs for me and my wife. Invested 20% of the profit into it.
I also opened traditional IRAs and rolled it to Backdoor Roth IRA.
I later realized after reading the post here that it will hurt me to have SEP IRA since Prorata rule will apply.
What options do I have at this time?
Thanks for your time.
While it is probably possible to undo the SEP IRA, I don’t see why you would want to do that.
I think actually you are stuck filling out an 8606 until the end of time, which is just a piece of paper, but something I have tried to stay away from, just because of the hassle.
Dave
Additionally, undoing the SEP IRA wouldn’t really get rid of the 8606 problem, since the real problem is you put after tax money in the IRA.
It’s a pretty easy form to get another $5,500 into a Roth IRA in my opinion.
Open individual 401(k)s for this year, roll the SEP IRAs in there. Then you can do Backdoor Roth IRAs with no pro-rata issues.
WCI,
Isn’t the issue that one Roth pro-rata was already done in 2017 that would need to be undone, if it still can be??
Yes, that’s an issue. I guess you convert the whole SEP-IRA to get around that if it isn’t too big. You used to be able to recharacterize the conversion, but you can’t do that any longer. I can’t recall if you can go back and undo one done before 2018 though. I think you can. So perhaps they could recharacterize, open individual 401(k)s, roll the SEP-IRAs in, and then reconvert. Then do backdoor Roth IRAs going forward.
Do you know if I can do that with Vanguard?
I will email them to check as well.
My SEP and Backdoor Roth are in Vanguard.
Thanks
You cannot roll IRAs or SEP-IRAs into Vanguard Solo 401(k)s. You could do the conversions there though.
I’m a pediatrician (measly 150k/yr). I have a rollover IRA from employer contributions during residency. You recommend just converting it to Roth if the amount is small, since it is hassle-free. Would 4k be a “small sum?”
Yes.
Also, if your pay is measly realize there are many pediatricians who make more. If you’d like to make more, find out what they’re doing that you’re not and start doing it (or at least make a conscious decision not to). There is a lot of intraspecialty pay variation out there.
#18
Thinking that it is ALWAYS a good idea to put money in a Roth in the first place.
While I agree that almost anyone can benefit by having some tax diversity with some Roth funds, this concept is quite often overdone by those not understanding the math. Just because a little of something might be good, it does not translate that a lot will be better.
You seem to be confusing Roth contributions or Roth conversions with a Backdoor Roth IRA. While the first two are not always correct, a Backdoor Roth IRA is a no-brainer because you’re comparing it to investing in a taxable account.
WCI,
I think you are making assumptions that don’t apply to everyone.
If you “assume” your only two options are a taxable account or a Roth then fine – the outcome is most likely better for the Roth, unless of course you fall on hardship and need the money before age 59.5.
I realize this is a site mostly for doctors, but there may even be some doctors who aren’t maxing out all their tax-deferred options, in which case it may not make sense to put that money into a Roth of any kind, over using some other tax-deferred option.
In other words putting money in the Roth in the first place is certainly a way to screw up when other options are available and they make more sense for your tax situation.
I agree that a Roth vs tax-deferred choice is a different discussion than comparing taxable to Roth (even if you need the money before 59.5 as noted in this post: https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/).
This post, however, was about the Backdoor Roth IRA, so my comments have been focused on that. I guess if you are in your peak earnings years and do a Backdoor Roth IRA instead of maxing out your tax-deferred 401(k), that could be a mistake. But it’s not really “screwing up” a Backdoor Roth IRA.
#5….if I have an employer’s 401K, can I still open an individual 401K if I also have self-employment income?
Yes.
So is that a popular move to make for employed physicians who have employer 401Ks-to do some of those online surveys, get an Employer Identification Number and open up an Individual 401K? I’ve not heard of employed dr’s doing this but seems like it’s another way to get more money into tax-advantaged accounts?
That’s not going to help you get large contributions in there, no. But it will allow you to rollover an IRA you need to get rid of to do Backdoor Roth IRAs.
I have a retirement plan through my employer (which was totally contributed to by my employer on a pre-tax basis; I made no contributions of my own) which will have about $3000 vested in it when I graduate from residency. They say I cannot leave the money there so I was considering trying to get it into my Roth IRA. I am just a little confused about how to do this correctly and if this will count against my contribution limit of $5,500 for the year. This year I will go over the income limit to directly contribute to a Roth IRA (since I will be making an attending income for part of the year), so I will need to do a Backdoor Roth IRA for my contributions.
1. If I get the retirement account rolled over to my traditional IRA and then convert it to a Roth IRA the next day (backdoor Roth), will that conversion then count towards my total $5,500 contribution limit for the year? Or does it not matter because that money originally came from my employer? I’ve been told that I can rollover the money to a traditional IRA without affecting my $5,500 contribution limit for the year, but what I do not know is once I convert that money to my Roth IRA is it now seen as “my money” being converted to a Roth IRA and thus counting towards my $5,500 contribution limit for the year?
2. I realize I am not allowed to directly contribute to the Roth IRA since I will be over the income limit, but can I rollover a retirement account directly to my Roth IRA? Or is a rollover not allowed since I am not allowed to directly contribute to a Roth since I am over the income limit for the year? If I am allowed to directly rollover into the Roth IRA, would this count towards my $5,500 contribution limit for the year?
Thanks so much!
1. No. There are no limits on conversions, just contributions. Conversions aren’t contributions. It doesn’t matter that it came from your employer.
2. Yes. Rollovers/conversions are allowed at any income. It will not count toward your contribution limit.
2018 Tax Question:
I rolled over the retirement account (approx $3,000) from my former job (which my employer contributed to on a pre-tax basis) to a Roth IRA and now I need a little tax guidance. I also contributed $5,500 via a Backdoor Roth and watched your tutorial on how to fill out Form 8606 which was great but I am left with the following questions.
1. Does the rollover from my former job get reported somewhere on form 8606 as well?
2. Or is just reported on line 4a of the Form 1040 for 2018?
Thanks for your help!
You certainly have to put it on form 8606 if you stopped in an IRA first. See line 8 of 8606. I’m not sure how it is reported if you went directly from a 401(k)/403(b) to a Roth IRA. I spent a few minutes researching that and didn’t find an answer. Certainly the 401(k) will provide a 1099R for the rollover that you must enter into your tax software. I’m just not sure where it shows up. It could be on the 8606. But based on the instructions for Form 1040 Line 4, I think it doesn’t show up on 8606, it just shows up on line 4. Here’s the citation from page 32 of the 1040 instructions:
Rollovers
Generally, a rollover is a tax-free distribution of cash or other assets from one
retirement plan that is contributed to another plan within 60 days of receiving
the distribution. However, a rollover to a
Roth IRA or a designated Roth account
is generally not a tax-free distribution.
Use lines 4a and 4b to report a rollover,
including a direct rollover, from one
qualified employer’s plan to another or
to an IRA or SEP.
Enter on line 4a the distribution from
Form 1099-R, box 1. From this amount,
subtract any contributions (usually
shown in box 5) that were taxable to you
when made. From that result, subtract
the amount of the rollover. Enter the remaining amount on line 4b. If the remaining amount is zero and you have no
other distribution to report on line 4b,
enter -0- on line 4b. Also, enter “Rollover” next to line 4b.
Thanks for the help! I could not figure out how it fit into Form 8606 either. That was how I was interpreting the 1040 instructions as well. Now to figure out how to put it properly into turbotax.
I really appreciate your help.
Worst case scenario you go to “forms mode” (desktop version only) and do an override on line 4 of the 1040.
Just to be clear getting money from an IRA to a Roth is called a “Conversion” because you will need to pay income tax at your ordinary marginal income tax rate and because you are probably less than 59 1/2, this tax will need to come from outside the IRA.
I don’t really see this as normally a “smart” move for someone in the higher income bracket of a doctor (putting a lot of money in a Roth) because you will almost certainly have a lower tax bracket later on in retirement. In your case it sounds like you haven’t graduated yet from your residency, so you may be in a lower tax bracket in 2018. In that case it would make sense for you.
Otherwise, I think it always makes sense to have “some” Roth money even if it doesn’t make tax sense, it makes sense from a tax diversity standpoint and in your case $3000 is not a large amount so it may make sense from either point. Just remember to set aside the applicable amount of money for taxes and if necessary send in a quarterly tax payment to the IRS.
Jim,
I was interested in your comment in item #6. You said if you could do it over, you would invest in Vanguard through eTrade. 2 questions I had:
1. What is the difference/benefit between Admiral Shares vs. Investor shares? Minimum investment? Expense ratio?
2. What are the best Vanguard options to invest in through eTrade?
My wife just became a 1099 independent contractor. I want to set up an individual 401(k) for her.
Thanks for your time,
John
1. Investor $3K minimum. Admiral $10K minimum. ETF No minimum. The Admiral and ETF shares have ERs that are perhaps 0.1% per year lower. Not a huge deal, but on $1M, that’s $1K/year. You can pay for a few $5-10 ETF commissions and still come out way ahead. That’s all my comment was pointing out. It is convenient to have it at Vanguard though- helped us qualify sooner for Flagship status and I can see it at the same time I look at Roth IRAs, taxable account, kids’ accounts etc.
2. I would buy the same funds whether I was buying them directly in a Vanguard individual 401(k) or indirectly with ETFs in a eTrade individual 401(k). The “best options”? I guess it depends on your goals and asset allocation. Big holdings for me including Total Stock Market Index Fund at 25% of my portfolio and Total International Stock Market Index Fund at 15% of my portfolio.
Great post! Two questions:
1. I have been doing pretty much what mistake #1 says. I now want to see if I can fill up the rest of my $5,500 limit for 2018 in my tIRA and convert just that portion. In other words, say that I will (for now) leave the amounts contributed monthly from January to July (~$3208), contribute the remainder in one lump sum (~$2292), then convert just the ~$2292 the day after.
Is it possible to cherry pick the amount like that? (Is there a pro-rata rule similar to deductible IRA conversion for backdoor Roth?)
2. I’ve also been thinking of opening a SEP IRA or solo 401(k) for my side business. I have a day job already, where I fully fund the employer-sponsored 401(k). Is the solo 401(k) still the better choice? The main difference appears to be that there is no $18,500 employee contribution for SEP (which is covered under my employer’s plan).
I am 32 years old, not married, and will probably make under $200k this year (~130k job, will likely take a pay cut soon + ~60k projected income for side business).
Thank you!
Brian,
Don’t know why Jim didn’t answer but let me give it a shot.
1. You really can’t cherry pick which money in any (if you have more than one) traditional IRAs you want to convert. You have to file a 8606 (if you have after-tax money) which requires you to split out the pre-tax and after-tax money in your tIRA account(s) and pay tax on any pro-rata amounts of earnings or pre-tax money. By the way you didn’t mention whether you were putting pre-tax or after-tax in the account, but if the money has been in there for over a month you have probably at least gotten some interest or earnings on the funds which will need to be accounted for. This is of course one of the ways to mess things up by not filing the proper paperwork or filling it out properly. If the tIRA is all pre-tax money then it won’t matter what you do as a conversion will require you pay ordinary income tax on the converted amount, but don’t take that tax from the tIRA if you are under 59.5 due to penalty.
2. Personally I would think the 401k route is better, especially since having an IRA, (rollover, SEP, or otherwise) complicates any future backdoor Roth conversions by having pre-tax IRA money in the pro-rata calculation.
Must have missed it. I was en route to Paris when it was posted it must have slipped through the cracks. Thanks for hooking Brian up. I agree with your recommendations.
It sounds to me like it’s all non-deductible aside from earnings, so the tax cost for the conversion will be minimal. That’s a good way to correct it.
Definitely do the individual 401(k). You won’t be able to put any more money in it, but you’ll be able to do a Backdoor Roth IRA.
I am one of those sad people who somehow found a way to screw this up… I was under the impression that I was supposed to contribute to my Roth, convert it to a traditional IRA, then BACK to the Roth. What is the best way for me to remedy this for this calendar year?
Thanks for this straightforward summary.
Well that’s a new one. Hmmm….
I think you may not need to do anything. I think a Roth IRA contribution can still be recharacterized (Roth conversions can’t starting in 2018) and of course traditional IRAs can still be converted to Roth IRAs. Just make sure you fill out the paperwork right and I think you’re good. Might want to double check with a CPA.
Jim,
On Mistake #2:
“Technically, it’s not an error because you are allowed to contribute to an IRA up until tax day, which is usually April 15th of the next year and with extensions could even be October 15th of the next year.”
If you look in pub 590a you will find that extensions don’t give you an extension on when you can put money into last years IRA or Roth, just like they don’t give you extension on when you must pay what is due. They only give you an extension on filing the proper paper work.
Thanks for the correction. I’m pretty sure that doesn’t apply for a SEP-IRA though does it? That was my understanding so I was just generalizing it to all IRAs. I guess I could be wrong about that one too. At least Investopedia agrees with me:
https://www.investopedia.com/ask/answers/102714/when-are-simplified-employee-pension-sep-ira-contributions-due.asp
Jim,
Actually, if I am reading pub IRS pub 560 correctly I think we both may be wrong:
https://www.irs.gov/pub/irs-pdf/p560.pdf
Pay particular attention to the sections called “When to Deduct Contributions” for both the SEP IRA and the SIMPLE IRA and you will notice a subtile difference:
1. SEP IRA is more like a solo 401k in that you can contribute only during the calendar year, or fiscal year depending on how the plan is set up.
2. SIMPLE IRA, is basically like a traditional IRA or Roth IRA, in that you can contribute to them up until your filling date for your tax return (apr. 15-17 usually, depending on the year).
As far as your link above to Investopedia, I can’t confirm or deny that text because it talks about when the Employer can make their contribution, not when the employee can make theirs and that is another whole different set of documents I would rather not try to sort out, but I think pub 560 is what applies to the employee.
My understanding is that both employer contributions for a 401(k) and all SEP IRA contributions can be made until the tax date, not the end of the calendar year. I think you might get a couple of weeks into the new year to make employee contributions too. Pub 560 isn’t very clear on that though, I admit, but that is common practice. See this:
https://www.thebalance.com/sep-ira-contribution-limits-and-deadlines-3859079
https://www.myubiquity.com/401k/contribution-deadline/
Jim,
Once again both articles talk about making “Employer” contributions until their tax deadline but not specifically “employee” contributions. Are Employer contributions those that can be used by the backdoor roth method — maybe I missed that detail, as I thought we were talking about employee contributions, not the employer match or contribution.??
Of course in the case of a solo 401k, and maybe even some cases for a SEP-IRA the emplyee and the employer are one in the same or can be.
All that being said I think “we” as publishers on the internet, should try not to let other “internet” stories be the source of our information unless it can be verified. I include myself in that category of “not being an IRS expert” other than working with hundreds of tax returns on a volunteer basis every year. In that capacity I know even sometimes the IRS publications are not clear — and especially those dealing with employer plans.
Would be nice to hear from some readers who know of contributions made within an extension window and under what circumstances.
One comment made about the SEP-IRA in the above link was that they follow many of the same rules as the traditional IRA, but neither the IRS pub 560 nor pub 590 which covers the IRA indicates anywhere that the Employee can make any contributions beyond April 17th and in fact the pub 560 is more restrictive in that it uses the term calendar year or fiscal year.
This is maybe one area (making contributions in an extension window) where the “see your tax attorney” advice is well deserved.
What do you mean “the Backdoor Roth method?” I thought we were talking about 401(k)s and SEP-IRAs. A Backdoor Roth has nothing to do with those accounts, it’s an IRA.
You might ask on the forum for some instances of contributions made during the extension window.
And of course, seeing a pro is never a bad idea if you have an issue you can’t figure out on your own. In my personal case, I guess I don’t care all that much since I try to get all my contributions in as soon as possible rather than as late as possible. But I can understand why someone would want to try to get money in after an extension.
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I was thinking “mega” Backdoor Roth, where after tax money contributed to a 401k can be very much in play, but that is straying a little from the topic.
Let me just close with saying I would do the same which is to get my contribution in as soon as possible (if I wasn’t already retired and could actually make a contribution.)
We will just have to agree to disagree on whether an individual (who is also not the employer) can make any contributions to any tax-advantaged account after the April tax filing deadline.
If you re-read your item #2, your wording is such as to say;
“you are allowed to contribute to an IRA up until tax day, which is usually April 15th of the next year and with extensions could even be October 15th of the next year.”
I believe there is absolutely no evidence to suggest that you could contribute to “an” IRA (as an individual) within the extension period. If you want to claim that somehow the SEP-IRA gets some special privilege that is up to you, but there are some that believe as I do that the SEP-IRA follows very similar rules as the Traditional IRA.
https://finance.zacks.com/can-contribute-sep-ira-previous-year-6888.html
I’m not sure we disagree. I thought we acknowledged above that I was wrong about traditional/Roth IRA contributions. I’ll change the post to correct it. I thought we were just disagreeing about SEP-IRA and employer 401(k) contributions at this point.
Question on step 5 – I am in the process of converting my IRA to my 401K and i have 2 questions –
1. if i make a transfer from my IRA to my 401k and by doing so need to ‘sell’ an ETF which i invested in within a year – will I be subject to short term capital gains tax now or in the future? I’m assuming not since it was all done within tax deferred accounts – correct?
2. am i allowed to the ‘rollover’ twice in the same year? As according to the IRS website it states the following –
‘Beginning after January 1, 2015, you can make only one rollover from an IRA to another (or the same) IRA in any 12-month period, regardless of the number of IRAs you own. The one-per year limit does not apply to: rollovers from traditional IRAs to Roth IRAs (conversions) trustee-to-trustee transfers to another IRA.’
https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions
Any help here would be much appreciated as I am in the middle of this right now
Capital gains taxes don’t apply in IRAs or 401(k)s.
You can do direct transfers as many times as you want, but can only take possession of the money once. That rule is to prevent you from using a rollover as a free 60 day loan.
Thanks so much for your quick response!!
Love the blog!
Question about step 5/6
I’m just now learning more about investment and backdoor Roth IRA contributions. I’m not sure what do with my current traditional IRA, which has mix of tax deferred and non-tax deferred money:
I put $2500 in to a Roth IRA back in 2011 before my income for year increased and I no longer qualified to put money in a Roth. The money was invested and I recharacterized the shares I had purchased into a traditional ira and put additional $2500 for 2011 in on the traditional IRA. The total $5000 was tax deferred on my 2011 taxes.
I did not put any additional money in my traditional IRA until 2015, at which time I put $5500 non-tax deferred money in the account. The money has been invested in stocks. Currently the account value is $22000.
1. Am I able to roll the money into my employer TSR 401k (schwab scpmg) or do I have to open an individual 401k before making a back door Roth IRA contribution?
2. Is there an alternate recommendation?
1. Maybe. Read the plan document to know for sure. Might be a good way to isolate basis so you can just convert the $5500. You can also do it with an i401(k) at eTrade or Fidelity.
2. You definitely consider just converting it all and paying taxes on the gains and tax-deferred money, i.e. $16,500.
My first question for you is do you really need more money in a Roth account? In my experience if your income is so high you can’t do Roth IRA contributions, it is likely too high to make Roth contributions much of an advantage for you.
My second question is have you been filling out 8606 form since 2015. You will essentially need to be doing this until “end of days” of your Rollover IRA funds because now after-tax money is mixed in there and the pro-rata rule applies for any withdrawals and Roth conversions.
I would be surprised if you can put pure Traditional IRA funds in your 401k but it doesn’t hurt to ask as WCI suggests.
There might be an option (that actually appeals at least to me because I like simple) and that is to simplify having to fill out all those 8606s for the rest of your life and beyond with after-tax money in your IRA and that would be to AMEND your 2015 return and declare the $5500 as a pre-tax contribution and pocket the tax savings.
Of course as WCI mentions if you have no other rollover IRAs you could convert all of your traditional IRA to Roth and take the hit. This does assume you have been filing the 8606 forms faithfully since 2015, otherwise it’s three ammendments rather than one, IMO.
Dave
Dave-
You know with a Backdoor Roth IRA a typical high income professional isn’t comparing Roth to tax-deferred. She’s comparing Roth to taxable and in that case, Roth always wins.
WCI,
Not enough info by SDP to be able to tell if that is really true.
I may have assumed too much with the statement that $2500 was put in the traditional in 2011 and $5000 after-tax was put in in 2015. If the reason the $5000 was put in after-tax was because of high income or other employer plan then yes you are correct.
I will contend that for a MFJ couple it is not hard to stay in the 12% tax bracket in retirement, unless you live in CA or NY. This puts taxable on equal footing with a Roth with just a little bit of planning on where you put your assets.
The MFJ tax bracket only goes to a taxable income of $77K. I agree that for the average American it isn’t going to be hard to stay there. But the audience of this blog expects $40K+ just from social security, and most will retire as multi-millionaires. It would be pretty tough for me to retire right now and keep my income in the 12% bracket, and I’ve still got a decade or two or three of work ahead of me.
I think we’re just envisioning a different person/income level and I agree, there isn’t enough info to know for sure.
Jim,
You forget, 77,400 + $24, 000 SD = $101,400 + 15% of $40k (SS) —
So taxable income of $107,400 before you get to top of 12% bracket.
I am assuming the high income earner has paid off their house, so except for maybe outsized property tax, their budget “can” be if they so choose not much different from the more “middle” income couple who has saved 10-15% while they were working.
Let’s just do a little math on “your” above numbers.
$34,000 of SS is taxable, that leaves $73,400 to pull from your Traditional @ less than a 12% marginal rate. Let’s say you have a $3 million IRA. At age 71 this puts you about $36k into the 22% bracket, the rest at 12% and below. By age 79 let’s say you still have $2.8 million – 5.13% of that is $143.6k. Now you are $70k inside the 22% bracket. Still much better than the 25% + taxes you paid while working.
If you load 100% of your bond allocation into your IRA you can work it down faster.
Granted an “outsized” taxable account is going to come into play here if it is spinning off too much in dividends and capital gains, but generally I favor spending down a bond heavy IRA in the case of a large IRA and letting the other funds grow for you and heirs. This avoids heavy taxes for the heirs.
I’m not sure you understand the definition of taxable income. That’s what’s left after all deductions, including the standard one. And SS is taxed at a much higher rate than 15% at that income level.
Be careful with a recommendation to spend IRA money first. James Lange puts together a pretty good case for spending tax-protected money last, extending the benefit of tax protected growth and I don’t know anyone else recommending IRA first. (Others tend to recommend a balanced approach.)
Jim,
I just think it’s an issue of communication and your mixing of “taxable income” and income in the same paragraph — ie you speak of $77k taxable income, yet you somehow think $40k SS is significant to the story, when really if you use that as your “first tier” of income all but $10k of it is part of the SD (85% of 40k = 34k minus 24k). I have reviewed or done over a thousand tax returns in my volunteer work over the last 6 years, so I have a pretty good idea how the tax system works, and I’m pretty sure you do too, so most of this is just to make sure the readers do too.
You misunderstood what the 15% referred to which is the tax-free portion of SS (only 85% is taxable). So the point of my math was just to suggest the total income any retiree can get and spend before they move out of the 12% bracket. Without going into the complexities of qualified dividends and LTCG that number is $107,400 of spendable income in the 12% tax bracket.
My second point was how much money you have saved, or what your earning potential was when you were working is not really relevant to what your “budget” needs to be in retirement, that is purely up to you and with $107,400 of spendable income every year I think you could do quite nicely, if you don’t live in NY or CA.
I have nothing against a balanced approach, but if you have a $3-5 million traditional IRA, you have a specific problem.
No offense meant to James Lange, but the real fact is those that have followed his advice (which was by his own admission based on tax rates going up) have in most cases reduced their spendable income in retirement, not the other way around.
When you say “James Lange puts together a pretty good case for spending tax-protected money last” I am not sure what that means and at the risk of misunderstanding I will just point out both the Roth and the IRA are equally “tax-protected” based on the money earned. In other words they have what is considered 1 full-level of tax protection – which ocurrs either on the way in or the way out.
The taxable account too has tax-protection at what I would call 1/2 the level of the Roth or IRA, only because it gets a “tax bracket” deduction (based on type of withdrawal) on the way out, which depending on your marginal income can make it EXACTLY like a Roth being not taxed at all, or only partially like a Roth being taxed at a lower rate on the LTCG and qualified dividends.
Some other things wrong with “some” of what James Lange suggests, but this is not the forum for a critique of those.
I do hear your concern for those with the “ultra” large Traditional Account, or those that just want “the lifestyle they think they deserve.” That will certainly create a loss of income in the form of higher Medicare taxes and Net Inveventment Income, but like I said that is more of a lifestyle choice than a necessity. In most cases building a “bigger Roth” at a considerable tax cost will improve it little.
Just one clarification to the above when I say you can spend $107,400 of income before you get out of the 12% bracket, that assumed your number of $40k SS was part of that spendable income.
re: SDP. I may be in a similar situation, but I may have complicated it even more. I contributed $1000 pre-tax and $4000 after-tax money to a t-IRA several years ago, because I was in the MAGI that allowed a partial deduction, TurboTax recommended it, and I didn’t know any better. I reported form 8086 that year but haven’t since. This year, I was able to roll over all of the t-IRA into my employer’s 403, in anticipation of getting a higher salary as an attending that would put me above the Roth IRA contribution limit, and I was planning to do the backdoor Roth contribution and conversion this year.
But what happens to the basis in my t-IRA if all the money is now in my 403b and I no longer have any money in t-IRAs? I wouldn’t report that as a conversion since it’s gone into another tax-deferred plan. The gains on that basis would have been tax-deferred, but now that it’s in my 403b, can I just take the double tax hit (of having already paid taxes on the nondeductible basis, and having to pay taxes on the gains at withdrawal), and proceed with the backdoor Roth contribution and conversion as if I have no more t-IRA basis?
Also, how would I report that on a form 8086?
Yes, that’s a bit of a mess. Your 403b thinks that’s pre-tax money but it isn’t. If you’re not careful, you’ll end up paying tax on that $4K twice. I suppose the government isn’t going to complain if you just pay taxes twice, but I’d try to fix it if I could. You might have to back out of the rollover, at least with the basis and convert that to a Roth IRA. You would likely have to file last few 1040Xs/8606s to do that though.
Could you also provide instructions on “# 3 Not Doing The Conversion During the Calendar Year”, or maybe consider “an entire post about how to fix it”? 😀
I don’t procrastinate with my investments/taxes, but this year I’m really screwed by Wealthfront and BOA. Here’s my story for those who’re interested:
– I’ve contributed to Traditional IRA and then backdoored to Roth IRA twice at Wealthfront, but this year they stopped supporting backdoor due to priorities and bandwidth constraints (https://support.wealthfront.com/hc/en-us/articles/209335726). I didn’t become aware of that until I’ve contributed to Traditional IRA this year.
– I wanted to move my two IRA accounts to another provider so that I can backdoor. A Medallion Signature Guarantee is required for this process. Surprisingly BOA, the only bank I have an account with that has physical branches, doesn’t support MSG. I’ll need to establish a couple of months of account history with another bank before they can offer me MSG, which means there’s no way for me to backdoor by end of calendar year 2018.
You can find that info here:
https://www.whitecoatinvestor.com/late-contributions-to-the-backdoor-roth-ira/
and a more updated version here:
https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/
Is it possible to open a solo401k at fidelity and roll over all Traditional/SepIRA’s into and never contribute to account? So I could then complete Backdoor Roth before calendar year. Then participate in my companies Simple ira the following year and rinse and repeat.
Would this strategy work?
Thank you for your comments/thoughts.
Probably looks a little funny to the IRS if you never contribute to it. I probably wouldn’t do that. Is it required? I dunno. You are required to have a legitimate business though.
Remember SIMPLE IRAs have tricky rollover rules. I think you have to leave the money there for 2 years before you can roll it over. Ongoing contributions to a SIMPLE are going to keep most from doing Backdoor Roth IRAs.
White Coat –
i’ve maxed out my Roth IRA for 2018 but suspect I may earn more than the $120K (not more than$130K though)… so fall within the partial limit. In speaking with Vanguard it’s easy enough to withdraw the excess contributions during the calendar year ( and with this recent market dip, no resulting earnings). I’m just not sure exactly how much $ until my W-2 comes out next year. The back door seems easy enough to set up, but I am confused on next steps. Is there any advantage or disadvantage to regular Roth contributions vs non-deductible? If I don’t know the ratio am I better off withdrawing all and stetting up a backdoor, or keeping each as partial? Tried to scan your articles, but couldn’t find this specifically addressed. Thanks for your expertise!
Just recharacterize it to a traditional IRA and then convert it back after the requisite waiting period. No big deal.
Quick question – spouse has no IRAs, I do; MFJ and over income limits – can he open IRA, make non-deductible contribution and convert to ROTH IRA without having to account for my IRA balances (pro-rata rules won’t apply)? In other words – is pro-rata requirement based on each individual’s IRA balances or the total held by the family?
Benefit of ROTH vs just investing in standard taxable acct is no tax on gains? How to determine if it’s worth the hassle factor, including triple checking TT for the rest of our lives?
Thanks for the very thorough and thought provoking articles and dialogue via the comments.
Yes. IRA stands for INDIVIDUAL Retirement Arrangement as noted in the post above. Your IRA has nothing to do with his ability to do the Backdoor Roth IRA.
The main benefit of Roth is that earnings are never taxed. But you also get slicker estate planning and in most states, better asset protection.
You don’t have to triple check your tax returns for the rest of your life, but it’s worth looking at the bottom of your 8606 each year for as long as you’re doing Backdoor Roth IRAs. The benefit starts relatively small (10% of $5,500 is only $550, taxes on that might only be $100) but gets larger and larger as the years go on. Whether that’s worth the hassle for you is up to you. It is for me.
I am a W2 employed physician at a large health system at present, in a very high-tax state. In light of my six-figure income tax bill, and the extraordinary cost of living my my locale, I have decided that after contributing the maximum to my 403 (b) , I would put any additional funds into my employer’s 457(b). It’s a large organization with a very low risk of bankruptcy, so I figured the added pre-tax contributions would best help my bottom line at present, when I am raising a child, paying a mortgage and thus need the money in hand. I have recently decided to take a new job in a different state, with a lower cost of living, but with an employer that doesn’t offer a 457(b) plan, so am now looking at the backdoor Roth IRA option.
The problem is that 10 years ago, I did a fair bit of 1099 consulting, so contributed to a SEP IRA at that time to defray taxes. I haven’t contributed in several years, but the amount has grown to more than $120K over two different SEP plans. I also opened a traditional IRA a couple years ago and put some money into it (post-tax) before deciding to go the 457(b) route. If I am reading your posts on this topic correctly, I need to promptly roll over my 2 SEP accounts and my traditional IRA into my current employers 403(b) plan, if i want to avoid the pro rata taxation on a future backdoor Roth plan? I say “promptly,” because i don’t know the offerings in my next employers 403(b), and my current organization has Vanguard target date funds with low management fees.
Appreciate your help.
Yes, I would do the rollover.
This is great. I am 3.5 years out from fellowship working in an academic practice, paid off my 350k student loans with a loan from my employer (I pay taxes on the payments as if it were income, so about 90K overall is my payment), max out my 403b with a 7% match, just started the HSA, put a small amount into a 529 (we get tuition assistance through my practice for our children), have 40% equity into our home that is only 1.25x my income. I am a financial illiterate as money discussions were not allowed when I was a child (probably because we didn’t have any) and even now at the workplace. So I purchased your book and got through the first 2/3 of your bootcamp and cannot thank you enough to have this outlet to help get us through the rough patches and I would not have a positive net worth without it.
Our situation: I have 403b from residency, tiny but present. I have a 403b from my current employer. I have $400 in individual stocks from 10 years ago (don’t ask) that I just sold and that account is closed. My wife has two 403b accounts from prior employers that are frozen in money market accounts as she does has not worked there in so many years, they froze them. She is employed part time and doesn’t qualify for retirement. She sells a cosmetic product to a friend through a company so she can get a discount on the product she already uses (I chose what battles to fight, this is not one of them).
Questions for WCI or all the financial literates out there, any advice is welcome:
1. I don’t think we will get punished by the pro rata rule, but want to clarify before we move forward setting up a backdoor Roth for both of us. Are any of our accounts opening us up to this?
2. I am having a hard time trying to figure out how to open an individual retirement account for my wife. My understanding from WCI is she needs minimal income from the side hustle. She sells the cosmetic product and I think that counts. I just cannot, for the life of me, figure out a good tutorial for this so she can convert her old retirement accounts to start investing.
1) You don’t mention any IRAs, so no.
2) A spouse can open a spousal IRA without any income. She contributes based on your income. If the old 403bs are tiny, just roll them to an IRA and pay to convert them. That’s probably easiest. If they’re big, maybe open a solo 401(k) for her side gig and roll them in there.
Situation: Have been contributing max/year to a trad IRA since 2014, currently valued at $27K. Have $15K in a Roth IRA as well (from 2011-2012). Will be entering a fellowship in 2020-2021 and therefore will earn less than now, and will be therefore eligible to contribute to Roth again for 2020 only for that year. Also, I will be in a lower tax bracket for 2020 only. its like a one time window (I hope. ha.)
so. a few questions/notes…
1. should i roll over the trad into Roth during that low tax bracket year (2020)?
2. Another option is that i will have access to a 403b as a fellow through the hospital system during that 2020-2021 academic year. should I roll over the trad into that? they automatically add approx $10K into it without any contributions from me. I wonder if theres a cap on that…
3. (I will also contribute directly to the Roth that year of 2020 due to lower income).
4. for today, i have $6000 ready for the trad IRA for the 2019 contribution. should i go ahead and toss into trad IRA? or can i backdoor just that $6K into the Roth? or do i simply just backdoor the whole thing at once (and wait until the end of 2020)?
many thanks! this is a huge help in wrapping our minds around personal finance.
1. Yes
2. I would also make 403b contributions, Roth if possible and convert to Roth the year you leave if not.
3. Great
4. I’d do the contribution and wait on the conversion until you convert the rest of it so you don’t get pro-rata’d.
I just realized this: that i have been contributing to a 401k (Thrift Savings Plan – TSP) since 2013, and therefore all of my contributions to the traditional IRA have been non-taxdeductible. Therefore, when i convert that to a Roth IRA, I only pay taxes on the EARNINGS, yes? -not on the entire $27K that is currently in the trad IRA?
thanks!
That’s right, only the earnings are taxable if you never got a deduction for the contribution. Cool eh? Of course, make sure you didn’t fraudulently claim a deduction.
Thanks for all of the great information. I’m still a bit confused on how to fill out the 8606 form if Error#3 was made (# 3 Not Doing The Conversion During the Calendar Year). My wife started a Traditional IRA in 2005 and has made contributions to it almost each year.
– In 2007 she opened a Roth IRA as well and started to make after tax contributions. She also completed a rollover of $11K in 2007 from a 401k to her Traditional IRA acct.
– In 2012 she completed a 2nd rollover of $61k from a different 401k to the Traditional IRA Acct.
– In 2016 she made no contribution to the Traditional IRA but decided to do a conversion. She moved the entire balance ($150K) from her Traditional IRA to her Roth IRA but never completed an 8606.
We received form CP2000 for tax year 2016 about that $150k conversion and was told by the IRS that form 8606 Part II needs to be completed. Now to my Questions. Do we need to complete Part I since no contribution were made that year and if so, what would the basis be? Also, given the figures mentioned above, how would we complete Part II ? Last, how can we prevent paying taxes again on the after tax contributions she made from 2005 – 2015? I understand I’m asking for advice and do not hold you nor Whitecoatinvestors liable for any suggestions given. Thanks for your help.
She contributed the max to a traditional IRA AND to max to a Roth IRA from 2007 on? That’s not allowed. This year it’s $6K total to ALL your IRAs. So that might be one problem.
But it sounds like you just failed to fill out 8606. So fill it out. No big deal. Just follow the instructions.
Part I Nondeductible Contributions to Traditional IRAs and Distributions From Traditional, SEP, and SIMPLE IRAs
Complete this part only if one or more of the following apply.
• You made nondeductible contributions to a traditional IRA for 2017.
• You took distributions from a traditional, SEP, or SIMPLE IRA in 2017 and you made nondeductible contributions to a
traditional IRA in 2017 or an earlier year. For this purpose, a distribution does not include a rollover (other than a
repayment of a qualified disaster distribution (see 2017 Forms 8915A and 8915B)), qualified charitable distribution, onetime distribution to fund an HSA, conversion, recharacterization, or return of certain contributions.
• You converted part, but not all, of your traditional, SEP, and SIMPLE IRAs to Roth IRAs in 2017 (excluding any portion
you recharacterized) and you made nondeductible contributions to a traditional IRA in 2017 or an earlier year.
Doesn’t sound like you need to fill out Section 1 to me. Here’s # 2
Part II 2017 Conversions From Traditional, SEP, or SIMPLE IRAs to Roth IRAs
Complete this part if you converted part or all of your traditional, SEP, and SIMPLE IRAs to a Roth IRA in 2017 (excluding
any portion you recharacterized).
16 If you completed Part I, enter the amount from line 8. Otherwise, enter the net amount you
converted from traditional, SEP, and SIMPLE IRAs to Roth IRAs in 2017. Do not include amounts
you later recharacterized back to traditional, SEP, or SIMPLE IRAs in 2017 or 2018 (see instructions) 16
17 If you completed Part I, enter the amount from line 11. Otherwise, enter your basis in the amount
on line 16 (see instructions) . . . . . . . . . . . . . . . . . . . . . . . . 17
18 Taxable amount. Subtract line 17 from line 16. If more than zero, also include this amount on
2017 Form 1040, line 15b; 2017 Form 1040A, line 11b; or 2017 Form 1040NR, line 16b . . . . 18
So you’ll have to do that. On 16 you put the amount you converted. no biggie. On 17 you put your basis. That’s the total of any non-deductible contributions you ever made. Sounds like that’s zero. So 18 is the same as 16, no?
She did not contribute the max to both every year. Some years she made no contributions at all to either and other years she made only a contribution to the Traditional IRA in the amount of $4k or she split her contribution to the Traditional and Roth maxing at $5,500.
Keep in mind that the Traditional IRA started in 2005. She had a Rollover of $11k in 2007 form 401k into the Traditional IRA. She had another Rollover in 2012 from a 401k in the amount of $61k into her Traditional IRA. The only conversion she ever made was in 2016 when she moved/converted the entire amount in her Traditional account to her Roth account.
When filling out the 8606 will she use the Form for year 2016 seen in the upper right corner?
Does she need to complete just one 8606 or will she need to complete one for each year she made a contribution to her Traditional IRA ensuring that the Year on the form matches the year the contribution was made?
I too figured she would put on line 16 the amount she converted. On 17 you put her basis (should this be total amount of all contributions to the Traditional since 2005 or should it be zero?). So, line 18 would be the same as 16 if the basis is zero but I’m not sure and need guidance here.
Thank You Much.
Glad to hear.
She needs an 8606 for each year she made a non-deductible contribution or did a conversion. So for 2016, she needs a 2016 8606. Unfortunately, you can only go back and file 1040Xs for the last 3 years.
The basis is the total non-deductible contributions made to the traditional IRA. Did she ever do any of those or did she get a full deduction for her contributions each year?
Hope that helps.
For any Dave Ramsey listeners out there- he is a proponent of funding Roth IRAs/Backdoor Roth IRAs, and he also recommends when leaving an employer, you roll your 401k into a Traditional IRA. Is he not aware of this pro rata rule??
Also- I’ve been talking with a dental specific accountant about this topic and he tells me that a lot of their clients have money in Traditional IRAs and Roth IRAs. Does it sound like this accountant is unaware of the pro rata rule & ignoring Form 8606??
A question about #3: This is my first year out of dental school, and I was planning on maxing out Roths for myself and my wife for 2018 along with converting a Traditional IRA she has to Roth (about $6k). I assumed that the deadline for this conversion would be tax day 2018. Is this not the case? Would the conversion be taxable for the year 2019?
I’ll bet he hasn’t ever filled out an 8606, no. But bear in mind it’s only the high earners doing backdoor Roth IRAs that shouldn’t do a 401(k) to IRA rollover upon leaving a job. It’s good advice for everyone else.
Should have done the conversion last month. That’ll cost you some taxes. While you have until April 15th to make an IRA contribution, conversions are taxed in the calendar year they were actually done. So yes, a conversion done now is taxed on your 2019 taxes.
Thanks for this info! Wanted some clarity for my situation.
– Contributed $5500 for 2018 to tIRA then converted to ROTH IRA 3 days later. Want to avoid the pro rata rule, so always convert everything over… except…
– Earned $0.15 interest in tIRA in those 3 days.
– Called Merrill Edge. They said I could just leave it in there or donate it to charity.
My other idea was to convert the $0.15 as a separate conversion (my second for 2018) since the IRS rounds down. Not sure if I can do two conversions in one year, and if that’s a red flag to the IRS. So I would have converted $5500.15, but the IRS would see $5500, if that is correct?
Also a few more specifics that I couldn’t find the answers to:
1.) Would donating that interest to Merrill Edge’s charity fund cause an issue/red flag for taxes?
2.) Since the IRS ignores anything under 50 cents, would it be best to leave those $0.15 in the tIRA for next year since it wouldn’t trigger the pro rata rule (i.e. the IRS would see $0.15 in the tIRA account but essentially see $0 since they round down)?
3.) Would it just be best to do my 2019 backdoor now as well and throw those 15 cents in with that contribution?
Thanks for any help!
Anyone ever heard of donating that interest earned?
PoF has an article (https://www.physicianonfire.com/backdoor/) outlining how to do the backdoor roth IRA through Vanguard. This seems to be contrary to point #5 in this article, which explicitly says not to use Vanguard. I would prefer to use a brokerage where someone has carefully outlined the steps, because I am slow and unable to figure this out on my own–as such I am inclined to use PoF’s advice on this and follow his step-by-step guide. Is Vanguard a major no-no? Maybe I’m thinking too hard about it and should just go with Fidelity?
Furthermore, I need to do late contributions for 2018 as well (this will be my first time doing all of this). Going to have an accountant figure out the forms and double check his/her work. Do you recommend against doing late contributions?
Nobody says don’t do a Backdoor Roth IRA at Vanguard. Mine is at Vanguard. What you can’t do at Vanguard is open an individual 401(k) and roll a traditional IRA in there. Vanguard’s 401(k) doesn’t accept rollovers.
Fidelity is fine for both a Backdoor Roth IRA and an individual 401(k). But I prefer Vanguard if it works for you. Your call.
Thank you so much for all of the helpful info on your website. I just started learning about all of this stuff and have already gone through half of your podcasts. I was hoping to ask for some clarification regarding #12 above. I am proposing to my girlfriend this month and thus have been talking quite a bit about finances. I have 1.5 years until I finish residency but am thinking ahead to the future for our individual and spousal backdoor roth IRA. Current situation:
-I have a Vanguard Roth IRA with max contributions for 2018 and 2019 ($11,500). In 2020 I will still be under the limit and contribute the maximum again. I also have a 401k through my employer that I am contributing to at this time.
-Her employer only provides retirement benefits through a Simple IRA. They provide a 3% match which she contributes to gain that maximum benefit. Currently the Simple IRA has ~$3,700 in it in total. She all in all receives about a $960 benefit yearly from their match. She plans to be with this company for the foreseeable future.
Once I am out of residency making an attending salary and we are married I would plan to continue funding my roth via backdoor Roth IRA method and then create a spousal one for her, but I do not want to be penalized by the prorata rule with her having an open Simple IRA with money in it. I was thinking she would need to either make an individual 401k to roll over the Simple IRA money or pay the taxes on converting it to her own Roth IRA which she would need to open. However, based on your post above in #12 it seems this may be unnecessary as long as I am funding both Roth IRAs. In #12 above, are you saying that despite her having a Simple IRA I can fund both a personal and spousal IRA myself both under my Vanguard brokerage account and in this way she could contribute to get her employer benefits to her Simple IRA and we would avoid any penalties from the prorata rule? If that is the case I would then wonder how to file this in our taxes… Would we need to file separately in that case and would her spousal IRA only be in my 8606, only in her 8606 or both? Thank you again for all of your help. I can’t state enough how immensely helpful all of the information on your podcasts and website has been.
She’s not going to be able to do a Backdoor Roth IRA if she wants to use the SIMPLE and get the match. She could do the contribution step each year and maybe if the situation changes with the SIMPLE down the road she could come up with a way to convert it all at that point and just pay taxes on the gains. Her IRA goes on her 8606. They’re INDIVIDUAL Retirement Arrangements.
Why not just convert the SIMPLE IRA to Roth every year? This should be allowed if she’s participated in the SIMPLE for at least two years. We’re talking what like $2k per year? Just pretend that’s an extra $2k on her backdoor Roth. Conversion is taxable, problem solved.
I’d have to check, but I think you have to leave every contribution in the SIMPLE in there for two years. So if you’re contributing to it every year there’s always going to be money in there that can’t be converted yet.
I think the two year rule is just two years from first participation. Not a two year baking period for each contribution. I’ll try to find a source.
You are correct – 2 years from initial contribution. After that you are free to roll into a Roth as long as you pay the tax from somewhere else.
Here is the IRS reference:
https://www.irs.gov/retirement-plans/simple-ira-plan-faqs-distributions
Thanks! That does make it a lot less painful.
The advice in this thread has been immensely helpful! Thank you for getting my life back on track. I have transferred our tIRAs to solo 401ks at ETrade (from our residency retirement plans, about $65k each). I have added additional independent contractor income to my solo 401k as well to avoid paying taxes on that income. I am now getting ready to make traditional IRA contributions to convert to Roth IRA accounts for 2018 and 2019. I can also transfer existing Roth IRA accounts ($7k each) from another institution into the new Roth IRAs I am creating. Here are my questions:
1) What are the advantages/disadvantages of keeping all accounts at Etrade? Should I do the tIRA to Roth IRA conversion at Etrade or Vanguard?
2) I need to sell the existing conglomeration of individual stocks in my solo 401ks at Etrade to consolidate and buy index funds. Are there restrictions on investor and admiral shares of Vanguard index funds outside of Vanguard? Can I only buy ETFs at Etrade?
1. Either is fine. I prefer Vanguard but the differences are very small if you’re buying Vanguard ETFs at eTrade. Basically a few small commissions is all.
2. You should probably just buy the ETFs; the commissions will be much less.