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!
Can backdoor Roth with a SEP IRA? If not, should I set things up differently? I am a self-employed specialist. I started my own solo practice when I finished training in 2015. I took on more debt to do this and made some expensive mistakes learning how to run a business. Fortunately, I was able to survive by just “running faster and farther.” Since 2017, my employees have been employed through a management company and they have a retirement plan available to them through that business entity that employs them. This management company controls my practice bookkeeping, HR, billing, collections, accounts payable, etc. All money left over from the practice (all revenues less all expenses) is passed over to my S-corp to run my payroll. So if/when the entire practice is in the red, I’m the only one who gets no paycheck. I am the only employee of my S-corp. My payroll is run at 400k per year (via my S-corp). The extra profits are handled as a distribution. Aside from my payroll, the only other expenses in the S-corp are business debts payments, equipment leases, assets (equipment) purchases, etc. My accountant and I decide how to handle those funds to minimize my tax burden (capital equipment purchases, small business debt payments, etc.). My profits in 2018 were 1.4 million, my AGI ended up being ~950k. I’ll be 36 years old this year. I expect my income to rise for the next few years as my partner (currently my employee) gets busier, buys half the practice and takes over half the shared overhead. However, I do not expect (or want) to keep up my current pace/volume for my entire career. What I am getting at, is that my income tax burden will likely be at its max for next few years. I elected to max out a SEP IRA for 2018 to tax defer as much as possible. I can’t figure out how to do a back-door Roth with a SEP IRA. The low max limits on individual 401ks made it worth forgoing a Roth (if I had to) to do a SEP-IRA. Any advice would be appreciated. I’d like to tax defer as much as possible THEN max out a backdoor Roth and only THEN wipe out low interest debts vs. invest in taxable accounts. My wife does not generate any income and does not have an IRA… I don’t know if there is a way to do some tax advantaged investing (deferred and/or Roth) in her name. I’ve finally turned the corner from a negative net worth to positive net worth and I want to minimize my financial mistakes. Any advice would be much appreciated.
Who owns the management company? If you, then your employees and you are all eligible for whatever retirement plan you offer through either company.
In short, I doubt you’re even eligible to contribute to a SEP-IRA. I don’t think this is going to pass an audit.
And no, you can’t do a Backdoor Roth IRA with a SEP-IRA.
What’s the point of having two businesses instead of one in this situation anyway?
Yes, your wife can do a Backdoor Roth IRA.
Oh I missed that the management company was an entity he established, I thought the management company was completely separate from him, like it was a staffing agency or something like that.
Can’t blame you, he wasn’t entirely clear, but I think that’s what he was saying.
WCI: “In short, I doubt you’re even eligible to contribute to a SEP-IRA. I don’t think this is going to pass an audit.” I am unsure, but it should be an easy call to a CPA (Can a self employed with no employees start a SEP-IRA ?). If not, surely the wife can become an employee in some legal & lawful capacity, no? That way he can fund his SEP and his wife the same percentage?
My point is he has employees because the two companies are basically looked at as one.
Thanks for all the great information. I don’t believe this exact scenario has been mentioned.
I contributed 5500 to a Roth account in 2018. In February 2019 I realized my income was too high to have contributed to the Roth, so through Fidelity I recharacterized the 5500 into my existing Fidelity IRA and then converted that 5500 back into the Roth. I believe this would have turned out well except the IRA it went into had 85,000 of Tax deferred rollover money from a previous employer’s 401k. As a result I suppose I will be taxed at my top rate on most of that 5500 conversion.
My intention is to simplify now that I have commingling of pre and post tax money in the same IRA which defeats the backdoor advantages. I believe my options are:
1. Convert it all and take a large tax bill (not preferred)
2. Keep track of the basis for contributions and withdrawals forever (not preferred)
3. Hoping to walk it back and unconvert the 5500 and then move the pre tax Ira money to my current employer’s 401k but I believe you can’t walk back a conversion making this option unusable.
4. I’m currently seeing if my employer 401k will accept the pretax money if I can show it separated out, but they seem resistant to believing it can be separated out correctly and a basis formed for transfer into the 401k. This is ideal if they will let me do it as I can then take the remaining 5500 and backdoor to Roth and the Ira would be empty every year for rinse and repeat.
5. Last option I’m not sure if this is allowed but based on reading other posts, open a solo 401k at Fidelity and see if they will allow me to separate out the Ira pre and post tax money and move the pretax money into it. I do have an EIN for rental properties I manage as well as some rehab flip real estate I do as a side job. Would this be allowed to have two 401ks (one I max at my employer) and another opened for the purpose of side business money but really being used to move that pretax comingled IRA money into (assuming Fidelity would allow it)?
Thanks in advance for any thoughts and advice.
Can’t do # 3 any more. You can’t recharacterize Roth conversions starting in 2018. So if you can’t separate out the basis somehow, you’re stuck with # 1 or # 2. Here’s how I separated out the basis of my TSP:
https://www.whitecoatinvestor.com/how-to-get-your-tax-exempt-tsp-money-in-to-a-roth-ira/
Your # 5 would work if Fidelity allows it. Basically, you just roll an amount equal to the total minus the basis into the 401(k), then convert the basis. If the 401(k) only accepts pre-tax rollovers (like most) then of course the basis is left behind when you do the rollover.
Question about step 5 (zero’ing out tax-deferred IRA’s). I plan to roll over my tax-deferred IRA to my employer sponsored 401(k) so as to comply with step 5 and not have to deal with the pro rata rule. But the 401(k) plan administrator’s rollover form says they only accept rollovers from the following type of IRA: “an IRA with no after-tax contributions.” My IRA was funded with after tax money in the sense that I funded it using my already-taxed earnings, but I (properly) took a deduction for the full amount of the IRA contribution on my taxes. Does that count as an “after-tax contributions”? Or is it considered all “pre-tax” because I fully deducted the contribution? I imagine this issue comes up quite frequently because many 401(k) plan administrators have similar restrictions on incoming rollovers.
Apologies if this has already been asked/answered in other comments.
No. That is pre-tax money since you took a deduction for all of the contributions. It’s actually a helpful 401(k) limitation to some docs because it helps them isolate basis to do tax-free Roth conversions of after-tax money in their 401(k)s.
Hi WCI, You are amazing. Thank you for all that you do. I have been reading like mad, and this process is still giving me a bit of an ulcer. I have a real fear of the tax man. Would you mind taking a look at my situation below and sharing any thoughts?
For year 2018, I contributed $5500 to my Roth when I wasn’t eligible due to high MAGI. I recharacterized this contribution to a traditional IRA (done after 12/31/2018). For pro-rata consideration, I do not have another traditional IRA, SEP-IRA, or Simple IRA. I do have an employer 401K, a 401(a), and a 457(b) account.
In year 2019, I also contributed $1000 to my Roth in error and withdrew this amount to a personal, non-tax advantaged brokerage account. I then contributed $6000 to my traditional IRA (non-deductable). I now plan on converting (i.e. backdoor) my traditional IRA (total ~$11500, 2018+2019) to my Roth account, and in the process, zeroing it out (including a few dollars in earnings, about $5).
On my 2018 taxes, I reported my excess Roth contribution of $5500 and filed my 8606 reporting my recharacterization to a non-deductable IRA (using Turbo-tax). My year 2018, 8606 form looks like this:
Line 1: $5500
Line 2: blank
Line 3: $5500
Line 14 (basis): $5500
So, given all of this, for my 2019 taxes, I plan on filing another 8606 and reporting 1) my excess $1000 Roth contribution and withdrawal of excess (to avoid penalty) 2) my $6,000 traditional IRA contribution and 3) my Traditional to Roth conversion of $11,500. If done correctly, I shouldn’t have tax liability correct (except on the $5 or so in interest gained when the money was in my traditional account)?
Did I get all of this correct?
Moving forward I plan to make a much simpler backdoor contribution as you outline.
This process has been very confusing. I appreciate your help/re-assurance.
P.S. I am a PhD, not an MD. That counts as white coat right?! : )
That’s right, there should be no liability.
Jim, a sincere thank you for your time and the education you provide.
Also very grateful. One piece of information I haven’t seen on these incorrect Roth contributions and required recharacterizations, how does it fall out for penalties and 5498 reporting? This came up because I just received my 5498 thinking I should now have my final backdoor Roth conversion considered only to learn from the brokerage that anything done in 2019 would be on the following 5498 (received in 2020). I did an incorrect Roth contribution (AGI too high) in 2018, recharacterized it back to traditional in Jan 2019 at the suggestion of my CPA, then converted to my Roth IRA right away thinking all was ok. Then the 5498 comes still showing a Roth contribution in 2018. I am guessing it doesn’t matter as long as the 8606 for 2018 is filled out correctly (I have an extension for 2018)? Is there no penalty for crossing tax years between an incorrect Roth contribution and the recharacterization/conversion to get the back door Roth? I took it from the opening dialog to this article that it is “fixable” just harder since tax laws changed on recharacterization. Not sure if I’m hosed or ok as long as the 8606 is done correctly.
The only change is you can’t recharacterize a conversion, which you didn’t do.
Not sure why your 5498 shows a Roth contribution in 2018. It seems to me you did a traditional contribution for 2018 as far as the IRS is concerned.
I was told by Schwab that if a Roth contribution is made in 2018 and not converted in calendar year 2018 then it stays on record as a Roth, hence the indication on the 5498. Hoping the CPA will clarify, my thinking is that the 8606 sorts it out when the 2018 tax return is accomplished, and the indication of “roth contribution” on the 5498 is not necessarily a tax collection related event that the IRS cares about. After all, normal Roth contributions are not taxable and not reported on the tax return since after-tax funds are used. However, if they are checking to see if you had too much income to make a Roth contribution, then I would think they care. It almost has to go back to the 8606 being the final say if you are indeed allowed to convert to traditional and back to Roth the following tax year. This brings up another question, if the conversion of a 2018 contribution is done in 2019 is it documented on the 2019 or 2018 8606? I’m thinking it must be the 2018 8606 to make the contribution “back-door” and allowed, otherwise would be disallowed in 2018 due to AGI being too high.
You told me it was recharacterized and thus treated as a traditional contribution. I don’t fill out 5498s. They’re filled out by the IRA custodian. My custodian doesn’t even send it to me, they presumably just send it to the IRS.
Yes, it was recharacterized to traditional and moved back into the Roth IRA account (I was using word “converted” for both transfers), but all was done in Jan/Feb 2019 for an April 2018 contribution. I’ve since heard from the CPA and gone over the brokerage statements, it should “come out in the wash” when the 2018 return is completed. Schwab lists conversions and recharacterizations under the Contribution and Distribution Summary sections of the monthly statements for each account — its all in the English. Funds leaving the traditional account are listed as a Roth conversion but with no year label. So, the original Roth 2018 contribution remains as a 2018 Roth contribution in the records, but is technically a converted back door Roth IRA (2019 conversion), but with some earnings, so no disallowance or penalty should result. I always have received 5498s mid-year and even have a corrected one, but they are not used to prepare tax returns, maybe they would support an audit.
Thank you so much for this tread, I have been an avid follower since I started residency, but unfortunately I have fallen under mistake #1 – trickling in contributions as well as another mistake that is not listed above. I started my Roth IRA during residency and maxed out my yearly contributions by doing automatic monthly contributions.
I am now an attending (as of July last year) and unfortunately, I forgot to discontinue my monthly contributions to my Roth IRA.
For the year thus far I have already inadvertently contributed $2000 to my Roth IRA.
I have already discontinued my automatic contributions to the Roth, but I am wondering what I should do now.
Recharacterize the contributions, then convert them.You’ll owe taxes on the earnings.
Thank you for this website! It has changed my life!
Sorry if my question is a repeat question. I tried to do a backdoor ROTH for 2019. I contributed $6000 from my bank account to a Traditional Vanguard IRA. After a few days, I rolled over $6000 from IRA to a Roth-IRA at Vanguard. Unfortunately, I now have $5 in the IRA account (from interest) from awaiting for bank to clear. I successfully rolled over $6000 into the Roth-IRA prime money market fund.
What can I do with the $5 of interest that remains in the Traditional IRA since we have to zero it by 12/31/2019? Can I roll that small amount into my 403b, 457, or DCP plan to zero out my IRA?
If I cannot do the above, would you prefer leaving in the IRA or converting what’s left over $5 into the Roth IRA (and essentially overcontribute by 5 bucks)?
Thank you!
Convert it.
https://www.whitecoatinvestor.com/pennies-and-the-backdoor-roth-ira/
Thank you WCI for all your wisdom. I just recently learned about your site and realized I made a few of these mistakes and was hoping for some advice. I contributed $5,500 into my Traditional IRA on April 12th 2019 for the 2018 tax year. I then mistakenly recharacterized it to my Roth IRA on April 16th 2019 (day after tax day). I was following a different website that used the wrong verbiage thus leading to my misunderstanding. I have just recently realized my mistake and have recharacterized the money back into my traditional IRA. I now have $5,550 in my traditional IRA. I was hoping you could help me understand a few things: Can I still convert the money, should I rollover the additional funds into my employer 401k before converting the $5,500, what year/ forms will I be completing (2018 v. 2019 and 8606 v. 1040x), and finally is this something I should try to do myself on TurboTax or hire a CPA (my taxes are otherwise uncomplicated). Thank you for your time in reading this. I definitely won’t be making these same mistakes now that I’ve come across your website.
Yes.
Uh oh. You contributed/recharacterized non-deductible money into the same IRA as tax-deferred money? You’ve just mixed the cream with the coffee and made things more complicated. You might be able to separate out the basis and convert it by rolling the tax-deferred money into a 401(k). Alternatively, convert it all and pay the taxes on the tax-deferred bit.
Contributions are reported on the taxes for the year for which the contribution is made. Conversions are reported on the taxes for the year in which the conversion is actually done.
I would feel very comfortable reporting all that on Turbotax but you would be in the majority of docs if you hired an accountant to assist.
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?
No need to stop in a traditional IRA. Just go straight from the solo 401k to a Roth IRA if you want to do that. Kind of classic for a Mega Backdoor Roth IRA. It’ll cost you a lot of taxes of course, but if you think it makes sense in your situation, you may be right. Bear in mind the rule of thumb is to max out tax-deferred options during peak earnings years. Going all Roth goes against that. So if by “a lot in traditional 401(k)” you mean $5M, then it’s probably a good idea. If by “a lot” you mean $500K, it probably isn’t.
Thank you for your quick reply. I just signed up for your email service and have loved your blog so far. I have 1m so far so no where near the 5m. I may need to rethink. What I was considering is including my itemizations and reduction of business tax burden using a reinsurance product my overall personal bracket is low, near 24% last few years sometimes lower. . I’m afraid when I stop all the complexities during retirement and change to withdrawals only I may be in higher tax bracket. I suppose I can only guess. My goal is to have about 5-8m in next 20yrs between contributions and growth. Perhaps I should do balanced now between solo and Roth 401k. My lean toward Roth is because we are at such low tax rates right now it’s hard for me to imagine any lower. I need to read more about your video workshops as I’m sure I’d learn more. Thanks.
You may be right. If you’re in 24% now and expect to have $8M in 20 years then all Roth may very well be right for you.
I have spent last several days educating myself from your amazing site and just bought your book off of amazon also. According to your criteria a mega backdoor Roth is worth me considering. As a physician, I am so glad you are doing this with your life and educating all of us.
Your previous comment to me on the Mega Backdoor Roth conversion led me to your article about doing those. I could fall into Variation #1, except my current broker doesn’t allow after tax 401k donations. I could ,of course, change brokers, however, To me, this doesn’t seem like totally necessary, but is where I need your help.
My question is:
Wouldn’t I just be able to donate the $37k (as the employer in my solo 401k) which gives me the corporate tax deduction (Im LLC filing as S corp), then turn around and do an inservice distribution from the 401k to a Roth IRA which my plan does allow?
This last step will generate a tax consequence and 1099 of course to me personally, but I think it would wash out between the employer tax deduction from the 401k donation and personal 1099 from the conversion if I did them within a short period of time since S corp taxed as pass through. Thanks for your time.
Yes, if the plan allows it, you could do that. The business would get a deduction for the contribution and you would have a tax bill for the conversion. But in effect it would be the same as a mega backdoor Roth except as regards the 199A deduction, if that’s a factor for you (that’s why I’m doing a MBD Roth.)
Love your site – read your book as a resident and it has helped me tremendously. My current situation is that I rolled about 21k from a 403b from residency to a traditional IRA with vanguard and have contributed about another 6k with post-tax income – there’s about 32k in that account now. I also have a 401k with employer match that I max out (non Roth contributions) I’m interested in starting to use the backdoor Roth option for myself and my wife.
From what I gather – I will need to do a Roth conversion on this traditional IRA first, correct? Since I’m maxing out the employer sponsored 401k, I can’t really roll it into the 401k (vanguard incompatibility issues notwithstanding)
So by my calculations I’d be looking at taxes on 32k-6k = 26k at my current tax rate as a result of the Roth conversion? Do you see this as a good move? I’ve probably got close to 30 years left before retirement.
You could roll it into the 401(k), that would probably allow you to isolate the basis and convert it to a Roth IRA tax free. The simpler but more expensive solution is to convert the entire $32K and pay the taxes on $26K of it. That’s honestly what I would probably do, as long as I had the $10K or so I needed to pay the tax bill.
This article is so great. Thank you for all the details. I have $200k in a Rollover IRA. A rollover IRA prevents me from being able to do the backdoor Roth, correct? My employer 401k has terrible investment options. Therefore, it seems I should go the EIN/i401k route, correct? Where do you recommend opening the i401k? Thank you for helping me understand this.
Depends on what you want from the 401(k). If it’s just a rollover option to do Backdoor Roths, the easiest is like eTrade or Fidelity.
Hello,
I just realize that I made a huge mistake. I did backdoor roth in 2012, 2013 and 2014 without filling out form 8606. What can I do now? It is only worth $19k. Should I just leave the investment as it is and pass it on to my kids as inheritance 20 years from now and hopefully the tax bracket for my kids will be lower than mine.
Thank you for any feedback!
Sleepydoc
Sounds like a good question for your CPA. It also doesn’t sound like the IRS has noticed at all. Most audits are within 3 years and the IRS only requires you to keep records for 7 years. But you may end up paying taxes twice on those contributions if you’re not careful. If it’s all in a Roth IRA now you’re probably okay since the problem is the documentation, not what you actually did.
Probably guilty of one of the mistakes. Started a Backdoor late in December and the IRA disbursement took too long to clear and the funds were not available by Dec 31, so I did the conversion right after Jan 1 in the 2019 tax year. I hadn’t made one in 2018 but believe this now counts on my 2019 taxes right? Is there a way to fix this? My IRA balance was $0 in the Vanguard account as of 12/31 but the funds were not available for me to transfer.
Dear WCI, Thank you for the great investment education website. I have been contributing to backdoor roth for last three years, but recently realized there was an old (from 2004/2005) traditional IRA with total ~9K that got left out at custodian that I completely forgot about . My current 401k doesn’t accept trad IRA reverse rollover to 401k. What is my best recourse at this point of time? Appreciate your response. Thank you.
Oops. I’d convert it to a Roth IRA ASAP. Assuming it is all pre-tax, that shouldn’t be a big deal. If there is some basis in it, you probably should go back and file 1040Xs with 8606s for the last 3 years.
Thank you for the prompt response. My old trad IRA is all pre-tax with no cost basis, so if I convert that all into ROTH, so I pay taxes on those funds and not have to worry about adjusting 8606 for last 3 years, right? Also does pro-rata rule apply in this case? Thanks again
Well…you probably need to file the 1040Xs and 8606s for each year you did a Backdoor Roth IRA because all of those conversions should have been prorated. Whether the IRS notices or not is another question and in the end it won’t make a huge difference or increase tax by much.
Yes, the conversion of the $9K is a taxable event. It’ll likely cost you $3K+ in taxes but then that money will never be taxed again.
I’m kind of amazed to run into people who have money they’ve totally forgotten about. Very foreign to me!
Hi WCI,
Thank you so much for all this super valuable information. This is my first foray into the backdoor Roth and I think I messed things up and am a little lost on how to fix it. After reading this article, I am still a bit lost and was hoping you could help me or point me to someone that could help me sort out this mess 🙁
On April 8th of 2019, I made a two contributions into a traditional IRA with plans on executing the Backdoor Roth for 2018 and 2019 simultaneously. I made a $5500 non deductible contribution for 2018, and then made a $6000 non deductible contribution for 2019. I had forgotten to do the Backdoor Roth conversion. Fast forward to now, I want to do a Backdoor Roth for $6000 for 2019. That would leave me with a non-zero amount in my Traditional IRA (a little more than $5500 due to earnings of non-deductible contributions).
I panicked, and requested my custodian to return $~5600 worth of my 2019 contribution to leave my Traditional IRA at $~5900. This way, I can do the Backdoor Roth for the full amount of my traditional IRA balance with the ultimate goal to zero out my Traditional IRA. I feel like I messed up something and made life really hard for myself and would also be lost at how to report this to the IRS. How bad of shape am I in?
Thanks WCI!
Would this a reasonable way forward solution given what has happened?
1. Fill out a 2019 form 8606 with a basis of ~5500
2. Submit a 2018 form 8606 that shows the $5500 non deductible contribution, which would the source of the basis for the 2019 form? (I did not submit an 8606 for the 2018 returns).
I am thinking the filled out 8606 forms would look like this https://imgur.com/a/jJGf9W2
As often happens, you were doing just fine until you panicked. There are no limits on conversions, only contributions. So if I were you, I’d reverse the panic move by contributing that $5600 back in and then convert the whole thing back to a Roth IRA. Then report your 8606 as appropriate.Your 2018 8606 shows the contribution for 2018. The 2019 8606 shows the contribution for 2019 and the entire conversion. I don’t think this is a very bad screw-up at all. I think you’ll look back on it and chuckle.
Ah wow. Thank you WCI. Very much appreciate that and am sooooo relieved! I thought for some reason that since there was a limit to the contribution, that therefore there would be a limit to the conversion. I understand now that is not the case. I think this will be an easy fix now and indeed it is a chuckle to see how much unnecessary stress a small misunderstanding could cause!
Thank you for your blog! A financial dummy doctor like me finds your articles so helpful. Regarding my backdoor Roth conversion…I opened up a Vanguard traditional IRA account last year and put in $5,500. I forgot to convert it to backdoor Roth last year but did so this year. This year, the entire traditional IRA money now is $5,656.33. I just converted this whole amount into a new Roth account with Vanguard. Then in addition, for this year, I contributed $6000 to the traditional IRA account. Can I now also convert that $6000 from my traditional IRA to the Roth account this year without having to pay any tax penalty? That would mean I end up with $11,656.33 all converted to Roth for this year, leaving me with 0 in my traditional IRA. I have no other IRA accounts from the past. I’m trying to get away from pro rata tax. Is this similar to Evan T’s post just above? Thank you.
Yes. You’ll owe taxes on $156.
So, just to be clear, the reason I would want to make backdoor Roth contributions is because I’ve already maxed out my tax deferred retirement savings and am looking to squeeze in a little more? I currently have a SEP IRA and only contribute about $30K/yr, so my best move is just to contribute more to the SEP, right?
The reason is it is better than investing in taxable or a non-deductible traditional IRA. You probably want to use an i401(k) instead of a SEP-IRA, max it out, AND do a Backdoor Roth IRA on top of it. Is $30K really enough to reach your goals?
But the SEP-IRA is deductible, correct? I sure hope so since my accountant seems to be deducting it. For now $30K is enough. I also max out my HSA and split the leftovers between student loan pay down and buy and hold real estate investing. I plan to have zero debt in retirement and will only require $60K/yr for expenses. My retirement accounts will get me to the $1.5M I need (assuming 4% withdrawal) in 15 years ($111,000 current balance plus $3075/mo for 15 years at an assumed 8% return) but I plan to get my rental cash flow to $60K/yr in parallel much sooner than that so that the retirement accounts are really just back up.
Yes. And if you really only want to save $30K/year it’s pretty easy to justify just doing a SEP-IRA and skipping the Backdoor Roth IRA.
Good deal. Thanks so much for your help!
I left an employer that I had a 401k with. Which is the best scenario: transferring the 401k to the new employer 401k or my IRA? Thanks.
401(k) so you can still do Backdoor roth IRAs.
So if you transfer a 401k to an IRA you’re not able to put money into the IRA for the year? Is there a max amount you can transfer for the year? For instance, if you have 20k in the 401K and make it the transfer into the IRA will you be penalized? I understand you’re able to contribute 6k to your IRA, but that’s direct contribution, right?
No. There is no limit, penalty, tax due on transfers. But money in an IRA on Dec 31st screws up the backdoor Roth IRA pro-rata calculation.
You can contribute $6K to a combination of IRA/Roth IRA each year you are under 50 and you or your spouse has at least that much income. If you have too much income though, you can’t do direct Roth IRA contributions.
Besides the fact of being able to do a back door roth IRA (not likely for the person I’m asking this question for), there’s really no difference/benefit in transferring an old 401k to a new 401k or IRA?
If you’re not going to do Backdoor Roth IRAs, just do an IRA rollover. You might get slightly better asset protection in some states by keeping it in a 401(k), but that’s the only benefit.
Thanks!
Regarding #4 and #5. What do you consider a “small amount” in a rollover IRA to pay the taxes on when converting to the roth IRA? I have ~$5000 in a rollover IRA from years ago. Would it be easier/better just to pay the taxes on that and convert it to my vanguard Roth IRA when I am doing the backdoor roth? Or should I put it into my fidelity 403b? I have already maxed out my 403 b for this year so I would need to wait until next year and my employer pays my 401k.
Regarding #4 and #5. What do you consider a “small amount” in a rollover IRA to pay the taxes on when converting to the roth IRA? I have ~$5000 in a rollover IRA from years ago. Would it be easier/better just to pay the taxes on that and convert it to my vanguard Roth IRA when I am doing the backdoor roth? Or should I put it into my fidelity 403b? I have already maxed out my 403 b for this year so I would need to wait until next year and my employer pays my 401k.
$5K certainly qualifies as small in my book. Would the taxes on $5K cause you a problem? I doubt it if you’re doing BD Roth IRAs.
You don’t have to wait to roll it into your 403b because there is no limit on rollovers. They don’t affect your contributions.
Question regarding IRA to Roth conversion and back-door Roth conversion.
In order to start doing the back-door Roth conversions, I first need to convert $36k I have sitting in my traditional IRA today of which all the contributions were non-deductible but has about $8k in gains.
I decided to go ahead and convert the entire IRA balance to a Roth in 2019 and both accounts are in Vanguard which makes it easy.
I’m assuming that the $8k will count as income in 2019.
Now I’m also wondering if I could do a back-door roth contribution this same year.
Meaning after my initial conversion of the $36k, i then contribute another $7k non-deductible to that same IRA and convert it to the IRA the next day.
Will my subsequent back-door conversion be somehow taxed because of the prior taxable gain on the original conversion the same year? Should I wait until next year to start the back-door conversions?
Yes, you can (and should) do that. There will be no additional tax bill aside from the tax due on the $8K in gains.
Hello, I’m working on finishing my backdoor Roth on Schwab
Currently I have $6000.4 in my IRA (gained a little interest in a month).
I tried to do a transfer of the IRA to my backdoor Roth account but it gives me a warning and makes me go through a separate process where I actually convert the money. Is this the right way of doing it or am I violating rule 10. I’ve emptied out any other IRAs already.
Thanks
If the warning is simply saying “this may be a taxable event” then that’s pretty routine. Yes, it is a taxable event, but the tax due is $0.
I’m doing the same thing with Schwab right now. Just did my own and it does have to be cash contributed to the traditional (non-deductible) temporary hold account. I found a simple transfer between the traditional IRA and Roth IRA accounts works great, and the transaction correctly shows as a conversion in the system, in my case was a $7,000 contribution converted. About to do my wife’s conversion transfer.
Hmmm, hoping this isn’t the dumbest question ever, but I can’t seem to find a definitive answer to this on the interwebs, so maybe you can help. I did my first back-door Roth in January 2019 and am looking forward to doing it again in 2020. Can I use my existing zeroed out traditional IRA to make my 2020 contribution and convert it to my now existing Roth IRA or do I need to open new accounts? If the answer is the latter I would have 25 separate Roths by the time I retire, which just doesn’t sound right. What say you? THANKS!
Kevin, no new account needed. If your financial institution will let you keep that traditional IRA open with a zero balance (which it sounds like they do), then you’d keep using that same account year after year.
Thanks so much for the quick response!
Thanks so much for all your information and work in this area!
I have a question about my ability to contribute to a tIRA and make conversions to a rothIRA.
I graduated this year from residency and had some money in a 401k that I then rolled over into a tIRA. In hindsite, I should have rolled this into my new employers 401k, but didn’t so here I am. I have 8k of rolled over 401k money as well as $3100 in direct tIRA contributions in the tIRA.
What is the best way to deal with this? Should I roll the entire tIRA into my new 401k and then open a new tIRA (vanguard) and make a roth conversion? If I do that, can I only contribute $2900 to the new tIRA as I have already contributed $3100 this year into another tIRA? This money would no longer be in a tIRA, but does it still count as an IRA contribution?
Or after i roll it over into a 401k, can I make another $6000 contribution to a tIRA?
Thanks!
I’d just convert all $11,100 to a Roth IRA personally, assuming you can afford the tax bill. If it’s all pretax money you can just roll it into your 401(k), then start the Backdoor Roth IRA process from scratch. That would save the tax bill. Only 2019 contributions count as 2019 contributions. Conversions and rollovers don’t count. So if that $3100 was not a 2019 contribution, you can still contribute $6K to an IRA for 2019.
Hopefully this is a quick question. As is the case with many of you, my income is too high to contribute directly to a Roth. I have maxed out contributions to my employers 403B and 457B plans for the last several years. I do not have any traditional IRAs. I am trying to determine the best time to do a backdoor Roth. It is currently Sunday, 12/29. If I open a traditional IRA with Vanguard tomorrow (12/30), will I be able to do the backdoor Roth conversion on 12/31 to keep it within the same calendar year (to avoid mistake #3) or is there typically a few business days required to get the funds in? If there is a bit of a lag, would it be best for me to just wait until after 1/1 to do this (although that would put me in the mistake #2 category if I want to do this contribution for the current calendar year)?
As a follow-up question, lets say I end up waiting until after 1/1/20 to do the backdoor Roth for the current tax year (2019), could I do another backdoor Roth in the same calendar year (2020) as a contribution for the 2020 tax year? Part of me just wants to keep it as simple as possible and wait until after 1/1/20 to make the contribution and do the backdoor Roth for the 2020 tax year to avoid mistakes #2 and #3 altogether, but I would be missing out on contributing in 2019.
I think I am suffering from “paralysis by analysis,” and I just need to commit to something, anything that may be better than CDs and “high”-interest savings accounts and taxable investments.
Thanks for any help you can offer.
Probably not. It’ll probably be next week for the conversion. Might as well try though. If it doesn’t work out, it’s not the end of the world, you just report the conversion on your 2020 8606 instead of your 2019 one.
And yes, the 2020 BD Roth is totally separate and can also be done next week.