By Dr. James M. Dahle, WCI Founder
Setting up a Backdoor Roth can be confusing, so I thought I’d put together a tutorial on the Backdoor Roth IRA steps people can refer to when they go through this process. Let's get started.
Table of Contents
- What Is a Backdoor Roth IRA?
- Who Should Do a Backdoor Roth IRA?tra
- When to Do a Backdoor Roth IRA?
- Backdoor Roth IRA Pros and Cons
- Backdoor Roth IRA Tax Implications
- Backdoor Roth IRA Steps
- How to Fix and Prevent Backdoor Roth IRA Mistakes
- Backdoor Roth IRA FAQs
What Is a Backdoor Roth IRA?
Despite its name, a Backdoor Roth IRA is not an account, it is a process with two steps:
- Contribute to a Traditional IRA.
- Complete a Roth conversion.
If you understand the rules of both of these steps, putting them together is no problem.
Who Should Do a Backdoor Roth IRA
Remember that if you are a low earner you can just contribute DIRECTLY to a Roth IRA and skip this Backdoor Roth IRA process.
Roth IRA Limits and Conversion Rules
Low earner is defined as a Modified Adjusted Gross Income (MAGI) under a phaseout range in 2023 of $138,000-$153,000 ($218,000-$228,000 Married Filing Jointly). Some docs like residents, employee dentists, part-timers, and even some medical attendings in the lower-paying specialties who are married to a non-earner can just contribute to a Roth IRA directly.
Anyone who earns at least $6,500 ($7,500 if 50+) can contribute $6,500 ($7,500 if 50+) to an IRA [2023]. If your income is below a MAGI of $138,000-$153,000 ($218,000-$228,000 Married Filing Jointly), you can contribute directly to a Roth IRA. If you have a retirement plan offered to you at work and your MAGI is below $73,000-$83,000 ($116,000-$136,000 Married Filing Jointly) you can deduct your traditional IRA contributions. Since most readers of this blog have a retirement plan through their job and have (or soon will have) a MAGI over $228,000, they will find that they can neither make direct Roth IRA contributions NOR deduct their traditional IRA contributions. Thus, their best IRA option is the Backdoor Roth IRA process, i.e., an indirect Roth IRA contribution.
Spousal IRAs
Married physicians should be using a personal and spousal Roth IRA, and will usually need to fund both indirectly (i.e., through the back door). Not only does this provide an additional $6,500 each ($7,500 for each spouse that is 50+) of tax-protected and (in most states) asset-protected space per tax year, but it allows for more tax diversification in retirement. Tax diversification allows you to determine your own tax rate as a retiree by deciding how much to take from tax-deferred (traditional) accounts and how much from tax-free (Roth) accounts. Remember that IRA stands for INDIVIDUAL Retirement Arrangement. So even if the pro-rata rule (discussed below) keeps you from doing the Backdoor Roth IRA, it doesn't necessarily keep your spouse from doing so. Each spouse reports their Backdoor Roth IRA on their own separate 8606, so the tax return for a married couple doing Backdoor Roth IRAs should always include two form 8606s.
Married Filing Separately
The contribution and deduction income limits are particularly low if you are filing your taxes Married Filing Separately (MFS). Both the ability to contribute directly to a Roth IRA and the ability to deduct a traditional IRA contribution if you (or your spouse) are eligible for a retirement plan at work phase out between $0 and $10,000. Basically, the best option for anyone filing their taxes MFS is the Backdoor Roth IRA process, i.e., an indirect Roth IRA contribution.
There is an exception to these rules if you do not actually live with your spouse. In that case, your ability to contribute directly to a Roth IRA phases out between a MAGI of $138,000-$153,000 in 2023. If you live separately and are not covered by a retirement plan at work, you can deduct a traditional IRA contribution no matter your income. You can still do a Backdoor Roth IRA process in these situations where your IRA contribution is either partially or completely deductible. The tax bill will be precisely the same, $0 when done properly. However, instead of having no tax cost for either the contribution or the conversion, your deduction on the contribution will precisely equal the tax cost on the conversion, resulting in that same $0 tax bill for the entire process.
Mega Backdoor Roth IRA
A Mega Backdoor Roth IRA is completely different from a regular Backdoor Roth IRA. Despite its name, you actually do a Mega Backdoor Roth IRA with a 401(k), not an IRA. It requires a 401(k) that both accepts after-tax (not Roth) employee contributions and allows for either in-service withdrawals (and thus conversions to a Roth IRA) or, more commonly, in-plan conversions. Using the Mega Backdoor Roth IRA process, one might be able to put as much as $66,000 ($73,500 if 50+) [2023] per year into a Roth 401(k) (or possibly a Roth IRA in addition to your usual $6,500-$7,500 contribution). However, this process has nothing to do with the Backdoor Roth IRA process we are discussing in this post.
When to Do a Backdoor Roth IRA?
Lots of people wonder about the timing of a Backdoor Roth IRA.
IRA Contribution Deadline
There is really only one deadline to meet with the Backdoor Roth IRA process. IRA contributions for a given tax year must take place between January 1st of the tax year and April 15th (even if you file an extension) of the following year.
Backdoor Roth IRA Conversion Deadline
The conversion step may take place at any time. It can take place the next day or even the same day as the contribution. I don't recommend it, but you can wait months, years, or even decades between the contribution and the conversion step. There is no deadline on Roth conversions. If you need to perform a rollover or conversion of a traditional, rollover, SEP, or SIMPLE IRA in order to avoid the pro-rata rule, you have until December 31st of the year you do the conversion step.
When Should You Contribute and Convert?
You should do both steps as soon as possible. Many white coat investors do the IRA contribution step and the Roth conversion step the first week of January each year. This maximizes the amount of tax-free compounding that can occur on those dollars. Minimizing the time between contribution and conversion and doing both steps within the calendar year is not required, but certainly simplifies the paperwork.
Want to really make your paperwork complicated? Contribute to your IRA each month and convert it each month. Then you have 12 contributions and 12 conversions to keep track of each year. Seriously though, if you make enough money that you have to contribute to your Roth IRA(s) through the Backdoor Roth IRA process, you make enough to do it in one fell swoop each year.
Can I Do a Backdoor Roth IRA Every Year?
Yes. My wife and I have done one every year since 2010 and do not plan to stop until we no longer have any earned income. It is just one of the investment chores we perform once a year.
5-Year Rule
One factor that may push you to do a Backdoor Roth IRA earlier is the 5-year rule. Now there are at least three 5-year rules related to IRAs, but the main one to pay attention to here is the 5-year rule after a Roth conversion. This rule determines whether the withdrawal of principal from the account prior to age 59 1/2 will be penalty-free. The 5-year period starts on January 1st of the year you do the conversion, so it could be a little less than 5 years. Roth IRA principal generally comes out tax and penalty-free (it is only the earnings that may be subject to penalties), but that is only the case after the 5-year rule has been fulfilled.
In essence, if you do a conversion of a Roth IRA at age 51, you can then withdraw the principal tax and penalty-free starting at age 56 rather than age 59 1/2. This can provide funding for living expenses to early retirees. If you do a Roth conversion at age 57, you still get access to that principal (and earnings) tax and penalty-free at age 59 1/2. So it's 5 years or age 59 1/2, whichever comes first.
There is also a completely separate 5-year rule on IRA contributions, but this starts from the time you make your very first IRA contribution, not every contribution, so it should not apply to most early retirees.
Backdoor Roth IRA Pros and Cons
There are a lot of great things about the Backdoor Roth IRA, but it isn't all peaches and cream.
Pros of Backdoor Roth IRA
The main benefit of a Backdoor Roth IRA is that it provides you another retirement account. Via the Backdoor Roth IRA process, you can continue to contribute to a Roth IRA even after your earnings rise above the income limit for direct Roth IRA contributions. Retirement accounts eliminate the tax drag that applies in a taxable, or non-qualified account, reducing your taxes and allowing your investment to grow at a higher rate so you can reach your goals sooner.
How much can that tax protection be worth compared to a taxable account? It depends on the return of the underlying investment, its tax efficiency, and the amount of time the money is left in the account. At my marginal tax rate, $10,000 earning 8% in a tax-inefficient investment over 50 years would grow to $469,000 in a Roth IRA but only $88,000 in a taxable account. More realistically, over 30 years the use of a Roth IRA versus a taxable account for a tax-efficient investment would still result in 29% more money.
Retirement accounts ensure simple estate planning. By using beneficiaries, that money does not go through the probate process, so your heirs get it sooner with less hassle, more privacy, and no cost. They can even stretch the tax-protected growth benefit for another decade after they inherit the account. Retirement accounts like a Roth IRA also provide substantial asset protection in most states, meaning that in the admittedly very rare event of a dramatically above policy limits judgment that isn't reduced on appeal, you can declare bankruptcy and still keep what is in your retirement accounts. Roth money is tax-free forever, so by continuing to contribute each year you can increase tax diversification in retirement.
Cons of Backdoor Roth IRA
Roth IRAs, even when you contribute via the Backdoor Roth IRA process, are still retirement accounts with all of their downsides. Retirement accounts limit the investments you can put in them and prohibit the use of margin investing. If you withdraw Roth IRA earnings prior to age 59 1/2 without an approved exception, you will owe a 10% penalty.
Due to the pro-rata rule (see below), the Backdoor Roth IRA process requires you to either convert or rollover into a 401(k) any traditional IRAs, SEP-IRAs, and SIMPLE IRAs you may have. If you have self-employment income, you will need to use an individual (solo) 401(k) instead of a SEP-IRA to shelter that income from taxes. Doing Backdoor Roth IRAs each year also adds one form (IRS Form 8606) per spouse to your tax return. If preparing your own taxes using tax software, it can be tricky to ensure the software reports the process correctly. If you do a Backdoor Roth IRA instead of (rather than in addition to) maxing out your tax-deferred accounts during your peak earnings years, that can also be a mistake that results in the accumulation of less money.
Perhaps most significantly, there are now two steps to getting money into your Roth IRA each year instead of just one. While I think the process is pretty darn simple, I am continually amazed at all of the unique ways that doctors manage to screw it up. Later in the article, I'll show you how to fix all of those screw-ups.
Is a Backdoor Roth IRA Worth It?
Yes! Most of the time. It really is just a little bit of hassle to do each year, although there may be some additional hassle the first year if you need to take care of another IRA first to avoid the pro-rata rule. There may be times when someone has a large traditional IRA they cannot afford to convert to a Roth IRA and cannot roll over into a 401(k) because they don't have a 401(k) at all, their 401(k) charges high fees, or because the IRA assets are invested in something they cannot invest in within a 401(k). If your employer-provided retirement account is a SIMPLE IRA or a SEP-IRA, the Backdoor Roth IRA process is also probably not worth it. Finally, some multi-millionaires don't want to bother with even the minor hassle of the Backdoor Roth IRA process because getting an extra $6K-$14K a year into Roth accounts just isn't going to move the needle for them.
Backdoor Roth IRA Tax Implications
Roth IRAs are all about avoiding taxation on earnings, so naturally, there are lots of tax implications of this process.
Pro-Rata Rule
The most important tax implication to be aware of is the pro-rata rule. I would estimate that 90%+ of Backdoor Roth IRA screw-ups involve the investor having his or her conversion pro-rated. When you report a Roth IRA conversion on IRS Form 8606 (see below) there is a pro-rata calculation made. The numerator is the amount converted. The denominator is the total of ALL traditional, rollover, SEP, and SIMPLE IRAs, but not 401(k)s, 403(b)s, 457(b)s, Roth IRAs, or inherited IRAs. Therefore it is critical that you DO SOMETHING with any IRA balance you have PRIOR to December 31st of the year in which you do a Roth conversion of after-tax money. Later in this article, I'll describe the exact options you have of what to do with this money.
Tax on Backdoor Roth IRA Conversion
Done properly, there is NO tax on a Backdoor Roth IRA conversion. Zero. Nada. Zilch. While the money you put into a Roth IRA (indirectly via the Backdoor in this case) was taxed when you earned it, it is NOT taxed when you contribute it directly to a Roth IRA or when you contribute it as a non-deductible IRA conversion nor when you subsequently convert that money to a Roth IRA. In fact, it is never taxed again.
Do I Need to Worry About the Step Transaction Doctrine?
There used to be a concern that the IRS would have a problem with the backdoor Roth due to an IRS rule called The Step Transaction Doctrine. This rule basically says that if the sum of a bunch of legal steps is illegal, then you can’t do it. Some wondered if this backdoor conversion from traditional IRA to Roth was a legal transaction considering this doctrine. Those concerns, valid or not, are no longer an issue. The IRS clarified in early 2018 that no waiting period is required between the contribution and conversion steps of the Backdoor Roth IRA and essentially has given its blessing on the whole process. Waiting just makes things more complicated on the 8606, as discussed in Pennies and the Backdoor Roth IRA.
How to Report a Backdoor Roth IRA on Turbotax
Reporting the Backdoor Roth IRA properly on Turbotax is unfortunately even more complicated than filling out Form 8606 by hand. The key to doing it right is to recognize that you report the conversion step in the Income section but you report the contribution step in the Deductions and Credits section. Since you generally do the income section first, you report the conversion before you report the contribution, even though you actually did the contribution before the conversion. At the end, you want to look at the Form(s) 8606 that Turbotax generates, just like you would check up on one filled out by an accountant.
More information here:
How to Report a Backdoor Roth IRA on TurboTax
Backdoor Roth IRA Steps, Tutorials, and Walkthroughs
In this section, we'll explain exactly how to do the Backdoor Roth IRA process and how to report it on your tax return, whether you file on paper or using tax software. You can easily walk through these Backdoor Roth IRA steps at Vanguard, complete a Backdoor Roth at Fidelity, or knock out a Backdoor Roth IRA at Schwab, three of the most popular brokerage/mutual fund companies.
How to Perform and Report on Paper the Backdoor Roth IRA Process
While it is really just a two-step process, it is best to think of it as a five-step process. These steps don't all have to be done in order (it might be easier to do Step 3 before Step 1), but they will all need to be done.
Step 1 – Contribute to a Traditional IRA
Make a $6,500 ($7,500 if 50+) non-deductible traditional IRA contribution for yourself, and one for your spouse. You can use the same traditional IRA accounts every year—they just spend most of the time with $0 in it. Most fund companies, including Vanguard, don’t close the account just because there is nothing in it. I do this every January 2nd.
Step 2 – Leave the Money in Cash
An account like a traditional IRA is not an investment, of course, just like a suitcase isn't clothing. When putting money in a traditional IRA, you also have to tell the IRA provider what you would like to invest in. In this case, just leave the money in cash, whether a money market fund or a settlement fund. At Vanguard, the settlement fund is the Federal Money Market Fund. You really don't want to have any gains (or especially any losses) between the contribution and conversion step because it makes the paperwork more complicated. The best way to minimize the gains is to leave it in cash (and then of course to do the conversion as soon after contribution as possible to minimize the “pennies” issue).
Step 3 – Convert the Traditional IRA to a Roth IRA
Next, convert the non-deductible traditional IRA to a Roth IRA by transferring the money from your traditional IRA into your Roth IRA at the same fund company. If you don’t already have a Roth IRA there, you’ll need to open one. This can be done in a minute or two online at Vanguard and is essentially the same process as opening the traditional IRA. I do this the very next day after I make the contribution. It is very straightforward. When you transfer the money, the website will throw up a scary banner saying something like “THIS IS A TAXABLE EVENT.” That’s true. It is taxable. It is just that the tax bill is zero for it since you’ve already paid taxes on the $6,500 and couldn’t claim your contribution as a deduction because you make too much money. You can do Step 3 basically immediately after Step 1. Some companies will let you do it the same day. Other companies will make you wait until the next day or even a week or so. But there is no reason to wait months to do it.
Step 4 – Invest the Money
Now you will need to select an investment for the money in your Roth IRA. If you already have an investment in there, you can simply add $6,500 to it. Otherwise, you will need to select an investment in accordance with your written investing plan. If you do not have a written investing plan yet, you can leave the money in cash or put it into a Target Retirement 2050 or other lifecycle fund until you get that part of your financial plan worked out.
Step 5 – Beware of the Pro-Rata Rule
Get rid of any SEP-IRA, SIMPLE IRA, traditional IRA, or rollover IRA money. The total sum of these accounts on December 31st of the year in which you do the conversion step (Step 2) must be zero to avoid a “pro-rata” calculation (see line 6 on Form 8606) that can eliminate most of the benefit of a Backdoor Roth IRA.
You Can Get Rid of These IRA Accounts in Three Ways:
- Withdraw the money (not recommended, as the money would be subject to tax and/or penalties, not to mention DECREASING your tax-advantaged/asset-protected investment space).
- Convert the entire sum to a Roth IRA. Only recommended if it is a relatively small amount and you can afford to pay the taxes out of current earnings or taxable investments with relatively high basis.
- Roll the money over into a 401(k), 403(b), or Individual 401(k). 401(k)s don’t count in the aforementioned pro-rata calculation. Some physicians even open an Individual 401(k) at Fidelity, eTrade, or Vanguard (rollovers from traditional IRAs to solo 401(k)s is a recent addition to Vanguard) in order to facilitate a Backdoor Roth IRA.
Step 6 – Fill Out IRS Form 8606 Correctly
The next part of the Backdoor Roth IRA is done months later when you (or your accountant) fill out your IRS Form 8606 on your taxes. Don't forget to do it or there is a $50 penalty. Remember that you need one form for each spouse. INDIVIDUAL Retirement Arrangements. You need to double-check this to make sure it is done right, even if you hire a pro to avoid screwing this part up. Advisors have told me that they have had to help clients fix dozens of these that tax preparers have done improperly. If you don't do it right, you'll pay taxes twice on your Backdoor Roth IRA contribution.
Page 1 (below) shows a “distribution” from your non-deductible IRA. Since the money was already taxed, the taxable amount on your distribution is zero. Line 1 is your non-deductible contribution. On Line 2, your basis is zero because you had no money in a traditional IRA on December 31 of last year (if you've been carrying a non-deductible IRA for years this may not be zero). Line 6 is zero in a typical year. Note that Turbotax may fill this out a little differently (may leave lines 6-12 blank) but you end up with the same thing. Line 13 is the same as line 3, so tax due is zero.
On page 2 (below), you are showing the Roth conversion. I'm not really sure why you have to do this twice (since you're just transferring the amounts from lines 8 and 11 and then subtracting them), but that's what the form calls for. As you can see, a Roth conversion of a non-deductible traditional IRA contribution without any gains is a taxable event, it's just that the tax bill is zero for it.
When double-checking your tax preparer's work, you want to concentrate on lines 2, 14, 15c, and 18, and make sure they're a very small amount, like zero, and not a very large amount, like $6,500. The form can get more complicated if you are doing other Roth conversions at the same time or if you made a contribution for the previous year (i.e., made your 2022 contribution in 2023). See below for more details.
Notice how there is no place on the form to put the date when you made the contribution or the date when you made the conversion. It isn't on the form your IRA custodian sends to the IRS (1099-R) either.
Do It All Again Next Year
You do not have to wait any period of time between the contribution and conversion. Each year, I make my Traditional IRA contribution on January 2, then convert to a Roth IRA the next day or within a few days. That gets my investment money working as soon as possible and simplifies the record keeping. Vanguard won’t let you do it the same day (sometimes other providers will), so I have to wait one day anyway. Occasionally they'll make you wait up to a week. If you find you have a few pennies left in the account and are worried you'll get pro-rated, take a look at this post: Pennies and the Backdoor Roth IRA.
More information here:
How to Do a Backdoor Roth IRA with Vanguard
How to Do a Backdoor Roth IRA at Fidelity
How to Fix and Prevent Backdoor Roth IRA Mistakes
In this section, we're going to talk about how to fix and prevent common mistakes in the Backdoor Roth IRA process. In order to better organize these mistakes, we will break down the process into the six very clear steps used above and then will explain possible errors with each step and what to do about them.
6 Steps to Successfully Contribute to a Backdoor Roth IRA
- Step 1 – Contribute to traditional IRA ($6.5K, $7.5K if 50+ for 2021).
- Step 2 – Invest the money in a money market fund.
- Step 3 – Move money from traditional IRA to Roth IRA (i.e., a Roth conversion).
- Step 4 – Invest in your preferred investment (typically a stock, bond, or balanced index mutual fund).
- Step 5 – Ensure you have no money in a traditional IRA, SEP-IRA, or SIMPLE IRA on December 31st of the year you do the CONVERSION step.
- Step 6 – Report the transactions correctly on your taxes by filling out Form 8606.
Seriously. That's it. If you can do a cholecystectomy, you can do this. If you can work up a pulmonary embolus appropriately, you can do this. If you can manage hypertension well, you can do this. If you can fill a cavity, you can do this. Super easy.
However, people still manage to screw up on EACH of those six steps. Let's go through the mistakes people make, step by step.
How to FIX Backdoor Roth IRA Mistakes
Step 1 Error – Contributing Directly to a Roth IRA
An error that commonly occurs with a first Backdoor Roth IRA is that people simply don't realize that their income is too high to do a direct Roth IRA contribution. So instead of doing it indirectly (i.e., going through the Backdoor), which is no big deal even if you're under the limit, they contribute directly to a Roth IRA. Then they realize their Modified Adjusted Gross Income (MAGI) is over $138,000-$153,000 ($218,000-$228,000 Married Filing Jointly) for 2023. Now what?
Enter the Recharacterization
If you have made this error, now you have to recharacterize the Roth IRA contribution to a traditional IRA contribution. This basically makes it as though you never contributed to a Roth IRA but contributed to a traditional IRA instead. You usually have to call your IRA provider to get this done, but it's no big deal. In this section, I'll walk you through the details of how to do it.
You have until the due date of your tax return to do this (including extensions). So if you did an IRA contribution in January of 2021 for the 2021 tax year, you have until October 15, 2022 to do a recharacterization. There's no penalty or anything to do it. You can do the opposite as well if you contributed to a traditional IRA but meant to contribute directly to a Roth IRA.
Bear in mind that starting in 2018, you can no longer do recharacterizations of Roth CONVERSIONS (not contributions). This eliminated the “Roth IRA Conversion Horserace” technique for tax reduction.
Until recently, I had thought there was a waiting period after a recharacterization to then reconvert the money to a Roth IRA. However, that rule was only for recharacterizations of conversions, not contributions. There has never been a waiting period for a recharacterization.
Any gains that occur before the final conversion are, of course, fully taxable at your ordinary income tax rate in the year of the final conversion.
The Income Limit
The first thing to determine is whether this post even applies to you. If your income is below a certain amount, you can just contribute directly to a Roth IRA. That amount depends on several things. First, it is a MODIFIED Adjusted Gross Income (MAGI). That number is very similar to your Adjusted Gross Income (AGI). Remember how tax form 1040 works.
The first income line you come to is line 7b, your “Total Income.” When people think about income, this is generally what they think of. The third income line on the form is line 11b. This is your “Taxable Income.” This is what your tax bill is actually calculated from. It is basically your total income minus all of your deductions. In between those two, on line 8b, is another income, your “Adjusted Gross Income.” This is “the line” that people are talking about when they use the phrases “above-the-line deduction” and “below-the-line deduction.” If it comes out before your AGI is calculated, it is an above-the-line deduction. These are deductions such as self-employment tax, self-employed retirement plans, self-employed health insurance premiums, HSA contributions, student loan interest, alimony, tuition, and any IRA deductions. If it comes out after your AGI is calculated, it is a below-the-line deduction. These are EITHER your standard deduction OR your itemized deductions, like mortgage interest, state/local/property taxes, and charitable contributions. A MAGI is just a slight tweak to your AGI.
Below are the MAGI limits for direct Roth IRA contributions [2021]. If your MAGI is below the first number, you can just contribute to a Roth IRA directly. If your MAGI is over the second number, you cannot contribute at all. If your MAGI is between the two numbers, you can make a partial direct contribution (most shouldn't bother with this, just do it all through the Back Door).
- Married Filing Separately (and lived with spouse for at least part of year): $0-$10,000
- Married Filing Jointly: $218,000-$228,000
- Single or Head of Household: $138,000-$153,000
If you think you'll be anywhere close to that first number, do yourself a favor and just do your Roth IRA contribution indirectly, i.e., through the Back Door (contribute to a traditional IRA and then convert that contribution to a Roth IRA). Since 2010, there has been no income limit on Roth conversions and there has never been an income limit on traditional IRA contributions, just your ability to deduct them.
So how does a MAGI differ from an AGI? It's a very slight difference. Bear in mind that there are other MAGIs out there. We're only talking about the one that affects Roth IRA contributions here. But to get your MAGI, you simply take your AGI, you subtract some income from it and you add back in some other income to it. The worksheet showing you how to do this is Worksheet 2-1 in Publication 590.
Basically, you subtract income from a Roth conversion and you add income from IRA deductions (not sure why you'd have this), student loan interest (if you are using this worksheet, you probably don't have this), tuition deduction (you probably don't have this), a couple of rare deductions for foreign income/deductions (you probably don't have these), some savings bond interest you probably don't have much of, and some employer-provided adoption benefits. As you can see, for most people your MAGI = your AGI since all of these deductions are pretty rare for the folks worried about this limit for direct Roth IRA contributions. So focus on your AGI. That means if you contributed directly to a Roth IRA but late in the year realized you probably should not have, one easy fix is to get your AGI below that limit by contributing to an HSA or a self-employed retirement plan like an individual 401(k) or SEP-IRA. Note that giving a bunch of money to charity is NOT a solution to this problem because that is a below-the-line deduction.
How to Do an IRA Recharacterization
If you can't get your MAGI low enough, you will have to do an IRA Recharacterization. With a recharacterization, as far as the IRS is concerned it is as though you never made the Roth IRA contribution at all, but made a traditional IRA contribution instead. You don't report a recharacterization separately, you just report a traditional IRA contribution. Keep in mind as you read on the internet about recharacterizations that there used to be two types of them—a recharacterization of a Roth IRA CONTRIBUTION and a recharacterization of a Roth IRA CONVERSION. The second type was outlawed in 2018, but the first one, the one we're talking about today, is still perfectly legal. If you decide you want to undo a Roth conversion these days, you're simply out of luck. Here is how you do a recharacterization of a Roth IRA contribution:
- You tell Vanguard (or wherever your IRAs are) to recharacterize the Roth IRA contribution to a Traditional IRA contribution.
Yup. That's it. They take care of the rest. I mean, you can read all about all of the rules in Publication 590 Chapter 1 if you want, but that's basically what they say. Don't believe me? Fine. Here are the IRS instructions:
How Do You Recharacterize a Contribution?
To recharacterize a contribution, you must notify both the trustee of the first IRA (the one to which the contribution was actually made) and the trustee of the second IRA (the one to which the contribution is being moved) that you have elected to treat the contribution as having been made to the second IRA rather than the first. You must make the notifications by the date of the transfer. Only one notification is required if both IRAs are maintained by the same trustee. The notification(s) must include all of the following information:
- The type and amount of the contribution to the first IRA that is to be recharacterized.
- The date on which the contribution was made to the first IRA and the year for which it was made.
- A direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income (or loss) allocable to the contribution to the trustee of the second IRA.
- The name of the trustee of the first IRA and the name of the trustee of the second IRA.
- Any additional information needed to make the transfer.
In most cases, the net income you must transfer is determined by your IRA trustee or custodian.
See what I mean? It's just a phone call. Any earnings that the account had in between the contribution and the recharacterization just go over with the contribution. No big deal.
You have until your tax filing date to do this. Most of the time, that's April 15th of the next year. However, the IRS is even more lenient than that. You actually can do this for an extra six months after your tax filing date, but you will have to refile your return.
Where Do You Report a Recharacterization?
If you hire somebody else to prepare your taxes, you can skip this section. If you do it yourself, you'll need to make sure you report this correctly. According to Pub 590, you report it on our old friend Form 8606.
Pub 590 says this:
Actually, that's really misleading. If you read Form 8606, you will see that the only time it ever mentions a recharacterization is to tell you NOT to put it on the form.
So what is Pub 590 talking about? They're talking about this section in the 8606 instructions:
Reporting recharacterizations.
Treat any recharacterized IRA contribution as though the amount of the contribution was originally contributed to the second IRA, not the first IRA. For the recharacterization, you must transfer the amount of the original contribution plus any related earnings or less any related loss. In most cases, your IRA trustee or custodian figures the amount of the related earnings you must transfer. If you need to figure the related earnings, see How Do You Recharacterize a Contribution? in chapter 1 of Pub. 590-A. Treat any earnings or loss that occurred in the first IRA as having occurred in the second IRA. You can’t deduct any loss that occurred while the funds were in the first IRA. . .Report the nondeductible traditional IRA portion of the recharacterized contribution, if any, on Form 8606, Part I. Don’t report the Roth IRA contribution (whether or not you recharacterized all or part of it) on Form 8606. Attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2019, include the amount transferred from the Roth IRA on Form 1040 or 1040-SR, line 4a; or Form 1040-NR, line 16a. If the recharacterization occurred in 2020, report the amount transferred only in the attached statement, and not on your 2019 or 2020 tax return.
The bottom line is that you just report this recharacterized contribution on Form 8606 as if it were the regular old non-deductible traditional IRA contribution that you should have made in the first place. You also need to include a statement. What should your statement look like? I would write something like this:
To whom it may concern:
I made a 2021 Roth IRA contribution of $6,000 on March 13th, 2021, because I didn't know about the whole MAGI limit thing when I made the contribution. After becoming smarter, I recharacterized $6,137.14 (original contribution plus earnings) to a traditional IRA on November 4th, 2021, Thank you for helping our country fund its government. You're the best.
Hugs and kisses from your favorite taxpayer,
James Dahle
Seriously. It doesn't say what has to be on the statement, just that there is one “explaining the recharacterization.” You don't even have to tell them why you did the recharacterization. If you had a loss in the account between contribution and recharacterization, no big deal. It's still as though you made a $6,000 contribution to a traditional IRA and THEN it lost money. If you were able to deduct the contribution (you probably can't) you would get a $6,000 deduction. The IRA provider may also send you a Form 5498 (which has the recharacterized amount on line 4), but you don't actually do anything with it when you file your taxes. It's just an informational return.
Reconverting the IRA
Now here is where it gets interesting. You've now fixed your mistake in the eyes of the IRS, going from an illegal Roth IRA contribution to a legal traditional IRA contribution (that is probably not deductible for you). But you really aren't done with what you meant to do, which is put money into a Roth IRA. You now need to do a Roth conversion. You do it just like you normally would as if you had contributed originally to the traditional IRA. You can do it the very next day if you like. You can probably even do it the same day, just make sure there is a paper trail showing the money was actually in the traditional IRA at some point. There used to be a waiting period after a recharacterization before you could do a Roth conversion on that money, but that waiting period only ever applied to the recharacterization of a Roth CONVERSION (which is no longer allowed starting in 2018) NOT the recharacterization of a Roth CONTRIBUTION. So there is no waiting period. Just reconvert convert it and go on your merry way.
I hope this information helps you fix your mistake. Just do your Roth IRA contributions through the Back Door going forward and you won't have this problem again.
Step 2 Error – Not Investing in a Money Market Fund in the Traditional IRA
What happens if you LOSE money in between the contribution and conversion step? This problem is easily avoided by using an investment like a money market fund that does not go down in value for that time period, but some people fail to do so and end up losing money. When they work their way through their IRS Form 8606, they discover they have basis left over that they can then carry forward indefinitely for years! No big deal, it just makes your paperwork more complicated. Perhaps at some point in the future you'll do a Roth conversion of tax-deferred money and this carry forward basis will reduce the tax on that event.
What if you MADE money in the account between contribution and conversion? This actually happens most of the time, so I wrote an entire post on it called Pennies and the Backdoor Roth IRA. Technically, any money earned between the contribution and conversion step is fully taxable at ordinary income tax rates in the year of the conversion. If it is less than 50 cents, you just ignore it. More, you report it on your 8606 and pay taxes on it.
If it is still in the traditional IRA, either do another tiny Roth conversion or leave it there until you do next year's Backdoor Roth IRA process, either is fine. If you were smart and just used a money market fund and did the conversion as soon as your IRA provider allowed it (usually less than a week and sometimes as early as the next day), this won't be much money and there won't be much tax due.
Step 3 Error – Forgetting to Do the Conversion
If you forgot to do the conversion step for eight months afterward, it could be a huge gain you're paying taxes unnecessarily on. No way to fix this one, just pay your stupid tax and move on.
Step 4 Error – Forgetting to Invest the Roth IRA Money
Even worse than paying taxes on a huge gain, is not getting the gain in the first place because you left the money sitting in cash for months. No way to fix this one either. Your “stupid tax” this time comes in the form of opportunity cost. Just get the money invested ASAP to stop the cash drag. Maybe you even got lucky and the market went down in between contribution and investment so now you get to buy low.
Step 5 Error – The Pro-Rata Rule
Some of the most common questions I get are from people who make a late contribution to a Backdoor Roth IRA. What do I mean by late? Well, you are allowed to make an IRA contribution AFTER the calendar year ends. In fact, you have until tax day, usually April 15th unless you get an extension of up to six months. While it is to your advantage to contribute to retirement accounts as quickly as possible so that money can start compounding in a tax-protected way, I understand that we all have lots of good things to do with our money and sometimes this gets pushed back into the next calendar year. All it really does is complicate your paperwork a bit.
For example, if you made your 2020 IRA contribution in April 2021, instead of reporting both the contribution and the conversion on your 2020 taxes, you would report only the contribution there. The conversion would be reported on the taxes for the year you did the conversion, i.e., your 2021 tax return due in April 2022. Your 2020 IRS Form 8606 becomes a little simpler and your 2021 IRS Form 8606 becomes a little more complicated. Not a big deal if you can follow the simple instructions.
What confuses people, however, is the pro-rata rule. This is the rule that says you need to empty out your traditional IRA by December 31st of the year you do the conversion. Since these folks have never filled out a Form 8606 (or apparently read the instructions) they assume that for a 2020 contribution they need to have a balance of $0 at the end of 2020, even if they didn't do the conversion step until 2021. That's simply not the case. The pro-rata rule isn't applied until the year of the conversion, i.e., December 31st, 2021.
Emptying the IRAs
So how do you empty out those IRAs? You usually have two choices.
- Do a Roth conversion of the whole thing. This is what I generally recommend for small IRAs where the tax bill on the conversion would not be too onerous. It is quick, easy, and increases the amount of tax-free assets you have.
- Roll the money into a 401(k) or 403(b), either that of your current employer, that of a past employer, or to your own individual 401(k) if you are self-employed. This is usually a better option if you have a large IRA where you would rather deal with the hassle than pay the tax bill during your peak earnings years.
So how large is large and how small is small? Well, it's going to vary by the person and how much disposable cash they have. Most would consider an IRA under $10K to be small and an IRA over $100K to be large. In between, it's a personal decision as to which would be better for you.
What If You Didn't Empty the IRA?
So what if you screwed this one up? Well, your Backdoor Roth IRA conversion step just got pro-rata'd. There is a tax bill associated with that because most of your conversion was of tax-deferred money rather than post-tax money like it was supposed to be.
The fix for this is going to vary by the individual, but the easiest fix is to simply convert the entire IRA to a Roth IRA now, so you end up getting all your post-tax money into that Roth IRA. Another possible fix is to figure out a way to separate your basis in that IRA, roll the tax-deferred money into a 401(k), and then convert the basis left behind in the IRA.
Do yourself a favor and just empty the darn IRA by December 31st. Keep in mind that this is usually not an instantaneous process, so don't put it off until you're on holiday break at the end of the year.
Step 6 Error – Screwing Up the Tax Forms
Both individual taxpayers and professional tax preparers screw up IRS Form 8606 all the time. In fact, some of them haven't even heard of a Backdoor Roth IRA. (Incidentally, this is one of the best questions to ask while interviewing a potential tax professional—”How many backdoor Roth IRAs did you help last year?”)
The usual fix to this error is to file a 1040X (Amended Tax Return) and a new Form 8606. You can do this for the last three years if necessary. If you didn't file Form 8606 at all, you'll definitely want to do this. The key is to check lines 15c and 18 on Form 8606. They should both be a number very close to zero if the form is being completed correctly.
The tax preparer should NOT be filing Form 5439. If you did Steps 1-5 right, this form probably doesn't belong in your tax return.
A lot of people wonder about the 1099-R sent to them by their IRA provider and worry that it was done wrong and that it will cause them to pay tax they shouldn't have to pay. Sometimes the form was filled out wrong, but mostly this is just a lot of anxiety. What gets people anxious is finding something on Line 2a “Taxable amount.” As long as the box on Line 2b is also checked “Taxable amount not determined,” you're golden. Don't worry about it. If it is not, have the IRA provider send you a new, correct form, either with $0 in 2a or the box in 2b checked (usually the latter). Here's what mine looks like every year from Vanguard:
Note that Box 2b is checked, even though they are reporting a taxable amount of $5,500.07 to the IRS [$6,000.07 in 2021].
Again, if you're not sure how to enter this into Turbotax, check out my Turbotax tutorial.
Still Confused About the Backdoor Roth?
Need more help with a Backdoor Roth IRA? I wish Congress would just lift the rule against direct Roth IRA contributions for high earners and save us all this hassle, but who knows if that will ever happen.
- If you did your contribution after the end of the year, check out Late Contributions to the Backdoor Roth IRA.
- Here's a step-by-step tutorial for doing a Backdoor Roth IRA at Vanguard.
- Here's a step-by-step tutorial for doing a Backdoor Roth IRA at Fidelity.
- Here is a step-by-step tutorial reporting the Backdoor Roth IRA in Turbotax.
- Here is my prior post on 17 Ways to Screw Up Your Backdoor Roth IRA.
- You can hire a professional to help you, either a good financial advisor or a good tax strategist can assist.
- You can also ask your peers for help on the WCI Forum, the Private WCI Facebook Group, and the WCI Subreddit.
Late Contributions to the Backdoor Roth IRA
While it is “cleaner” to make your contribution and your conversion all in the same calendar tax year, you can make your contribution up until your tax filing date of the next year. Late Contributions to the Backdoor Roth IRA has more details about doing this but hasn't been updated in a while, so let's do it now. The key to filling out the 8606 correctly when you make a contribution after the calendar year is to recognize that the contribution step is reported for the tax year and the conversion step is reported for the calendar year. So imagine you did the following during the calendar year 2021:
- Made a 2020 IRA contribution (reported on 2020 8606)
- Did a Roth conversion of that contribution (reported on 2021 8606)
- Made a 2021 IRA contribution (reported on 2021 8606)
- Did a Roth conversion of that contribution (reported on 2021 8606)
Your forms would look like this:
2020 Form 8606 (Only Have to Fill Out Part I)
Note that all this serves to do is report basis for the next year. No tax is due. Since no conversion step was done during the calendar year 2020, you only have to fill out lines 1-3 and 14.
2021 Form 8606 (Must Fill Out Parts I and II)
Notice a couple of things here. First, you've got to do all of Part I plus Part II for this year because you did the conversion step, unlike last year (2020). Second, don't get confused by the fact that this form above says “2020” and line 4 asks about 2021. This is the 2020 form but you will actually be filling out the 2021 form. The 2021 form isn't published yet by the IRS so I had to use the 2020 form for this demonstration. So add one year to anything you see here. Let's go through this line by line.

Your Roth IRA contributions will need to go through the “backdoor” many times as you build your portfolio.
Form 8606 – Part I
- Line 1 – That's the money you contributed for 2021.
- Line 2 – This is your basis. Since you made a contribution for 2020 but didn't do a conversion during 2020, your basis is $6,000.
- Line 3 – $6,000 + $6,000 = $12,000
- Line 4 – Remember this is asking about 2022, not 2021 and since you won't make the mistake of doing your contribution late again, this will be zero.
- Line 5 – $12,000 – $0 = $12,000
- Line 6 – This is the line that triggers the pro-rata issue. Even though you made a 2020 contribution, you did so AFTER December 31st, so this line would still be zero if you filled it out for 2020, which you didn't because you didn't do a conversion in 2020 and got to skip lines 4-13. But this is the 2021 form and since you converted your entire traditional IRA, this will be $0.
- Line 7 – This doesn't include conversions. Since you didn't take any money out of your traditional IRA this year except the conversion, this is $0
- Line 8 – You converted a total of $12,000 this year to a Roth IRA, so $12,000.
- Line 9 – $0 + $0 + $12,000 = $12,000
- Line 10 – $12,000/$12,000 = 1
- Line 11 – $12,000 * 1 = $12,000
- Line 12 – $0 * 1 = $0
- Line 13 – $12,000 + $0 = $12,000
- Line 14 – $12,000 – $12,000 = $0 Note that when you do this form for 2022, line 2 will be $0. (Line 14 on 2021 form = Line 2 of 2022 form.)
- Line 15a – $0 – $0 = $0
- Line 15b – You didn't take money out of an IRA to help you survive a disaster, so $0.
- Line 15c – $0 – $0 = $0
Part II
- Line 16 – Line 8 is $12,000 so $12,000
- Line 17 – Line 11 is $12,000 so $12,000
- Line 18 – $12,000 – $12,000 = $0
Backdoor Roth IRA FAQs
Can I still do a Backdoor Roth IRA for last year?
You have until tax day (generally April 15th, but as late as October 15th if you file an extension) of the following year to make your traditional IRA contribution. There is no deadline for the Roth conversion step; it can be done at anytime. Make sure you fill out the paperwork properly according to the section above about late contributions.
Can I do last year's IRA contribution and this year's IRA contribution at the same time and convert them at the same time?
Yes. Just remember to report last year's contribution on last year's Form 8606 and this year's contribution and the conversion on this year's Form 8606.
Does my 401(k), 403(b), 457(b), Roth IRA, or inherited IRA count toward the pro-rata calculation?
No. Only traditional IRAs, rollover IRAs, SEP-IRAs, and SIMPLE IRAs count. See line 6 of Form 8606 for details.
What if it is a separate IRA? Does it still count?
Yes. All IRAs count toward the pro-rata calculation.
What should I do with my rollover or traditional IRA to avoid pro-ration?
If it is small, convert it to a Roth IRA along with this year's traditional IRA contribution and pay the tax due on it. If large, try to roll it into your employer's 401(k) or if you have self-employment income, into your individual 401(k).
I got pro-rated. What now?
The easiest solution is to convert the entire IRA, SEP-IRA, or SIMPLE IRA that caused the pro-ration and is now composed of both pre-tax and after-tax money. That is also the most expensive solution. A harder solution that may save you some taxes involves isolating the basis in that IRA by rolling the rest of the account into a 401(k) and then convert just the basis to a Roth IRA.
I am leaving my employer. Should I roll my 401(k) or 403(b) into a traditional IRA? If not, what should I do with it?
If you put it into a traditional IRA it is going to cause any future Backdoor Roths to be pro-rated. Better options include leaving it where it is, rolling it into your new employer's 401(k) or 403(b), rolling it into your individual 401(k), or if it is small, just converting the whole thing to a Roth IRA.
How much can I contribute to a Roth IRA via the Backdoor Roth IRA process?
In 2021, you are allowed to contribute $6,000 ($7,000 if 50+) per year for you and $6,000 ($7,000 if 50+) for your spouse. This includes all contributions to traditional and Roth IRAs. Rollovers/transfers do not count toward the annual contribution limit.
What should I invest the money into?
While in the traditional IRA for a day or two, leave it in cash. Once it is in the Roth IRA, invest it according to your written investing plan. If you don't have one, get one, but in the meantime it would be a good idea to put it into a lifecycle fund such as a Vanguard Target Retirement Fund.
Can I use the same traditional and Roth IRA each year or do I need new ones?
You can use the same ones each year.
The Backdoor Roth IRA process leads to more tax-free retirement account money for doctors and other high-income professionals. If you follow the simple steps outlined above, you will pay less in taxes, boost your returns, facilitate your estate planning, and increase your asset protection. Most members of The White Coat Investor community do these every year and you should too.
What do you think? Are you doing Backdoor Roth IRAs? Why or why not? Any questions about it? Comment below!
[This updated post was originally published in 2014.]
The only accounts I’ve ever had in the past are a 401k, my wife’s 403b, and a traditional Roth IRA from when I was underneath the income threshold.
Do I start at step #2 then?
Honestly I’ve seen you write about this a lot of times, but I’ve always felt if something seemed a little sketchy or non-traditional that it probably wasn’t a good idea and would come back to bite me in some way, shape or form… so despite understanding the logic, I’ve never done it.
But I continue to warm to it.
What is a traditional Roth IRA? There is either a traditional IRA or a Roth IRA, not both.
If you have no SEP, SIMPLE, traditional, or Rollover IRA, then you do not have to get rid of one before year end, that’s correct.
I meant a regular Roth IRA that was not done backdoor style.
I have a regular Roth IRA for me and my wife.
I have zero money in a traditional IRA, no SEP, Simble, or rollover or anything.
Only 401k a couple 403b accounts (both NON-roth)
If I contributed to a traditional IRA TODAY and converted it next week would it be for the ’13 or ’14 tax year?
It could be either or both. You can make 2013 contributions from Jan 2013 to April 2014. You can make 2014 contributions from Jan 2014 to April 2015.
So I can contribute 5500/ yr? If i contribute 5500 in December 2015, then make another contribution in 1/2016, do I just indicate that I made a single contribution for my taxes in 4/2016 and put the second contribution on the tax return in 4/2017?
Yes, you can do a 2015 contribution between Jan 1 2015 and April 15 2016 and a 2016 contribution between Jan 1 2016 and April 15 2017.
Yes, that is correct. You do not have to mention anything about the 1/2016 contribution when you file taxes in 4/2016.
When you file taxes in 4/2016, you just mention that you made $5,500 contribution (that you made in Dec 2015). And then again, in 4/2017, you indicate that you made $5,500 contribution.
So, I’ve been on the phone with Vanguard and Fidelity to look into a couple of things and I wanted to see if you could clarify because Vanguard has me confused.
Background:
EM doc. Finished Residency in 6/2018, now 1099 independent contractor. Looking to max out tax deferred retirement contributions for 2018. Looks like I will have to open SEP IRA to do so since I didn’t open individual 401K prior to the end of the year. Going forward, based on my understanding it would be easier to open individual 401k and max it out for 2019, open a traditional IRA max it out for 2019 and do backdoor roth conversion. This should total 56,000 401k+ 6,000 roth IRA, which I assume is decent for first full year out of residency. I am also investing in Real Estate, paying off significant student loans etc, saving etc…
With Fidelity I discussed opening SEP IRA contributing for 2018, then opening individual 401k/ traditional IRA –> roth conversion for 2019 + rolling over my 2018 SEP IRA contribution to my individual 401k to avoid any problem with the Pro-Rata Calculation.
AS you have stated, Vanguard does not allow SEP –> 401k rollover. But when speaking with them on the phone, they stated that I would still be able to max out an individual 401k for 2019, make traditional IRA and convert to roth despite having opening, contributing and maintaining a SEP IRA for 2018. This was not my initial understanding,I questioned them several times about this, they seemed confused/frustrated with my question but in the end guaranteed me that my 2018 SEP IRA would not affect Pro-Rata calculation for back door roth contribution in 2019. Where as on the phone with Fidelity they seemed to understand and agree with my initial plan to roll my 2018 SEP into individual 401k to avoid problems with Pro-rata calculation.
Hope that makes sense and I appreciate any clarification you can provide.
You can still do a 2018 Backdoor Roth IRA contribution. The conversion step will obviously be in 2019, but that’s fine. Just makes your 8606 a little more complicated.
Whoever you talked to at Vanguard is apparently not familiar with the pro-rata calculation demanded by line 6 of Form 8606. They’re right that you COULD convert to a Roth IRA, but it wouldn’t be what you really want due to the pro-rata calculation. I don’t think Vanguard phone reps are authorized to provide guarantees about tax advice such as this rep did. So either they did/said something dumb or you misunderstood.
Thanks for the quick reply. I’d probably be willing to do the extra work to do the 2018 Roth but I’m not quiet maxing out my SEP 2018 I’m close. Would it be worth using some of the SEP contribution to contribute to a back door Roth for 2018?
Don’t have enough info to say. I would probably do the SEP first if I were in my peak earnings years.
Do I have to get rid of inherited IRAs (ie convert to 401k’s) to avoid the pro-Rata rule to fund a Backdoor IRA?
No. They don’t count. Per the instructions, you file a separate 8606 for each inherited IRA.
I have a SEP IRA, my husband doesn’t. Can he do a back door Roth even if we file taxes jointly? Thanks!
Yes.
So do you contribute in the traditional ira 5000 or the max of 19500? And if I chose the maximum and I just started a new job in November, will the amount be deducted from 2 months only or throughout the year
You can’t put $19,500 into an IRA, that’s a 401(k). You can put $6K into an IRA ($7K if 50+). I’m not sure how your 401(k) deductions were set up. I’d call HR and ask exactly what will be taken out under your current settings. You may be able to put in more if you write a check. More likely, they won’t take anything out until you’ve been at the job for 6-12 months.
Hi,
Thanks for this post. Newbie over here trying to figure this out. in 2019 and 2020 I added the max 6000 each year to a traditional IRA. I invested that money into VFIAX. I have gained some money from it. My accountant confirmed that I already deducted the amount for 2019 on my tax return. I have not filed my taxes for 2020 yet. I wanted to see if it is too late to convert that money to a Roth IRA without being penalized or if it is just a matter of doing the backdoor roth IRA and just filling out the 8606 form?
Hope my question makes sense. Trying to make sense of it all after listening to your podcast and reading the article.
You can do it. If you got a deduction for the contribution, you’ll pay taxes on the conversion though.
Read your book few years ago! Enjoyed it!. I’m hopelessly conservative but thanks to this step-by-step guide I finally did this backdoor Roth this year with the urging of my tax preparer. I opened a new traditional Roth through Vanguard just this past week and it was converted to Roth IRA on April 5th 2021. We made this a “2020” contribution and a 2021 conversion). Main question is when should I do the next one? I’m assuming best time is right after the new year? ( because I’m assuming that it’s better to wait to contribute & convert until after December 31st 2021 otherwise I will have two conversions in 2021. But if I contribute sometime in 2021 but wait too long after in 2022 to convert I may earn too much interest which complicates things right?)
You can do it today. You’ll report a $6000 contribution for 2020 on your 2020 8606. You’ll report a $6000 contribution and a $12000 conversion for 2021 on your 2021 8606. More details here:
https://www.whitecoatinvestor.com/late-contributions-to-the-backdoor-roth-ira/
thanks!
I fear I have really screwed up my attempt at the backdoor Roth conversion. I contributed $5500 to a Vanguard traditional IRA in December and then shortly after converted it to a Roth. However, an old SEP IRA from a different bank was not yet 0–in process now. So…..it still had a balance on December 31. What are the awful consequences–for this year and future years? Many thanks!
You’re about to learn all about the pro-rata rule. Basically, for 2013, you’ll have to deal with the pro-rate rule and most of your backdoor Roth IRA isn’t going to work quite the way you hoped. However, during 2014, you should roll that SEP IRA into a 401K or convert it to a Roth IRA and all will be well in the end. It’s just going to make your 2013 taxes more complicated.
I have a situation. You said I should have 0 balance by Dec 31 of the year I make the roth conversion from a traditional IRA. Now I have some funds rolled over to my traditional IRA from my previous employer sponsored 401K plan, which need to be moved out (to an individual 401k plan, as per your suggestion). I am working as a locum tenen now and will receive a 1099. I do not own any business/corporation. Can I open an individual 401k with say Fidelity. Apparently, Fidelity denied to let me do so since I do not own any business. Can you please advise what to do in this situation, to reap the benefits of backdoor IRA?
Thank you.
What do you mean you don’t own a business? You absolutely do. It’s a sole proprietorship. Get an EIN from the IRS and tell Fidelity you own a business and open up that individual 401(k).
Thank you so much for your prompt reply. I believe I go to irs.gov and apply online for the EIN. Is there any fee for doing it myself? I have brokerage, IRA and roth IRA accounts with schwab. Do they allow rollover from IRA to individual 401k account.
I have another question. As an individual contractor what will be my best option for purchasing health insurance for family? My wife is joining school this fall and we may all join the student health insurance, which is not so good. In that case will 100% of the premium be tax deductible?
I don’t think there is any fee. Here is my article on individual 401(k)s but be aware that their websites often say one thing and their representatives another. I’m continually updating the data as readers tell me about it.
https://www.whitecoatinvestor.com/where-to-open-your-solo-401k/
Regarding health insurance, I’m no expert in what your best option would be for your family’s needs and local area. See a local broker. Premiums are deductible for the self-employed on line 29 of Form 1040. Employees who pay them have to put them on Schedule A with other medical expenses, subject to a huge 7.5% floor (which means they’re probably not deductible for a typical doctor.) In general, I like High deductible plans that allow you to use an HSA (stealth IRA.)
Hi – I am an academic MD and have a W2 income. I do some disability reviews/surveys that earn me $500-6000/yr – do I have to have an EIN to open a Solo 401K? Thanks
I don’t know of an individual 401(k) provider that doesn’t require an EIN. But it isn’t a big deal. A couple of minutes online and no money.
Hi!
I have been making backdoor IRA contributions the past few years. This year I made the traditional IRA contribution very late and the fund wasn’t available to convert to a Roth IRA until today which is the first of the new year. Unfortunately I’m too late to make the conversion for 2017 tax year. What would be the best course of action at this
time? Should I hold current amount in traditional IRA then add the additional $5500 for this new year in a few months and convert everything to a Roth IRA later in the year? Thanks in advance!
Just convert it now and make sure you fill out your 8606 right.
https://www.whitecoatinvestor.com/late-contributions-to-the-backdoor-roth-ira/
Was “shortly after” also in December 2013? If so, you will have to pay some taxes on your 2013 conversion, which may not be a big deal depending on what exactly you mean by “in process now” with regard to getting your SEP balance to zero. If you are converting the SEP to Roth in 2014, no big deal on your mess-up in 2013 — you pay a little more for 2013, a little less for 2014. If you are rolling the SEP over to a 401k-type qualified plan, be sure to rollover only the pre-tax money, not the after-tax money as a result of applying the pro-rata rule for 2013. If you rollover the whole SEP, you will eventually pay taxes twice on part of the money.
Alternatively, you can recharacterize your 2013 conversion and redo the conversion in 2014 (must wait 30 days) after you clear up the SEP.
Thanks, that’s very helpful. I knew I would be paying some taxes with the conversion process this year. I wanted to get rid of the SEP in order to facilitate doing tIRA–>Roth conversions in the future. The SEP is relatively small with a balance of $8000. I am transferring the assets to my Vanguard tIRA and will then do a conversion to the Roth–pre tax money only. I’ll have to check into recharacterizing the 2013 conversion–don’t know much about it.
Don’t worry about recharaterizing then if you are going to convert the SEP to Roth in 2014.
?typo on step 3. You stated, “is essentially the same process as opening the traditional Roth IRA.” I believe you meant “traditional IRA”, not “traditional Roth IRA”. It just seems a little confusing.
You can delete this post after you read it.
Thanks for pointing that out. I just corrected someone in a comment only to find I made the same mistake.
Nice and timely summation of a topic I’ve been very interested in. I have an IRA through a former (and rather nasty!) employer, who sent out paperwork as a 1099 on it – so I had to pay taxes on it already. I’d like to roll this over to a Roth, and would expect, since it’s already been taxed, it would be considered a non-qualified IRA, and as such, the conversion would be taxfree, as you outlined above.
Comments? Thanks!
I”m not sure what you mean by an IRA through a former employer. IRA stands for individual retirement arrangement, and doesn’t come through an employer. Do you have a SEP or SIMPLE? Those should be pre-tax. Something is screwy here.
I agree, if you hire an accountant, make sure they correctly fill out the 8606 form. I have always done my own taxes on TurboTax, but about 3 years ago I decided maybe I should hire a professional because I might be costing myself more in lost tax savings than if I just hired someone. I hired a very reputable local professional (not one of these H&R block outfits). This year I got an IRS notice saying I owed $10,000 on my Roth Conversion from the year he did my taxes. I noticed he never filed the 8606 form. I sent in my response with the form and everything was resolved. I’m back to doing my own taxes.
I am a graduating resident, so this is my last year to do a pure Roth, and also the first year I have had disposable income to contribute.
There is no limit to the number of Roth IRA’s that one has, right? can I have one at Scottrade (that allows option trading within the Roth) and in a year open a backdoor through Vanguard (for low ER funds)? I understand that it will take a few years until I can really start investing meaningfully in the Vanguard account anyway because of minimum requirements (3k)
The IRS considers you to only have one ROTH IRA, even if you have accounts at tem places. The term IRA stands for individual retirement arrangement, not account like most people assume.
You can have as many as you want, but can only contribute $5.5K total ($6.5K total if over 50) to all of them. I have 3 different Roth IRAs- one at Vanguard, one at Bridgeway, and one at Lending Club. Remember Vanguard has a number of funds with a minimum of $1K.
What happens if I contribute to a tIRA based on my measly resident income, deduct it and send my taxes in the next day, and then on the third day convert to a Roth…?
It’s the same as if you just contributed to the Roth in the first place.
To my understanding when I recently rolled over a SEP IRA to a Solo 401K, and now about to do a backdoor conversion is that you can have have a SEP or other retirement vehicles, you just can not contribute to them the same year you do the conversion. So if you have a SEP, you can still hold onto it, but don’t add money to it the same year you want to do the backdoor Roth conversion.
You can add money to it the same year, you just have to convert the whole thing or roll it into a Roth IRA. All that matters is the SEP IRA balance on December 31.
I see how that worked out. I can only contribute to a SEP or 401K in a single tax year. I chose to keep the SEP till the end of the year to maximize contributions for that year, and then rolled it over late Dec. Thanks for clarifying
For the past several years I have been making annual contributions of $5,500 each to non-deductible IRAs for both myself and my wife. I have no outstanding Traditional IRAs (I previously rolled them over into my 401k) so I can convert to Roth at any time. Currently, total non-deductible contributions are around 40K and the total value of the account is around 55K. As you can see, I am waiting for an opportune time to convert and I was wondering your thoughts on the matter. I will convert in either of the scenarios below…
1. The market drops considerably so my ‘cost basis’ would (hopefully) be close to zero when I convert (rather than about 15K as it is now) such that my tax liability would also be near zero.
2. I retire early and have a few years when my taxable income is zero or minimal. This would place me in a lower tax bracket and any tax liability resulting from non-deductible IRA to Roth IRA conversion would therefore be minimal.
Your thoughts on this strategy?
My wife’s situation presents more of a problem. As she has not worked for the past 8 years (since I began non-deductible IRA contributions) and has considerable investments in multiple IRAs (totaling perhaps $150K). What you advise for her? As she does not work currently, I cannot set up an individual 401K with Fidelity to accept rollovers for her deductible IRAs. I am hoping she either a) Starts up her own business earning at least $14k per year so she can open a individual 401k or b) Goes back to work as a teacher and opens a 403b that accepts rollovers. Any further ideas on how to handle my wife’s non-deductible IRA contributions since her current deductible IRAs present a conversion problem vis-a-vis the ‘pro-rata rule’?
1) You have your ‘cost basis’ backwards, but point taken.
2) That’s fine if it’s coming up shortly. If it’s still far off, by that time your $55k can become $255k.
You can rollover $15k pretax money to a 401k now and convert the remaining $40k. See the charts in my article linked in this post.
Your wife doesn’t need to earn $14k before she can open a solo 401k. $400 will do. How about tutoring?
I actually don’t have the ‘cost basis’ backwards. I have been making NON-DEDUCTIBLE IRA contributions over the past eight years totaling about 40K contributed which has grown to about 55K. Thus,my tax liability for a conversion would only be the difference (55K-40K=15K taxable at my marginal rate). The reason: I made these contributions for purposes of asset protection but was unaware, until only recently, that I could convert to a ‘backdoor’ Roth.
I will look for opportunities for my wife to earn $400 as a sole proprietor. Who knew the minimum to open a solo 401k was so small?!
Thanks,
Gary
He’s saying your basis is backwards because the $40K is the basis. You don’t pay taxes on the basis in the conversion.
You’re right that if the market drops before you convert that you’ll save taxes. The opposite, of course, could easily occur. Since the market goes up most of the time, I would convert yours sooner rather than later. In fact, I would have converted as I went along each year rather than saving it all up. Right now if you converted you’d owe about $5K. It’s quite possible in a few more years you could owe a lot more on a conversion. I wouldn’t wait for a lower bracket, since the increase in value is a far bigger factor.
I agree with Harry that if you can isolate your wife’s basis that will be the best course. I managed to do that with my TSP money a few years ago.
Is there actually a minimum amount of earnings you must have to open a Solo 401K? I’m not even sure you have to have earnings, do you? Just a viable business with an EIN as far as I know.
Thanks for clarifying. Harry Sit implies in his reply that my wife would need at least $400for a sole proprietorship to qualify for setting up a solo 401k but you seem dubious. Any idea where I might find an answer to this question?
I don’t know if he was using $400 as a specific number, or just saying you need very little income to justify a Solo 401K. I have never heard of $400 as some minimum income needed.
I appreciate this and hope I can utilize it in the future but really. How dumb are our tax rules? Why not just let everyone have a ROTH regardless of income and make it easier?
I am sure you are aware that government makes everything more complex. It ends up creating more jobs to understand and work through the complexity. Look at medicine today and how much paperwork is now required to do very simple things. In the past you can just send in your bill with a short free hand note and that was it. Now you need someone for coding and billing, claim disputes, file management.
I wish I had something like this post 5 years ago. It took me way to long to figure this out on my own.
Thank you for this amazing post. I just want to clarify my situation. If I have a 403b from my employer and a Roth IRA only, do I need to open a traditional IRA, make a contribution to that traditional IRA and then rollover to Roth IRA? If I do need to open a traditional IRA, do I fund it myself from my bank account or does it need to be a direct payroll deduction from my employer? Thank you again!
Yes.
Yourself.
Employers have nothing to do with IRAs.
Thanks a bunch!
So I have about 20K in a traditional IRA from before I qualified to contribute to my group’s 401k. I became ineligible to contribute more to the trad IRA once I qualified to the group’s 401k and have been maxing the 401 since then.
My question is, can I open another trad IRA account, put post-tax money in it, and just backdoor this new one to a Roth. Will my older trad IRA (with untaxed money in it) be any hindrance to this plan?
Yes. You must get rid of the old IRA. All IRAs are included in the pro-rata calculation. Roll it into your 401K or pay the taxes and convert the whole thing.
I am a little confused about the pro rata rule. If all IRAs are included in the pro rata calculation, and I move money into a Roth IRA, will I have to figure out where to stash it next year, so I can backdoor again? Won’t that defeat the whole idea? Or do only traditional IRAs, Sep IRAs, and Simple IRAs count toward pro rata, and not Roth IRAs? Thanks!
Exactly. Roth IRAs don’t count. Only traditional, SEP, and SIMPLE IRAs.
For pro-rata rule, do spouse’s traditional IRAs count if you file taxes jointly? Or do only those belonging to the individual doing the backdoor Roth count?
No. IRA stands for INDIVIDUAL Retirement Arrangement. You each get your own 8606 so you are each pro-rated separately.
“The total sum of these accounts on December 31st of the year in which you do Step 3 must be zero to avoid a “pro-rata” calculation that can eliminate most of the benefit of a Backdoor Roth IRA.”
I don’t quite understand these…can you explain?
Perhaps the best explanation is the cream in the coffee example. The non-deductible dollars in the IRA are the cream. The tax-deferred dollars in the IRA are the coffee. Once you mix them, you’re not getting the cream back out, it all comes out as a mixture.
What I do is I put the cream in an empty cup. Then I convert it. Since it is all cream, I pay no taxes. If you already have 4 ounces of coffee in the cup, then add 1 ounce of cream, it all comes out as a mixture. If you only take out 1 ounce of creamy coffee, then you pay taxes on 4/5 of it, since it is 4 parts coffee, and 1 part cream. That’s the pro-rata contribution.
In dollars, let’s take a look at this example. You have a $20,000 tax-deferred IRA. You then add $5000 of non-deductible IRA contribution. There is $25,000 in the account, with a basis of $5000. If you convert the entire account, you pay taxes on $20,000 and you get $5000 tax-free. If you convert half of the account, you pay taxes on $10,000, and $2500 comes along tax-free.
Does that help?
thanks. but I still don’t get it.
I don’t mix cream with coffee.
Keeping old tax-deferred IRA at Brokerage One; open new non-deductible IRA and just convert it at Brokerage Two.
Why I have to get rid of old IRA (rolling into 401K) before doing that?
That’s just the way the tax laws work. All IRAs are considered together, no matter where you hold them. Work through Form 8606 and you’ll see why. The IRS knows how much you have in IRAs because it is reported each year.
The person above could also transfer 20k into any 401k/403b that accepts transfers. Then he can backdoor the remaining 5k at no tax liability. At least, this is how I understand the schematic from Harry Sit.
I have 40k in a traditional IRA that was initially rolled over from a prior employers 403b. I also contributed 5.5k to traditional IRA in 2016 and 2017, both nondeductible. For 2017 I was initially thinking of doing a backdoor ira but have not rolled over my prior 40k traditional by December 31, 2017. Can I rollover my 40k into my current company’s 403b and then can I convert 15k to backdoor for 2018 (5k contributed in 2016, 2017, 2018). Or is it better to rollover all I have (including the 2016 and 2017 contributions) into current company’s 403b and just backdoor 2018. Don’t want to pay too much pro rata. Thanks!
Assuming I already hold a combination of traditional IRA’s and Roth IRA’s, could the pro-rata rule be avoided in retirement if I deplete the the traditional IRA’s before touching the Roth IRA’s ?
The pro-rata rule only matters for conversions. So if you wanted to do conversions in retirement, then yes, once your traditional IRAs are spent, you could do conversions without worrying about the pro-rata rule. That’s kind of too late for what you’re trying to do.
Please help me understand the timing of this. Do I have until tax day 2013 to do the initial contribution and backdoor conversion for 2012 or did this already pass on December 31st.
Also, can you refer me to the listing of the hierarchy of investment accounts. 1) 401k up to company match 2) hsa 3)… Etc and where this would fall along that spectrum.
The deadline for contributions is April 15th of the following year. There really is no deadline for conversions. The deadline to get rid of traditional IRAs to avoid pro-rata calculations on taxes for that year is December 31st. So the deadline for a 2012 contribution was April 15, 2013.
The hierarchy changes depending on many things. But a reasonable hierarchy for a typical attending would be:
1) 401K up to the match
2) High interest debt
3) HSA
4) Tax-deferred accounts of any type (401K, 403B, 457, DBP etc)
5) Backdoor Roth IRAs
6) Moderate interest debt
7) Everything else depending on priorities
Great post. You put contributions to a 457b ahead of a backdoor roth IRA, and this is something I just started to think about. To me, the 457 might have the advantage tax-wise as most of us attendings make more than we will withdraw in retirement and expect our current marginal tax rate to be higher than our retirement rate (though we may be wrong). On the flip side, 457 plans are subject to the credit risk of our employers, and that puts our jobs as well as our savings in the same risky basket. Things to think about…
It’s pretty tough to pass up on that tax break, even with the credit risk. Good reason to spend that money first in retirement, of course.
Hi. Great post. I have 2 questions.
1. Where do things like making a 529 account for kids come in this hierarchy ?
The hierarchy changes depending on many things. But a reasonable hierarchy for a typical attending would be:
1) 401K up to the match
2) High interest debt
3) HSA
4) Tax-deferred accounts of any type (401K, 403B, 457, DBP etc)
5) Backdoor Roth IRAs
6) Moderate interest debt
7) Everything else depending on priorities
2. And my second question is – Since my income is high and i have already paid my tax on that $5500 ( that i plan to put in trad ira), doesnt it make sense to convert it to roth ira every year ? I mean why isnt it a ‘no brainer’ ? The reason i ask this is that a lot of websites say , “this conversion might not be right for you if you are going to be in a lower tax bracket at retirement”, but i think that since I am funding this trad ira with POST tax dollars, why to leave that money in trad ira (only to be taxed again on withdrawal) . Please let me know if am thinking wrong ? Also , I have heard that I am subject to penalty if I open a roth ira if my employer is already providing a 403B ?
thanks in advance
Your list isn’t bad. However, I wouldn’t add 529s to it because they’re aimed at a completely different goal. While everything else is about improving your financial position (primarily getting you to financial independence), 529s are for college funding. So they’re above and beyond anything on that list.
Yes. The Backdoor Roth IRA IS a no-brainer because you’re comparing a tax-free Roth IRA to a taxable account or a non-deductible traditional IRA and the Roth IRA always wins that comparison. You’re confusing a standard Roth conversion with a Backdoor Roth IRA. They aren’t the same thing. One is contributing to a Roth IRA via the backdoor (always a good move) and the other is pre-paying tax on a tax-deferred account, which may or may not be a good move.
No, you aren’t subject to a penalty for opening a Roth IRA just because your employer has a 403(b). Whoever told you that is ignorant at best.
Sorry, im still a bit confused with the concept of a backdoor roth despite reading the blog and comments. Can you please help me? I get the concept that its another avenue of money to draw from if you retire “early” esp if before 59.5 and you need money to float you. Or that there are less penalties should you need to draw from it, but again what i have a hard time understanding is if you are in a high tax bracket say 30-35% and your paying this on your income and then taking 5500 out of THAT SUM and putting it into a tradition ira to roll over into a backdoor roth your still taking a pretty large tax hit right? I must be missing a concept here. Are you saying that i can put pretax money into a traditional ira and then roll it into a backdoor roth? I feel like one way or another i am going to pay tax either on my income or when i roll it? Am i missing the ball? Thanks for the help I appreciate it!
You pay the taxes on that money up front either way. Now you need to ask yourself if you would rather the money grow tax-free in the future or be taxed as it grows/kicks off dividends and capital gains. In addition, would you like it protected from your creditors and to pass to your heirs outside of probate? If the answer to those is all yes (and of course it is) then a Backdoor Roth IRA instead of investing in taxable makes sense. Remember that for a high earner with a retirement plan at work, a traditional IRA contribution is NOT deductible. So you’re not choosing between tax-deferred and tax-free. You’re choosing between taxable and tax-free.
Has anyone considered a Roth IRA that a teenager can fund? Can I have my teenagers work in my office doing filing and making copies and get them some earned income? Some day they will appreciate never having to pay taxes on the compounded earning.
Absolutely. In fact, many parents “match” their teen’s income, so all of it goes into a Roth IRA, but they still get to spend it all thanks to the Bank of Mom and Dad.
My parents helped me open an IRA when I was 10. This was pre-Roth, but by the time the Roth option came along, I still didn’t have any significant income so I was able to convert it without paying any taxes. In fact setting up a Roth IRA account for your kids is a great way to pass money down to them that will never be taxed again. And heaven forbid they actually learn how to work in the process, obviously them working is an essential component to being able to contribute to the account.
Thanks! Thats a great tip Jon.
Does that in any way help in my taxes if I open one for my son?
Just realized my son actually has to earn some money before I can put money for his Roth. For now its not a reality.
Wow, this is crazy timely. I just got a 2013 1099-R in the mail from vanguard and was crapping my pants. It says I got a distribution from my Traditional IRA of $5500 (which I did not, I just did the back door Roth) and that $5500 of it is taxable because of “early distribution, exception applies”. Did I F something up on my taxes last year (never filled out an 8606 last year, I did do a backdoor Roth for the first time in 2012), F something up in the timing of my conversion to the Roth, or is this a non issue that gets worked out with the 8606 form?
Do I need to go back and file an 8606 for 2012 taxes? I am not very tax savvy and may have gotten penalized without even knowing.
We should all get a 2013 1099-R this month. If you did a backdoor Roth in 2012, you should have done a 2012 8606 9 months ago.
So YOUR 1099 will say the same thing, that you have $5500 in taxable distributions? And we just ignore that because the 8606 cleans it up? When you fill out your taxes, you do own up to that 1099 but it gets negated by the 8606?
My 2013 1099R has the following in it:
1) 5500
2a) 5500
2b) X
4) 0
5) 0
7) 02
12) 0
14) 5500
My wife’s looks the same.
Since you put the basis ($5500) onto the 8606, then yes, that “cleans it up.”
Huge huge thanks!
A few years ago, I made the mistake of rolling over a 401k from a former employer into my nondeductible, traditional IRA. I didn’t realize until afterwards that it would complicate tax matters for backdoor roth conversions going forward.
Currently the value of the trad IRA is less than the sum of my nondeductible contributions plus 401k rollover(due to market losses). I now have the option to rollover pre-tax funds to a new employer 401k. Should I only do it for the amount in my trad IRA that is above my nondeductible basis? (rather than the original amount I rolled over from my old 401k).
So, just to make sure I understand correctly, even if I already have commingled funds, I can still rollover only the “pre tax” portion to a new 401k and keep only post-tax dollars for my Roth conversion, up to the amount of my original basis, and be able to avoid taxes at conversion?
Thanks, your website is awesome–you helped me find a solution to something that’s been bugging me for a couple of years!
If the 401K accepts transfers and only accepts pre-tax money, then roll all the pre-tax money into it, and then convert what’s left. No taxes should be owed.
my current 401K is with vanguard. I had a 403 B that was transferred to a traditional IRA years ago from my previous employer. Vanguard won’t accept these funds into my current 401 K. How or where can I eliminate this traditional IRA so I can do my backdoor ROTH,.
You can either find another 401(k) (at a job you have now, a job you can get, or an individual 401(k) opened at Fidelity or etrade) or you can convert the entire amount to a Roth IRA.
By the way, Vanguard does close accounts with 0 balance – after 18 months. We discovered it on Dec 31st when we wanted to do the contribution exactly as described above. However, the last conversion out of that account was in June 2012 (for some reason we did it mid-year then), 18 months and 12 days earlier and the traditional IRA was missing, so we had to go through the trouble of reopening. Just watch out for the 18th month mark, or do it around the same date every year for simplicity, that’s what I intend to do in future.
They closed my wife’s before 12 months went by!!! I was quite peeved. For some reason they didn’t close mine, and it was 0 for the same amount of time. I reopened my wife’s and put auto investments into each one, hopeful they won’t close an account early if it has an auto investment heading into it.
(My auto investment is $5500 on December 6 each year).
That was helpful. How about doing a similar tutorial on form 5500 for individual 401k accounts with assets over $250k?
I was just reading through this fantastic article on back door Roths and came across this comment. Completely agree given the implications of not filing your 5500 or filing it late. Maybe its on the site and I just haven’t seen it. Accountants charge $500 a return. I did 3 of mine late last year under the new Delinquent filing program and had to do the same thing this year which costs $500 for each return. I don’t plan on being late in 2018 😉
Jim – How long do you keep the money in the converted Roth in Prime money market funds? When you exchange/ convert to some other funds like Vanguard Total Stock Exchange, does it create any issues?
Thanks for the detailed info. Very helpful.
I wish you can do a similar detailed post about rebalancing portfolios at the end of the year and how to harvest tax losses.
I am a new attending an have been recommending your website to all our residents and fellows.
I put my money directly into my asset allocation when I convert to Roth. You could put it into Prime, but I don’t see any reason to. It shouldn’t create any issues to do that. Here is an article on tax loss harvesting:
https://www.whitecoatinvestor.com/tax-loss-harvesting/
Here’s one on rebalancing:
https://www.whitecoatinvestor.com/rebalancing-the-525-rule/
Thanks. I will look into them.
On a different note, if I am saving aggressively, and have maxed out by 401k, 403b, college savings, etc – what are the other options? I could put money into traditional IRA’s, but if I put a lot in to it – it will make it impossible to do the Roth conversion anymore (pro-rata), right? My wife’s a physician too and we don’t see any major options which are tax efficient and are relatively simple to implement. We are also doing the HSA and dependent saving accounts based on your posts. However, both these are employed based plans and makes it compulsory to withdraw the money in the calendar year unlike your HSA.
You are limited to $5500 total ($6500 if over 50) per person into traditional IRAs and Roth IRAs for the year.
HSAs are not employer based. You’re thinking of an FSA or something. I’m not sure what a dependent savings account is, but perhaps consider a UTMA/UGMA for money you want your kids to have.
Sounds like it might be time to move on to a taxable account. It can be very tax-efficient if you do it correctly.
https://www.whitecoatinvestor.com/retirement-accounts/the-taxable-investment-account-2/
Any way you could add a “print” button to make it easier to print out your articles in an “easy to print” format?
I try not to print much to stay green, but sometimes when you are going over stuff with your spouse it helps to have a written copy
Hmmm…..That’s a great idea. I’m not sure how to do it but I’ll look into it.
Well, that was easy. Look for the little buttons on the lower right corner of each post.
Thanks bro
I started an traditional IRA with Vanguard last year and placed $5500 in it with the thought of converting it to a Roth IRA but never did. Can I still convert the traditional IRA to a Roth at this time and have it count on last years taxes(2013) and then latter this year, contribute $5500 to my traditional IRA(I have not contributed anything yet in 2014) and convert it to into a Roth IRA a short time later all during this calender year?
You can still convert it now. There is no “counting” on the taxes. You don’t get a deduction for the contribution and don’t pay taxes on the conversion. The end result is just like contributing after-tax money into a Roth IRA. Make your 2014 contribution, then convert the whole thing.
Thanks!! Love the website!!
The minimum amount to open vanguard prime money market account is $3000. The key to not closing the account is to leave a little of money behind ($1) on that account before doing a back door conversion. For those considering using this particular fund for conversion…. Once again WCI, great post
Wouldn’t this mess with the prorata in the future? Is having the account closed such a bad thing, such as will it reflect on your credit score?
First, pay your bills and your credit score will take care of itself.
Second, investment accounts have no bearing on credit scores. It’s only closing credit accounts that affects it.
Third, the prorata calculation only has to do with dollars in IRAs, not the number of accounts.
You don’t have to leave money behind. I leave zero money behind in Prime Money Market Fund in a traditional IRA every year. $5500 spends one day in the account, then it is all gone. The account sits empty for 12 months, rinse, repeat.
If you have enough income that you need to do a backdoor Roth, you should have enough to fund it all in one fell swoop.
Ok, so when you contribute 5500 on Jan 2nd of a given year, then convert the next day is it for that given year or for the previous? For example, can I contribute 5500 on Jan 2 2017 for my 2017 contribution and then on Jan 3 convert to Roth for 2017 and that is it? Or do I have to prove I made too much money for a Roth IRA in 2017 first?
That year. I did the previous year in January of the previous year. But you could do it that way if you want. You don’t have to prove you made too much money to do a Roth IRA through the backdoor. Anyone can.
I talked to Merrill Edge about this today.. sounds pretty seamless except that they told me if I didn’t leave $50 in the traditional IRA that they would close it in 6 mo. and then I’d have to go through the hassle of setting up a new account again if I wanted to do this the next year.
Any thoughts on this… will it make things complicated tax-wise.. any workarounds?
Merrill Edge? Why would you invest there? Why not just open an account at Vanguard or Fidelity instead of dealing with Merrill? You don’t have to use an old traditional IRA when you can open a new one at Vanguard in 5 minutes.
WCI is right. If you’re reading this deeply into the blog you should have a pretty good understanding on the investment process and likely do better than the vast majority of Merrill advisors. Generally speaking, you won’t run into a whole bunch of bogleheads around the Merrill Lynch office — you’re better off opening a Schwab, Fidelity, Vanguard, etc. Just because you bank at BoA doesn’t mean you need to stick with their investment arm.
I don’t use their advisers.
Merrill Edge is their self-directed area.
And if you have enough money with them it’s the best deal in the business.
I was born at night, but it wasn’t last night
Because if you have 100K with Bank of American you get 100 trades per mo. free and so I can get any Vanguard ETF or iShares or anyone 100% free.. no trading costs, no maintenance fees, no fees of any kind ever.
No better deal in the business… bar none.
no to mention if you have the aforementioned 100K you get the keys to the best cash back credit card in the industry.. not to mention a ton of flexibility with your money.
Bank of America has really rolled out the carpet for rich guys.. their package if you keep good money with them is absolutely fantastic.
I think WellsTrade is pretty similar, lots of free trades as I recall. I know I’m not paying commissions for Vanguard funds in my HSA at TD Ameritrade as well. I’m curious to hear about the cash back card. Does it beat the Fidelity AmEx (2% on everything) plus PenFed (5% on gas)?
Maybe. 1.75 everything, 3.5 grocery, 5.25 gas.
It’s a 1 2 3 card in those categories with a 75 percent bonus if you are platinum plus privalege
That is a nice card.
I know this is an old thread but Z above is only referring to the Cash Rewards CC by BofA. The Travel Rewards CC by BofA gets you 2.625% cash back on everything with no limits if you have $100k combined between BofA checking/savings and/or ME. Pairing that with the Cash Rewards CC gets you 3.5% back on groceries/wholesale clubs and 5.25% back on gas (up to $2500 per quarter).
White Coat — I know this thread is old, I was researching another topic and saw this. I was considering moving my HSA investments to TD Ameritrade, and I specifically see you say that you, “know [you’re] not paying commissions for Vanguard funds in my HSA at TD Ameritrade”.
Can you elaborate on this? I can’t find a single Vanguard NTF fund at TD Ameritrade…there are no-commission ETF’s and no-load mutuals but I can’t find any Vanguard NTF’s…I was wanting to do what you are suggesting there, but was put-off by TDA’s $49.99 fee for No-Load funds (which most the Vanguard’s are). That would mean each transfer in/rebalance could really rack up the commission charges. What am I missing?
I buy Vanguard ETFs in my TD Ameritrade HSA account. Sorry for the confusion. I’m also put off by $49.99 transaction fees.
I was pleased to discover that Schwab leaves about three cents in my non deductible traditional Ira after I convert to my Roth account. They keep it open the whole year and it makes it super easy to re-contribute for the next year. They have figured this out in the last year or so because three years ago I had to re-create a new traditional Ira account after I converted. Hopefully Merrill will figure this out. If not, switch. Or call them and ask them to leave a few cents of accumulated interest that doesn’t get capitalized. This must be what Schwab is doing because I convert the whole account.
Thinking to open IRA at Merrill, since i do most of my banking at BoFa, anyone has encounter difficulties doing the Back Roth IRA with them?, if so I might just go with Vanguard to avoid the hassle. Thanks!
That is what I use and it is great.
Great!, thank you Tashfeen.
Personally, I’d go to Vanguard.
Any concerns with having to wait 8 days with Vanguard before you can convert the trad IRA to ROTH IRA? I haven’t checked the timeline for the other companies though. I’m graduating residency this year and have been reading a lot! Thank you for all of your posts. I am hoping to roll over my post tax dollars in my ROTH 401k to a ROTH IRA. As for the pre-tax dollars in my ROTH IRA, I’m unsure if I should pay the taxes on them with my 1/2 attending salary this year to roll them into my ROTH IRA as well **or** just roll them over to a traditional IRA, add money to that trad IRA, and then do the “backdoor” to a ROTH IRA.
I don’t really see an advantage to doing this. Why would I convert $230k of tax deferred into a Roth IRA and pay taxes when I’m in the highest bracket right now? If I prefer to invest my SEP with vanguard funds I don’t want to place my money with a different firm.
I don’t see such an advantage for $5500/yr to cause me to essentially forgo my SEP when I get 51k tax advantaged space. Once I get to the point I want to save amounts above that I will set up a defined benefit plan. As a 1099 SCorp this would be most advantageous, correct?
I am assuming doing these back door Roths are mostly for W2 situations, correct?
I like to keep investing as simple as possible which every year doing a conversion doesn’t seem to be. It seems to me to be easier to just buy stocks/funds through an account like scottrade for accumulating retirement monies to be available if I want to retire early.
I edited your three comments to put them all into one.
You are correct that converting a $230K SEP-IRA into a Roth at the highest tax rate in order to make $5500/year Roth IRA contributions probably isn’t a good move. However, if you have a 401K, or can open an individual 401K, you can then roll that SEP money into the 401K without any tax bill, and then do Backdoor Roths for the rest of your career. You could also do a spousal backdoor Roth IRA either way, unless you’re either not married or your spouse has a bunch of money in a SEP or traditional IRA.
While I agree that keeping investing simple is a good thing, leaving significant money on the table is not. Only you can decide how much money is significant to you. But consider $5500 per year contributed to a Roth IRA for 30 years vs $5500 per year invested in a taxable account. If the pre-tax investment is 8%, then after 30 years, you have $672,902 in the Roth and, assuming a 23.8% LTCG/Dividend rate, $507,259, a difference of $165,643, or about $5521 per year for the hassle of 5 minutes of work, plus maybe screwing around for an hour or two doing the initial rollover of the SEP. I’m not sure how much you make per hour, but I don’t make that much, so I find the hassle quite worth it.
There are plenty of ways to get to retirement money before age 59 1/2 if that is your main concern. Frankly, if you’re in the top bracket, you’ll probably have plenty of taxable money above and beyond your retirement accounts including backdoor Roth IRAs.
You can have an individual 401K at Vanguard, although you’ll probably need to open one elsewhere to do an initial rollover of your SEP since Vanguard’s doesn’t accept them.
Good luck with your decision. I hope you at least see the advantage, whether or not you feel it is worth the hassle.
You are right JIm. I did this the first time this year and it didn’t take more than 15 mins.
Also, don’t forget 5500 for your spouse, which doubles all the figures Jim just mentioned.
As Jim mentioned before, once you have maximized your 401k and other similar accounts, this provides a great tax diversification.
I definitely see how it can be beneficial, but you are omitting the fact that it costs money to setup you’re own 401k as a corporation, followed by the ongoing accounting costs of filing returns for the 401k. At least that’s what my CPA told me today.
Do the math on a Roth growing at the same rates you showed vs putting 9-10k/yr (pretax Roth funds) into a defined benefit plan. Once I retire I will have a much lower marginal tax rate and I would have had almost double the money grow for 20+ years?
Am I wrong on these points? I’m not trying to be argumentative, but a Roth isn’t always the best strategy for high income earners. Unless of course I am completely misinformed by my CPA.
Love the blog btw!
No no, you’re thinking about all the right things. I agree that you should max out all tax-deferred accounts before funding a backdoor Roth. That includes a defined benefit plan. I suggest you use a backdoor Roth instead of a taxable account. It doesn’t cost money to set up an individual 401K. It was free. It may cost money to set up a corporation, but you don’t need one to open an Individual 401K. You just need an EIN, which is free. In my view, an individual 401K + Backdoor Roth IRAs is a whole lot less hassle than a defined benefit plan. Once your individual 401K plan his $250K, you do have to file an additional form (5500) each year. I suppose that would be an expense.
Great post. We’ve avoided the back-door ROTH because my wife and I both have substantial SEP-IRAs from an S-corp with other employees. I assumed we couldn’t hide the SEP-IRAs in a individual 401k since we have employees and I hadn’t thought of the new EIN. But then going forward the SEP-IRA still felt easier to manage than 457s, 403b, 401s, etc as it restricts eligibility to certain employees. Thoughts? What am I missing?
I agree it gets tricky with employees, and sometimes a Backdoor Roth IRA isn’t worth what you may have to do to get it.
WCI, you said above: “Once your individual 401K plan his $250K, you do have to file an additional form (5500) each year. I suppose that would be an expense.” I have almost $550,000 in my Traditional IRA. I wanted to do a backdoor Roth, but your blog and several others who are your fans, stopped me because of the pro- rata rule. My tax accountant felt it was OK to go ahead and do it – she does not understand the pro rata rule (which I have read extensively about this week!) and says “you wont’ owe taxes on the $5,500 you roll over”, which I know! I want to open a Solo 401 K, but have some reservations as I quoted you here, because I have double the amount in my TIRA.
SO my questions are : 1. Were I to open a solo 401 K, can I start with this high amount? 2. What are the expenses 3. Since there is hardly any time left in 2017, and Vanguard/Fidelity have high call volumes, I want to do this in quiet time in 2018 after making sure I have all my information. So will I be able to do a backdoor ROth in the same year as I open the Solo 401K, i.e in 2018, or will I have to wait to 2019?
1. Yes. You just have to do a 5500EZ each year. It’s no big deal. I started doing them last year.
2. Vanguard has no additional fees, but doesn’t let you use the cheaper admiral funds. Be aware Vanguard doesn’t take rollovers though, so you will probably have to go with Fidelity or etrade. Fees are low there too.
3. You could do it all in 2018.
Thanks. Yes, I learnt the hard way! No wonder I was confused when I moved my assets from Fidelity to Vanguard to consolidate them as every one raves about Vanguard. Vangurad put my Rollover money into a TIRA and I was clueless what the difference was and Vanguard did not tell me either when accepting my $$. So your #2 makes sense now. Just an hour ago, I called Fidelity and they will take the Vanguard TIRA back into my ex-Rollover account – will initiate the move after this long weekend is over.
So I have missed out on the 2017 backdoor IRA, but I will do it for 2018 (your #3) early enough in 2018 to take the advantage of the entire year.
Just want to make sure, that once the TIRA gets recharachterised as Rollover at Fidelity, I can do backdoor in 2018 thru the then empty Vanguard TIRA without pro-rata consequences?
You can do the 2017 contribution until April 15.
And no, you need to get rid of all traditional, SEP, and SIMPLE IRAs in order to avoid the pro-rata issue. Best to do it before 12/31 because that is when it is reported. You can’t just move the IRA to another institution.
Hi, Current resident interested in learning the backdoor Roth.
I have a traditional IRA account that has $$ from previous job (10 yrs ago) . What should I do with this before starting the backdoor process as outlined above?
Thanks!
Either convert it to a Roth IRA (paying taxes on it) or roll it into your 401k or 403b.
Any concerns with having to wait 8 days with Vanguard before you can convert the trad IRA to ROTH IRA? I’m graduating residency this year and have been reading a lot! Thank you for all of your posts. I am hoping to roll over my post tax dollars from my ROTH 401k to a ROTH IRA. As for the pre-tax dollars in my ROTH IRA, I’m unsure if I should pay the taxes on it (6k) with my 1/2 attending salary this year (presumable lower tax bracket) to roll them into my ROTH IRA as well **or** just roll them over to a traditional IRA, add money to that trad IRA, and then do the “backdoor” to a ROTH IRA. Or just put that 6k into my future employer’s 401k. Any thoughts or advice? Also, to clarify – any amount in the TIRA can be converted to a ROTH IRA (not a 6k cap)? Still struggling with this concept. Thank YOU!