I’m still getting frequent questions on how to do a Backdoor Roth IRA. So I thought I’d put together a basic step-by-step tutorial people can refer to when they do this. Before I get into it, realize that if you are a low earner you can just contribute DIRECTLY to a Roth IRA and skip this Backdoor Roth IRA process. Low earner is defined as a Modified Adjusted Gross Income under a phaseout range in 2020 of $124,000-139,000 ($196,000-206,000 married) and in 2021 of $125,000-140,000 ($198,000-208,000 married). Some docs like residents or even attendings in the lower paying specialties who are married to a non-earner can just contribute to a Roth IRA directly.
Note also that a Backdoor Roth IRA is primarily a two-step process, an IRA contribution and a Roth conversion. If you understand the rules of both of these steps, putting them together is no problem.
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 $6,000 each ($7,000 each if you and your spouse are over 50) of tax-protected and (in most states) asset-protected space for both 2020 and 2021, but it allows for more tax diversification in retirement. That allows you to determine your own tax rate as a retiree by deciding how much to take from tax-deferred accounts and how much from 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 my tax returns always include two form 8606s.
5 Steps to Making the Backdoor Roth IRA Contribution
Step 1 Contribute to Your Traditional IRA
Make a $6,000 ($7,000 if over 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. Leave it in cash (i.e. a money market fund or settlement fund) while it is in the traditional IRA to keep the math simple. You don't want any losses or much of a gain between the contribution and conversion step.
2020/21 Contribution Limits
Step 2 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 $6,000 and couldn’t claim it as a deduction because you make too much money. You can now invest the money as per your investing plan. You can do step 2 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 3 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 accounts in 3 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 have even opened an Individual 401(k) at Fidelity or eTrade (the Vanguard Individual 401(k) doesn’t accept IRA rollovers) in order to facilitate a Backdoor Roth IRA.
Step 4 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. 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 $6,000. 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 2020 contribution in 2021). 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.
Harry Sit's blog, The Finance Buff, has a nice tutorial showing how to fill out form 8606 using Turbotax, which, believe it or not, is trickier than doing it by hand.
Step 5 Repeat Next Year
Contribute and Convert Each 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. 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, so I have to wait one day anyway. 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.
The Step Transaction Doctrine
There used to be 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.
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.
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)
-
Your Roth IRA contributions will need to go through the “backdoor” many times as you build your portfolio.
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 with Vanguard
Every year or two, Vanguard changes their process slightly. If you understand the Backdoor Roth IRA, these little tweaks are no big deal. If it's your first time, they can be confusing. For example, in 2021 I noticed it was a three day process for us. On Sunday January 3rd I put in an order for an IRA contribution. I didn't expect it to happen on Sunday as the markets are closed and so is Vanguard, but even by Monday (January 4th) evening I could not move on to the next step. However, by Tuesday morning (January 5th) I was able to do the conversion step. However, Vanguard did not let me actually invest the new money in the Roth IRA. That had to occur on Wednesday (January 6th). Some screenshots that may help:
The Contribution Step
Click on “Contribute to IRA” and it will then take you to a screen that looks like this:
Normally on this page, you would have the option to choose 2021 as the year you want to contribute to (or 2020 too if you haven't done that yet, at least until April 15, 2021). I just forgot to take the screenshot before I actually did it. Then you just pick the settlement fund (the Federal Money Market Fund) for the money to go into.
The Conversion Step
So on Day 2, you go to your traditional IRA and hit the “convert to Roth IRA button”
There are other ways you can get to the same place. For example, if you just go to the “exchange funds” link (on the buy and sell menu) it will look like this:
Even if you go to the wrong place, it'll still guide you back to the Roth conversion page when you try to move money from your traditional IRA to your Roth IRA. That page looks like this:
In the first step, you simply choose to convert the entire account.
In step 2, you select the holdings in the traditional IRA that you want to convert (it did it automatically for me as my only holding was the settlement fund). In step 3, you select the Roth IRA account you want to move the money into (it did it automatically for me as I only have one.)
Step 4 confuses a few people. Remember you don't owe any taxes on a Backdoor Roth IRA, so don't have any withheld. Be sure to check that box that says you elect not to have taxes withheld. You can get an email that tells you that you didn't have them withheld if you want. I have plenty of email to read so I check the box that says “Do not send a tax withholding notice.” Then you hit continue.
That will take you to the standard Vanguard “Review and Submit” screen. Look it over, then hit submit and you'll go to the standard Vanguard confirmation screen which looks like this:
The Investment Step
On Day 3, you can finally choose the investment you want in the Roth IRA. Just go into your Roth IRA account:
You can see the $6,000 credit there. This shot is of my Roth IRA, which is entirely in the Vanguard REIT Index Fund. So I'm going to just add the $6,000 to that fund. Just click the “buy” link at the top left or bottom right and you'll go to this page:
Put $6,000 in for step 1, then use the drop down menu to indicate your settlement fund in step 2. Then hit continue. It will then make you consent to electronic delivery of the fund prospectus.
Just hit “Accept” and it will take you to the next screen which looks like this:
Note that this particular screenshot is from my wife's account (which is all invested in the Small Cap Value Index Fund.) Also note that she had a few pennies left in her settlement fund from last year (63 cents to be precise). I just invested that along with the $6,000 contribution for 2021. One you hit submit, it will take you to the confirmation page.
All that is left now is to go do it for your spouse's account (if any.)
Unfortunately, Vanguard is known for low costs, not awesome customer service and great user interfaces. Some brokerages allow you to do the contribution, conversion, and investments steps all in the same day. Vanguard used to let you do this over two days. Now it takes three. In fact, if you bring money in from an outside bank, it might take a whole week as Vanguard waits for the money to “settle” before letting you convert it. But in the end, a couple of days are no big deal as long as you remember to come back and complete the process. It does lead to the “pennies issue” more frequently though. Come on Vanguard, you can do better than this.
The process will be slightly different at Fidelity, Schwab, and other IRA custodians, but the basic steps will remain the same.
As simple as this all seems, there are a few ways to screw up the process. Read 17 Ways to Screw Up A Backdoor Roth IRA to see them and How to Fix Backdoor Roth IRA Screw-ups to fix them.
What do you think? Are you doing Backdoor Roth IRAs? Why or why not? Any questions about it? Comment below!
Quick question – this will now be my third year contributing to a backdoor Roth for my wife and myself with Vanguard. The last two years the contributions sat in the IRA money market fun for a couple days prior to the conversion – as a result, the 6k contribution gained a few dollars. So I currently have literally $2 or $3 bucks in each IRA account as I just convert the $6k from IRA to Roth. Does this matter? What should I do with this? Cash it out?
Just convert it all. You’ll owe taxes on a few dollars.
https://www.whitecoatinvestor.com/pennies-and-the-backdoor-roth-ira/
I contributed through bank transfer $6000 to my traditional IRA at Vanguard 1/4/2021. When I went to convert it to a Roth IRA yesterday it says there are no funds to transfer, and the funds won’t be available until 1/11/2021. You say in your post that you convert the funds the next day. How do you do this the next day? Do you mean you do it the day after the funds are available? Sorry for the nit-picking.
Me too and mine came from the settlement fund in my taxable account at Vanguard. It’s a Vanguard thing, not a Backdoor Roth IRA thing. Keep checking back each day for up to a week until it settles. Let me try again right now. Yup, I could do the conversion. But it still didn’t let me invest the funds into the actual investment in the Roth IRA. I guess it’ll be a three day process this year. Thanks Vanguard.
I believe Fidelity changed its working when converting money from a traditional IRA to a Roth IRA. I did convert my entire $6k January 2, 2021 and the amount of money in my traditional IRA is $6k. It is now asking me if:
A. I don’t want to pay taxes now OR
B. I want to pay taxes now.
What should i pick? I’m thinking B since the amount of interest I earned in that 2 days will be none to minimal, but I just want to be sure.
Thank you.
hey man you can just choose pay taxes later- it should be $0 when you fill out your taxes come April 15th. that’s what I do and I’ve been doing BDR for couple years now.
I transferred my IRA (about 170K) to my employee 401k on 12/28/2020 and the funds appeared in my 401k account today 1/5/2021.
However my former IRA still shows small dividend income that keeps coming in e.g $15-20. Would that affect my contribution and conversion which I’m trying to do this January? Should I try to roll them over too (which is kinda annoying cos it was an indirect rollover) or just pay taxes on them when the time comes?
Yes, but it’ll be a pretty minor pro-ration, assuming that IRA shows a balance of only $15 at the end of the year. The end of the year is really a bad time to be rushing this sort of thing as it makes your paperwork more complicated and can even result in pro-ration. Much better to do it in January. And yes, you’re now going to have to do a rollover of $15 or just close that IRA and pay taxes on the $15. Your choice.
Happy New Year Everyone,
Some of us have the ability to contribute post tax dollars to a Defined Contribution Plan (AKA 401a) which we can then rollover into a Roth IRA in backdoor fashion. Because of this mechanism, it does not trigger Pro Rata even if one holds Pre-Tax money in a Traditional IRA.
I’m just wondering on the proper documentation for this?
Since it’s not a conversion from an IRA, we do not need 8086?
We only fill out Form 5498, boxes 2 and 10 correct?
First time doing this form of “backdoor” and wish to do it correctly. Thank you for any help in advance.
401(a) contributions show up on your W-2 and don’t go on form 8606. But yes, the conversions would go on form 5498, but on line 3.
You can also do a Backdoor Roth IRA in addition to a Roth conversion from your 401(a).
Thank you for such a timely response Jim.
Because I have some traditional IRA funds, a true backdoor Roth has the limitation of 1) Pro rata trigger and 2) a limit of $7,000 annually (I’m 54).
I felt that after I maxed out my 403b and 457b at $26K each, my next best recourse would be to put after tax moneys into the 401a and then convert the next day to Roth IRA at my Fidelity account.
The 5498 Instructions for Box 3 read:
Box 3. Roth IRA Conversion Amount
Enter the amount converted from a traditional IRA, SEP
IRA, or SIMPLE IRA to a Roth IRA during 2020. Do not
include a rollover from one Roth IRA to another Roth IRA,
or a qualified rollover contribution under section 408A(e)
from an eligible retirement plan (other than an IRA) to a
Roth IRA. These rollovers are reported in box 2.
Given this, I think it Box 2 makes more sense does it not? Instructions read:
Box 2. Rollover Contributions
Enter any rollover contributions (or contributions treated
as rollovers) to any IRA received by you during 2020.
These contributions may be any of the following.
• A 60-day rollover between Roth IRAs or between other
types of IRAs.
• A direct or indirect (within 60 days) rollover from a
qualified plan, section 403(b) plan, or governmental
section 457(b) plan.
• Any qualified rollover contribution as defined in section
408A(e) from an eligible retirement plan (other than an
IRA) to a Roth IRA.
• A military death gratuity.
• An SGLI payment.
Thank you once again. All the best.
I thought you were converting money from a 401(a) to a Roth IRA. That goes in box 3 as I understand what you have written.
Thank you Jim. Yes. I am converting money from 401a to Roth IRA. Will look into further but I’m immensely grateful for your direction. Warm regards.
M
Hi WCI,
Happy New Year!
Just curious, what is your Roth IRA composed of?
I have some individual stocks like AAPL, MSFT, and VZ, and also VNQ (REIT ETF) and VYM (high dividend ETF).
I am at TD Ameritrade so can’t buy Admiral funds for free.
Thanks!
Buying individual stocks is generally a bad idea for reasons discussed here:
https://www.whitecoatinvestor.com/picking-individual-stocks-is-a-losers-game/
You can buy Vanguard or iShares ETFs at TD Ameritrade, same expense ratio as admiral funds but minimal commission (if any). They’re basically the same as the admiral class of traditional Vanguard mutual funds.
You should look at all of your retirement assets (often including a taxable account) as one big investing account with one overall asset allocation. That’s what I do. My asset allocation is:
60% stocks (25% TSM, 15% TISM, 15% SV, 5% IS)
20% bonds (10% TIPS, 10% nominal)
20% real estate (5% REITs, 5% debt, 10% equity)
My Roth IRA is full of the Vanguard REIT index fund. My wife’s is full of the Vanguard Small Value Index Fund. The other asset classes are in other accounts.
I plan to open up individual and spousal IRA for 2020 with vanguard to convert to roth via the backdoor. I have a couple of technical questions. Do I need to open up a seperate account with vanguard for my wife’s spousal IRA and convert it on her account? Or, can I add 12000 to my individual IRA for her and me and then convert it? Any advice how to go about doing the spousal IRA? Best.
Yes.
IRAs are INDIVIDUAL. You each need one, even if it is a spousal IRA.
I got some bad advice from Fidelity a couple years ago and now I have dug myself into a hole. About 10 years ago I rolled over a 401 (about 35K) to a rollover IRA at Fidelity. I then contributed nondeductible after tax money (30K or so) to it over several years. I then learned about the back door Roth option. I was advised just to open a traditional IRA at Fidelity and do the Roth conversion with that. In reading your post though it seems that the rollover IRA is a problem because I converted 6K to Roth last year and the same the year before. My rollover IRA had 100K in it on Dec 31. How do I fix this? I’d like to use the back door Roth option moving forward. My questions:
1. Seems that I’m going to have to pay the extra tax for the last two years conversion? Pro-rata rule? Do I have to amend 2019’s return some how?
2. How do I fix the rollover IRA? Can I somehow separate the original rollover amount from the nondeductible contributions into different accounts? Should I move the entire balance to an individual 401 at Fidelity? Probably shouldn’t convert the 100K to Roth right?
Yes, your conversions will be prorated. The easy fix is just converting the whole thing and paying taxes on all the pre-tax money. But it’ll cost you something like $15K+ in taxes to go that route.
1. Yes. Yes. Yes.
2. Try to convert it if you can afford it. If not, try to separate the basis by rolling the pre-tax money into a 401k and converting the rest. You won’t have to pay taxes on the full $100K. The basis (the amount you didn’t get a tax deduction for) doesn’t get taxed again.
Thank you so much for your reply. I spoke with Fidelity. My 401 allows for a roll-in from the IRA. So I moved all the pretax money out of the IRA and will convert all the after tax money to the Roth IRA. I appreciate all your work on this website. Such a great resource.
Awesome. Sounds like it will work out great for you.
I have a $1.50 in my traditional IRA account and if I do contribute the $6000 allowed for IRA it will be $6001.50. Should I then convert $6000 into Roth IRA or convert the change as well? I am just not sure about how it would impact my tax filing.
Convert it all and invest it all. You might owe $1 in tax.
With Fidelity, when you go to convert the $6K from the traditional IRA to the Roth IRA it requires you to pick either “I don’t want to pay taxes now” or “I want to pay taxes now.” Should the latter be selected? And should it be $0?
Hey I just did BDR past 2 years at Fidelity and have always selected “I dont’ want to pay taxes now.” There is really no tax to pay anyway should be $0 comes April 15th.
No, the former. They’re asking if you want to withhold money. You don’t, because no taxes will be due.
In case anybody was interested in conversion times when doing the BDR at Fidelity, both me and my wife contribute to the traditional IRA from our PNC checking account, and I was able to complete the conversion in 2 days, whereas my wife is still awaiting for the trad IRA money to settle, and the only difference is I have a taxable brokerage account at Fidelity while wifie doesn’t.
thanks Jim for teaching us this stuff! We currently have $40k in our Roth IRA’s (soon to be $46k) and all in small cap value.
Thanks for all you do. My wife worked in 2020 through November 1st and maxed out her 403b for 2020, and currently we have extra savings. If she wants to now make a 2020 IRA contribution (with plans for backdoor Roth IRA conversion), on Vanguard it asks about whether or not the contributor is employed.
It’s unclear how to answer this question. While she is not currently employed, she was during the majority of the 2020 tax year. So if she answers no, will she then not be permitted to make an IRA contribution, as one needs to be employed to contribute to this type of account? On the other hand, if she answers yes, it wouldn’t technically be true given the present tense version of the question. How would you approach this scenario?
The only reason to ask that question is to determine whether the contribution is deductible or not. I don’t know why Vanguard is asking, it’s none of their business. Vanguard never asks me that question when I do IRA contributions so I’m not sure why or how they’re asking you that.
You can always make an IRA contribution as long as you earned at least as much as the contribution (maybe that’s why they’re asking?), it’s just a question of whether you can deduct it or not.
You don’t need to be employed to make a contribution, but you (or your spouse) needs to have earned income to make IRA contributions.
Can you help with form 8606? I converted the rollover ira to roth and did a backdoor in 2020. I don’t know where to report the rollover conversion.
Which line are you having trouble with? You put how much you converted where it says to do so, lines 8 and 16 as I recall.
I convert $18K and did then a backdoor $6K. Do I put 18K on line 2 (basis) and $24K on line 8 and 16?
Explain what you mean by “did then a backdoor $6K”. If you mean you contributed $6K and then converted $6K, then you put $0 on line 2 (you had no basis, i.e. non deductible money in the account on the previous 12/31) and $24K on lines 8 and 16.
Dr Dahle,
I did backdoor Roth IRA last year at Vanguard. I got issued 1099-R for that. My CPA filed form 8606 but he is also reporting it on Line 4a of 1040 (IRA distribution). He states it is to be reported as 1099 R was issued.
He also reported it on form 5329 line 15 as excess contribution which generated additional tax 360x 2 ($720 married filing jointly). What is he doing wrong.?. He states he knows how to do it but somehow it does not seem right.
It doesn’t matter if it is on 4a as long as it isn’t on 4b! It won’t increase your taxes due.
There’s no excess IRA contribution though (right?, you didn’t contribute more than $6K/7K?) so I have no idea why he is reporting that. Income limits affect deductibility, not contribution amounts.
I had few dollars more than $6 ($6009) but CPA put the whole $6009 as excess contribution instead of just $9.
My question is that should he be filing form 5329 at all or not?.
I tried to argue but he leads me to other direction. I want to know I have a better understanding before I talk to some other CPA.
thanks for your time
Have the CPA fix his work. It’s not an excessive contribution if you only contributed $6K. It’s a $6,009 conversion. You should owe tax on $9 but not have to fill out 5329.
I just stuck with the late conversion. But my case might be a little unique. I made a 2020 traditional IRA on 1/6/2021 and did the conversion to Roth IRA on 1/8/2021 with Vanguard ( assumed it was for 2020 Roth conversion. Obviously I am wrong about this.). A few days, I checked the record and I was told that the Roth conversion is counted for the tax year 2021. To save me the trouble, I don’t plan to make any 2021 traditional IRA contribution any more since I can’t make any Roth conversion for the tax year 2021. What should I do? I looked at your example, I don’t understand how you can have to Roth conversion in 2021. Therefore, I don’t know how to solve my relative simple case. Could you give me some hand? Big THANKS!
I’d go back and make your 2020 contribution and do another conversion. You have until tax day to get it done. You can certainly do two Roth conversions in 2021. The 2020 contribution will go on your 2020 taxes and your 2021 contribution will go on your 2021 taxes. The conversion of $12K total will go on your 2021 taxes.
Thank you so much for such prompt response! I called the Vanguard yesterday and were told that the conversion was final since I did with their online tool ( I just don’t understand why the Vanguard doesn’t provide one option to select between 2020 and 2021 during the conversion.). And I noticed that the contribution limits of my 2020 has already been hit when I made my initial traditional IRA contribution on Jan. 6th,2021. Therefore, I guess I can’t go back and make the 2020 contribution and do another conversion. Today I watched the video you posted and looked the example for “Late Contribution to the Backdoor Roth IRA” again. It seemed to me that you make the 2021 traditional IRA contribution 6000 in 2021, since the 2021 contribution limits has been hit yet. And then you do that conversion right away for 2021. Then under the Rollover contribution, we will find 12000 dollar in 2021. 6000 out 12000 was from 2020’s IRA 6000 contribution I did on Jan. 6th,2021. The other 6000 of 12000 will be from 2021’s IRA contribution 6000 I will do on Sep. 10th,2021. Am I right? Thanks!
Yes, you can’t recharacterize conversions. You also can’t do a conversion in 2021 and call it a 2020 conversion. You can do that with the contribution though until tax day. If you already did a 2020 contribution, no, you can’t go back and do another one. Yes, you can do a $12,000 conversion in 2021.
Hi WCI,
Similar to a question above – our Roth is through Vanguard – they issued a 1099-R for 2020 showing our contribution as a gross distribution from IRA and therefore taxable. What do I do with this?
If box 2b is checked (as it should be) it’s no big deal. It’s obviously not taxable. If it isn’t checked, have them fix it.
Ok great, it looks like it is checked. So still submit 1099 form to our accountant? Or just have him do the 8606?
Yes, no, maybe so?
If I were hiring someone to do my taxes, I would give him all of my 1099s and have him do all the tax forms including the 8606s.
I hope that answers your question(s).
Hey all, I’m not sure what to do with this re pro-rata and form 8606:
-I opened an etrade account and did a Roth conversion in mid-2020, clearing out the traditional IRA account, just like we’re supposed to
-However, late in the year, etrade put $200 into the traditional IRA that I had cleared out, as some kind of promotion
So:
1) Do I need to report this on line 6 of form 8606, even though I didn’t contribute the money? (or where does this fit on 8606?)
2) When I do my 2021 contribution/conversion, should I just contribute $5800 in new money into the account, so I can rollover a total of $6000, and not exceed IRA contribution limits?
What a headache from free money!
1. yes. Line 6
2. No limits on rollovers, only contributions. So contribute $6,000 and convert $6,200. You’ll be pro-rated for 2020, but it’ll all work out by the 2021 taxes.
Got it, thanks!
WCI,
Thanks for this thread. My first foray in Turbotax for a while. I usually have someone do my taxes but I figured I would play around a bit with it this year but may still have it done elsewhere. Turbotax seems to insist this is a recharacterization:
From Turbotax —–
This means that you first contributed money to a traditional IRA, but then later moved your money to a Roth IRA. This is sometimes referred to as a “recharacterization.” A recharacterization such as this is different from a Roth conversion because your Roth IRA contribution is for the same year as the original traditional IRA contribution. So, the money would be both contributed to the traditional IRA and subsequently moved to the Roth IRA during the time period of January 1, 2020 until April 15, 2021 unless you file an extension in which case you would have until October 15, 2021.
This is under the “Tell us how much you transferred” section….they seem to use “switch” and “recharacterize” synonymously. Do you enter 0 in this portion? How do you get it complete the 8606?
Thanks
See if this fixes your issue:
https://thefinancebuff.com/how-to-report-backdoor-roth-in-turbotax.html
I’m really new at all this so be easy on me. In your example you take out all the money from your IRA so that you can roll it over, but what if you have put money in that account in prior years? Do you have to leave zero dollars in your IRA account to avoid penalty? Lets say I put 6k in an IRA account in a given year, then in another year I try to do the rollover with another 6k. Can I simply take out the 6k from the IRA that i want to roll over? It seems like it would leave you with a value in Line 6 on form 8606.
After reading other posts you seem to emphasize have zero in the IRA account in order to avoid the pro-rata rule. Does that mean in order to roll over into a roth account in some years you completely convert or dissolve ALL prior IRA funds including past years? I think when I read it the first time I assumed you meant you can’t have contributed other funds to your traditional IRA, SEP IRA, and simple IRA in that same year only.
Yes, the entire value must be zero including all prior contributions. I’m sorry if that wasn’t clear before. How could I have worded it so that wouldn’t be misunderstood?
You worded it fine, I think It’s more surprising to me that the pro-rata rule would penalize a contribution even if the existing traditional IRA balance had been sitting in an account for 20 or more years, but I guess those are the rules.
Yes.
If you put two $6K contributions in over 2 years, you can then convert $12K to a Roth.
I completed a direct rollover from my recently completed residency prudential (pretax) 403b into my vanguard Roth IRA on 1/11/2021. The former account withheld 20% prior to sending the check to vanguard. This rollover was a small amount, 2k ($1600 sent), as I was mainly contributing to Roth 403b during residency, and have already rolled that over to vanguard a couple months ago.
1.) When this is reported April 2022, will there be any underpayment consequence to ONLY having 20% withheld, verses whatever tax bracket I am in, or do they just tax the difference (say I owe 4% more taxes on the 2k if I am in 24% tax bracket)? Also whatever more tax I owe will only be on the original rollover amount (2k), not on any gains that are made on the rollover amount over the next year correct?
2.) This will not affect my ability to do a backdoor Roth in 2021 correct? And in terms of reporting both of these on the 8606, this added rollover seems to throw me off a little bit with how to fill it out
1. You don’t want ANY of it withheld if you can help it. You want it paid out of other assets if at all possible. Otherwise, your Roth is now smaller than it otherwise would be.
2. No, won’t affect it. Roth IRAs don’t count in the pro-rata calculation.
Ok I may have played with my money in a horrible way.
Here is what I did.
In Jan 2020, I deposited 6000 from my wife’s bank to TIRA at VG and then converted it to Roth. This was for year 2020.
I did the same in Jan 2021, for the year 2021.
So far, so good !
However, here are 2 things making it real fun.
1. in Dec 2020, my wife’s old employer’s 401k company said that they will no longer service the plan and sent a distribution check to us. At that time, I didn’t think of it much and told them to put the check in Vanguard’s name. It is approx 21,000. So in Jan 2021, after doing the above conversion, I rolled over those 21,000 to my wife’s vanguard TIRA.
Now as I am reading your blog,I think I should have rolled it over to a 401k instead. I realized that vanguard 401K doesnt allow rollovers. I wanted to make one at Fidelity, but the check had vanguard written over it and i doubt fidelity would have accepted it.
Now I am concerned about the pro rata rule, as my ‘contributions’ to TIRA are now 27,000 (I think for tax year 2021, I am hoping i will be ok for year 2020).
Am I understanding the problem correctly ? What are my options to avoid paying taxes ? Should i roll it over again to a 401K in Fidelity ?
2. My wife was an independent contractor in 2017 and opened a SEP IRA with Betterment with one time $1600 in 2018 and now it has $2100 and she has not contributed to that account since. We have been doing the $6000 trad to Roth IRA conversion every year as described above. But never really bothered with that money since.
My question is will that SEP ira be subject to pro rata rule for my 2020 taxes / backdoor Roth , even though the account is inactive since ? If so, whats the best stratergy for it ? Just open a I-401k at fidelity or something and transfer there ?
Please help me ! I feel like i messed up big time !!
edit – she is currently unemployed due to covid, if this helps ?
1. No, your contributions are $6K. Rollovers don’t count toward your contribution limit. Yes, you’re fine for 2020. For 2021, you have 11 1/2 months to figure out whta to do with that $21K. If you can afford the tax hit this year, the easiest thing to do is just convert it all into her Roth IRA. The alternative is roll it into another 401(k) your wife has access to.
2. This is a problem. Every conversion you’ve done is pro-rated due to that SEP-IRA. You probably need to refile all your taxes that you’ve done a Backdoor Roth on that you can still refile (2017, 2018, 2019). If that’s just 2020 and 2021, you’ll get pro-rated for 2020 but again, you can correct it just by converting the entire thing to a Roth IRA in 2021. A 1040X with a new 8606 isn’t a big deal though.
No, being unemployed due to covid doesn’t help anything other than maybe your income is lower so the tax cost on a conversion is lower.
Oh wow, that sounds scary. Can I just reduce my 2021 conversion and convert this sep ira to Roth to total 6000, instead of going through every year ?
Also , let’s say my balance went from 1600 to 2100 over 3 years , so assuming the numerator is in this range , does the denominator remain 5500 or 6000, or does it keep on increasing every year based on the money in my Roth account ?
It just sounds like a disaster where I will lose thousands.
Not sure what you’re talking about. Conversions don’t count toward your annual $6,000 contribution limit though if that helps.
also, i just realized, that i funded that SEP IRA with post tax dollars from my bank, and not with pre tax dollars. does it change anything ? sorry its a confusing mess by now.
You can’t fund SEP IRAs with post tax dollars, so not sure what you’re referring to.
I meant that when I opened my sep IRA, I did not use pre tax dollars , but deposited the money from my bank account after taxes.
But you took a deduction on your taxes, right? So it’s pre-tax money.
Jim. Thanks for bearing with me and giving me detailed advise.
So I consulted about this with my tax ‘advisor’. He tells me that there is no need to refile / amend any of the returns. But I have a feeling he is not understanding the issue at hand.
So as i see it, let me summarize this. And you tell me if I am doing it right.
Wife opened a SEP IRA in 2017 using post tax dollars (small amount $1700) and we deducted that amount from our MAGI. Since then she has converted $6k every year (2018-19-20-21) using this backdoor method (from bank to TIRA to Roth). But that SEP IRA remained as it is, increasing in balance as the stock market increased (for example 1800, 1900, 2100 and now 2200) (although no contributions were done from our end). We did *NOT*think about the pro rata rule while converting these $6k.
At this point, I was thinking can I just refile my 2017 returns (the year in which i deducted that SEP IRA initial contribution from my MAGI) ? Removing that deduction makes it post tax contribution ?
And I think, the other option is to amend all the returns for the years wife did backdoor Roth ? Now if I do it, my tax guy will make big bucks (sadly). If I do file it on my own , do i file just the amended 8606 and 1040 or the entire return ? Also I am assuming this does not affect state returns ? I have used creditkarma free service once in the year that I did file myself, otherwise I have used CPA. Is there a good recommended filing software for amended returns ?
Can you share a screenshot or a tutorial of how a 8606 amended looks like , especially if i have some SEP IRA contributions that are not zero and therefore subject to pro rata ? or guide me to a good link ??
Thanks, will really appreciate the help. And no Tax ‘advisor’ from next year hopefully.
additional side question – what happens if IRS checks and catches a mistake in my return ? What are the consequences , especially if i am filing myself without any cpa or additional protection from softwares ?
Well, you did conversions while you had a SEP-IRA. So all those conversions will be pro-rated. Nothing you can do about that now, but you can make sure you’re tracking the basis right so you don’t have to pay taxes on the basis twice. That’s the main point of refiling the taxes. You just need to make sure you told the IRS what you did. Now, if your tax person is telling you that you DID tell the IRS exactly what you did, then there is no need to refile.
If it affects how much you owed in state taxes, you should amend those filings as well.
An amended 8606 looks exactly like a regular one, it is just accompanied by Form 1040X. Here’s an example of 1040X.
https://www.whitecoatinvestor.com/household-employees-and-the-1040x-kids-corner/
Your 8606, of course, will have the balance of that SEP-IRA on line 6.
If the IRS catches your mistake, it typically asks you to correct it. Maybe it sends you a check, maybe it asks you to send them a check, maybe they audit you. It just depends. But as a general rule, if you’re trying to do the right thing I’ve found the IRS to very reasonable (although slow) and they make about as many mistakes as I do.
Thanks WCI !!
Question – Your comment “but you can make sure you’re tracking the basis right ” – what does it mean exactly ? Does that pertain to line 2 in 8606 ? What should it be – the balance of my SEP IRA on dec 31 ?
Also, just realized that my tax guy might not have filed a 8606 every year. Can i just file it with my amended return ?
sorry if it sounds repetitive
Remember once you start getting pro-rated, some of that conversion is taxable and some isn’t. So later when you do the next conversion, the amount that wasn’t from the year before needs to go into the calculation. That’s why you should try to avoid being pro-rated, but you didn’t. So now you just need to keep records of what actually happened with the pro-ration each year. In essence, some of your SEP-IRA right now is post-tax dollars in the eyes of the IRS. The way you know how much is by what’s on the correctly filled out 8606s.
Yes, you’ll need to file a correct 8606 with a 1040X for each year. And get a new tax guy that actually knows how to do his job. It’s one thing to screw this up yourself. It’s entirely different to pay someone else to screw it up for you.
[Redacted – found the answer! Thanks!]
I just found out about the Backdoor Roth in the first few weeks of 2021. My employer allows for reverse rollovers to my 401(k), so I will be rolling money from an old IRA to my employer’s plan, but don’t know if I can still do that for the 2020 tax year.
I know I can do a backdoor ROTH up until April 15, 2021 for tax year 2020, but can I still do both a reverse rollover to a 401(k) and a backdoor ROTH for the 2020 tax year? Or would I have had to complete the reverse rollover to my 401(k) before December 31, 2020? Thank you.
Forgot to note that I will be contributing $6,000 to my emptied IRA (once reverse rollover completed to employer 401(k)), then rolling to a ROTH IRA one day later.
No. But you don’t need to. Because you won’t be doing a conversion in 2020. You only need to zero out your IRA balances by 12/31 of the year you do the conversion. If you do the conversion in 2021, you have until 12/31/2021 to zero out that IRA to avoid getting pro-rated.
What could I have written in the post above that would have made that more clear for you because I’m getting this question a half dozen times a week and I can’t figure out why.
Yeah, I know you can contribute to an IRA (then backdoor to Roth) up until April 15, 2021 for tax year 2020. But wanted to see if I can apply the reverse rollover for tax year 2020 as well before April 15th. Because if I want to contribute to my IRA (then backdoor to Roth), doesn’t the IRA account need to be empty first (via the reverse rollover)? Or will I still be able to do a backdoor IRA contribution for 2020, then do the reverse rollover for tax year 2021, and also make another backdoor contribution for tax year 2021? I feel like the reverse rollover has to be done first, then I can only make a backdoor contribution for tax year 2021 only. Basically I have to give up on trying to make a backdoor contribution for tax year 2020, because I was not able to execute the reverse rollover before 12/31/2020. That’s the part I’m confused about. I know I can do it for 2021 though. The April 15, 2021 deadline for 2020 contributions is what’s throwing me off. I don’t know if that date also applies to do a reverse rollover for 2020 as well.
No. You cannot do a rollover in 2021 and tell the IRS you did it in 2020. Contributions are the only thing where the IRS gives you until the next tax day to make a contribution for the previous year. You can’t do that for conversions, rollovers, reverse transfers, or anything else.
The only 12/31 that matters is the one in the year you did the conversion step for. So if you do the conversion step in 2021 (even if the money you converted was contributed in 2020 or 1990) then it is a 2021 conversion and the pro-rata calculation only applies on 12/31/2021.
Why have you given up on contributing for 2020? The only reason you would do that is if you did not understand what I just wrote above.
Yeah I was just worried that the money I would be contributing for 2020 ($6k) would get commingled with the funds sitting in my IRA (old pre-tax funds from a previous job) that I would be sending to my 401(k) via the reverse rollover. Looks like I can start the process to do the reverse rollover (applied for tax year 2021) now, let the money get pulled out, then make a contribution for 2020 to that existing IRA (then backdoor to my existing Roth—before April 15th), then make another contribution for 2021 (then backdoor again to the Roth) anytime during the rest of this year (or technically up to April 15, 2022). I guess I’m just trying to structure the transactions so it’s as clean as possible.
They will be commingled if you put them in the same IRA.
Your solution should work.
If I know my 2021 MAGI will be $129,000, in the phase-out range, so the regular ROTH contribution I’m allowed is $4,400, but I still want to maximize to the $6,000. Which option should I choose?
Option 1: Contribute $4,400 directly into ROTH IRA, and contribute $1,600 as non-deductible contribution into traditional IRA and immediately transfer to ROTH IRA (backdoor).
Option 2: Just do $6,000 backdoor now in Jan 2021.
Two concerns:
1. Option 1 allows me to periodically contribute and take advantage of dollar cost averaging, option 2 as soon as the $6,000 lands into ROTH IRA I would want to invest all of it right away, so I could potentially buy at a high point.
2. There are mixed info out there about this, but some people favor a regular contribution to a backdoor for the 5-year rule (10% penalty) on early withdrawal. For ROTH IRA withdrawal ordering, first in the order is regular ROTH contributions (not subject to 5 year rule), second is taxable conversions (each layer is subject to 5 year rule separately), third is nontaxable conversions/backdoor, fourth is earnings. There are mixed information out there on whether the third bucket of nontaxable conversions/backdoor is subject to the 5 year rule. Forbes and Motley Fools say yes the third bucket backdoor is subject to 5 year rule.
I don’t believe backdoor principal amount is subject to the 10% penalty on early withdrawal, after running through the entire Form 8606 and Form 5392 Additional Taxes on Qualified Plans (see examples on page 4), and the actual code here https://www.law.cornell.edu/cfr/text/26/1.408A-6, Q-5 (b), see second to last sentence.
(b) The 10-percent additional tax under section 72(t) also applies to a nonqualified distribution, even if it is not then includible in gross income, to the extent it is allocable to a conversion contribution, if the distribution is made within the 5-taxable-year period beginning with the first day of the individual’s taxable year in which the conversion contribution was made. The 5-taxable-year period ends on the last day of the individual’s fifth consecutive taxable year beginning with the taxable year described in the preceding sentence. For purposes of applying the tax, only the amount of the conversion contribution includible in gross income as a result of the conversion is taken into account. The exceptions under section 72(t) also apply to such a distribution.”
What’s your take on this?
I’d just do it all via the backdoor. That’s especially useful if your income ends up being higher than you think.
I have an IRA account from way back when I was in residency and has some initial pretax contributions but now mostly post tax contributions. How do I do back door Roth?
The same way as everyone else, except you need to do something with that IRA to avoid the pro-rata rule. Probably easiest to just convert the whole thing to a Roth IRA and pay taxes on any of the pre-tax money that went in there (as well as all of the earnings). But if you can’t afford that tax bill this year, it might not be an option.
Thanks and then what about the IRA by my wife that is ALL post tax.
The earnings would be taxable when converted, but the rest would not. That’s the sort of thing that is generally a no-brainer to convert ASAP.
Thanks. I checked and she has about 100,000 potential capital gain. Is it ok to do it in parts?
What do you mean okay? Legal? Yes. Will you still get prorated on a backdoor Roth if you do it over years? Yes.
Thanks. Can you please elaborate on prorate? How does it work?
As noted in the post above, if you have pre-tax money in a traditional IRA on December 31st of the year you do a conversion, your conversion will be pro-rated. For example, if you did a $6K conversion but still have $6K in the traditional IRA, you will pay taxes on $3K of your conversion and left in the IRA will be $3K in pre-tax money and $3K in post-tax money.