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 2021 of $125,000-$140,000 ($198,000-$208,000 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 $6,000 ($7,000 if 50+) can contribute $6,000 ($7,000 if 50+) to an IRA. If your income is below a MAGI of $125,000-$140,000 ($198,000-$208,000 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 $66,000-$76,000 ($105,000-$125,000 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 $208,000, 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 $6,000 each ($7,000 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 $125,000-$140,000 in 2021. 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 $58,000 ($64,500 if 50+) [2021] per year into a Roth 401(k) (or possibly a Roth IRA in addition to your usual $6,000-$7,000 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 or complete a Backdoor Roth at Fidelity, two 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 $6,000 ($7,000 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 $6,000 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 $6,000 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 $6,000. 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.
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 ($6K, $7K 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 $$125,000-$140,000 ($198,000-$208,000 Married Filing Jointly) for 2021. 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: $198,000-$208,000
- Single or Head of Household: $125,000-$140,000
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.]
If I open a T-IRA to convert into Roth-Ira. Can I do open it now, and convert it before April 15,2021 and claim it as 2020?
You can claim the contribution on your 2020 taxes, but the conversion will be reported on your 2021 taxes.
This may have been asked and answered in one of the 2,400+ comments before this that I just don’t have time to read, but it is what I believe a simple question that so far I have not seen clearly addressed by anyone talking about backdoor Roth IRA.
Is a backdoor Roth IRA subject to the same contribution limits as a “normal” IRA?
More specifically, if my MAGI is in the phase-out range and limits me to direct contributions of 1/3 of the limit ($2000), am I limited to the remaining 2/3 ($4000) for a backdoor Roth contribution?
Yes, $6K for 2021, $7K if 50+.
There is no contribution limit for traditional IRAs, which is where you are contributing your money in the Backdoor Roth IRA process. Remember there is no account called a “Backdoor Roth IRA.” There is a traditional IRA and a Roth IRA. The process is to put the money into the traditional IRA and then move it to the Roth IRA.
Sorry, but I am confused by your response.
According to the IRS (https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits), total annual IRA contributions, including traditional and Roth, are limited by the amounts noted in the first part of your response. Additionally, deductible contributions to the traditional IRA, and any contributions to a Roth, phase out depending on your modified AGI ($66-76k for the traditional portion, and $125-140k for the Roth).
I don’t see it stated explicitly anywhere, but this suggests to me that above $140k MAGI, you can only contribute $6k/yr after-tax to a traditional IRA, which you would almost certainly want to convert to a Roth IRA using the backdoor approach.
Is this accurate — the $6k/yr limit always applies, and above the MAGI limit you can only make this contribution using after-tax dollars?
I agree with your comment. $6K limit always applies. Above the MAGI limit, you can’t get the deduction.
So, if I am in the MAGI phase-out range for Roth contribution, does it make sense to make a direct contribution to the Roth up to the reduced limit, then separate after-tax traditional IRA with a backdoor conversion for the remainder — or just do it all as traditional/back-door conversion?
In my opinion, it doesn’t matter either way. Roth contributions, phased out or not, are after-tax. Since you are in the phased-out range for the Roth, you are certainly making too much income to use traditional contributions to reduce you’re taxable income. In other words, your traditional contributions are after-tax, as well.
If you contribute say $3000 directly to the Roth, then $3000 after-tax to the traditional, followed by converting the $3000 traditional contribution to the Roth, tax-wise it’s the same as contributing $6000 to the traditional and then converting it to the Roth. Still have to file form 8606, except the contribution numbers are different.
This year my husband and I are filing separately. I used the backdoor roth IRA and my husband didn’t.
Next year we were planning on filing jointly. Our income is higher than the MAGI therefore we are not allowed to contribute to the roth IRA directly. However in January and February 2021 he has made contributions to his roth IRA directly (did not follow backdoor roth IRA instructions).
What options do we have now? Should he keep contributing directly and we file againt separately or is there a way to do the back door roth IRA for the remaining months March-December?
thank you!!
https://www.whitecoatinvestor.com/ira-recharacterizations/
Recharacterize to a traditional IRA contribution. Add the rest for the year. Then convert it.
Hi WCI,
1st TY for sharing your knowledge with us all. I have told my fellow Registered Nurses to check out your website for help with back door ROTH IRA.
Question:
I contributed $6000 to a ROTH IRA in 2019 and later found out that I made too much money when doing my taxes in 2020. Most tax preparers told me to withdraw the money (I’m glad I found you). In 2020 I recaractherized the 2019 ROTH IRA to a TIRA and 3 days later converted it back to ROTH IRA, but with a loss, so final amount was $5600. In 2020 I did it the smart way and did the back door ROTH IRA for $6,000 but I gained some money and the conversion was for $6,050. So for my 2020 taxes, does the IRS need to know that I lost money for the 2019 backdoor ROTH IRA and gained money for the 2020 backdoor ROTH IRA, and have my form 8606 show to pay taxes on the extra $50? Or will my line 8 in form 8606 show less than $12,000 and won’t have to pay taxes on the $50 because of the $400 loss the previous year?
You should have carried that $400 loss over on your 8606s, so that $50 should be tax free.
In doing the 8606 everything looks good until I get to line 14. I looked at all the comments for a similar example and didn’t find one. Could you help explain how Line 14 is not 0 and how to fix calculation, for us that loose money when doing a late backdoor roth IRA?
This is For 2020 taxes with a late backdoor roth IRA for 2019 taxes done in 2020 & also a 2020 backdoor roth IRA.
Line 1: 6,000 (2020 contribution)
Line 2: 6,000 (2019 contribution)
Line 3: 12,000
Line 4: 0 no contributions in 2021 for 2020
Line 5: #3 – #4 = 12,000
Line 6: 0
Line 7: 0
Line 8: 11,650 (amount actually converted to ROTH IRA due to loss)
Line 9: #6 + #7 + #8 = 11,650
Line 10: #5 / #9 = 1
Line 11: #8 X #10 = 11650
Line 12: #7 X #10 = 0
Line 13: #11 + 12 = 11650
Line 14: #3 – #13 = 12,000 – 11650 = 350 (I THOUGHT THIS HAD TO BE 0)
Line 15a: 0
Line 15b: 0
Line 15c: 0
Line 16: 11650
Line 17: 11650
Line 18: 0
You lost money between contribution and conversion. So now in some future year you can have $350 in gain without having to pay taxes on it.
Hi,
I have a question on 529 plans. I live in TX and also earn some income (W2) from SC for part of the year. Since I will be paying state tax on income from SC, can I open a 529 in SC for Tax break from SC state tax? Will living in TX mess up any tax advantage on SC income? Please note I will be residing in SC part of the year.
Thank you.
Yes, a non-resident or a resident can claim a 529 deduction in South Carolina against their South Carolina income.
https://www.whitecoatinvestor.com/best-529-plans-reviews-ratings-and-rankings/
Hi, thank you for the helpful posting!
However, I have a question.
I contributed to Traditional IRA in 2020 ( all $6000 ) and did not covert to Roth right away. Instead, I bought some EFTs and the earning became $200 which made total about $6200 when I made Roth conversion in Feb.
I made a conversion to Roth all my balance ( $6000 + $200 ) .
Also I contributed another $6000 for 2021 and made a conversion to Roth right away. So my balance in Roth is now around $12200.
And I have not filed tax for 2020 yet. I understand that I need to fill a form 8606 for $6000 contribution (not earning) for 2020.
Here is my real question. When a tax filing for 2021 comes, how should I write the 8606 form for 2021? I read over your posting but I am not sure where I should write down my earnings. Could you tell me where I need to put those earning in form 8606 in part 1 and 2? It is very confusing.
Thanks.
Yea, these studies are garbage in, garbage out for sure. If you assume you’re paying 2% to an advisor every year and 2% in mutual fund expense ratios, investing in insurance starts not looking too bad by comparison. Wade Pfau’s study had similar issues.
I’ve already contributed $7000 to my Vanguard Roth IRA for 2021 and my wife has contributed to hers with monthly payments. I am now realizing that our modified adjusted gross income for 2021 will most likely be over $198,000. How can I remedy this situation by using the backdoor Roth?
https://www.whitecoatinvestor.com/ira-recharacterizations/
Where could I have put this link so you would have seen it without having to post your question as a comment?
I did Backdoor Roth IRA conversion for 6k in Jan 2020 when I was PGY-3 and planning to start working after graduation likely potentially earning over the income limit. But I ended up starting fellowship so my AGI is far less than income limit. Do I need to fill out 8606? The 1099-R I received states 6K for both Gross distribution (Box 1) and Taxable amount (Box 2). I am confused why its making 6K taxable as I have already paid taxes on them. Thanks in advance for your help!
Yes, you should fill it out since you went through the backdoor even though it turned out you didn’t have to. No biggie though.
See if there is a little box checked saying “taxable amount not determined”. I bet there is.
I want to do a backdoor ROTH IRA conversion but have money in a SEP and traditional IRA already. That business has an employee so I can’t open a solo IRA. Can I create a new business entity so I can open a solo 401k? Can I move an IRA from one entity into a different entity’s 401k? How about into my wife’s solo 401K?
No, because the businesses would be considered to be affiliated since you own both. Yes, you can roll IRAs into 401(k)s.
Thanks for the response. I meant can I roll my IRA into my wife’s 401k?
No. All retirement funds are individual. Yours are yours and hers are hers. Unless one of you dies.
Thanks. So unless I’m ok paying pro-rata on my current IRAs doesn’t seem like I can do a backdoor roth
Just got my 1099 for 2020.
I followed exact instructions as above but I want to make sure IRS doesn’t think I owe taxes.
My 2020 Form 1099-R
Gross Distribution: 12,000.52. (Box 1)
Taxable Amount: 12,000.52. (Box 2a)
Taxable amount not determined X. (Box 2b)
Federal Income tax withheld: 0.00. (Box 4)
Distribution Code: 02 (Box 7)
State tax withheld: 0.00 (box 14)
For clarification.
For 2019 Roth
December 2019–>$6,000 to traditional. It converted to Roth with $6000.26 on 1/2/2020
For 2020 Roth
December 2020–> $6000 to traditional. It converted to Roth with $6,0000 on 12/22/2020
Have I screwed this 2019 up because although I “converted ” before 2020, it didn’t register the conversion to the Roth until 1/2/20.
I hope the 8606 form can clear it up. I hope.
Your 2019 IRA contribution should be documented on your 2019 8606.
Your 2020 IRA contribution and the $12,001 conversion you did in 2020 as documented by your 1099-R should be documented on your 2020 8606.
If you screwed up and put a $6000 conversion on your 2019 8606, you better refile it.
Thank you. Can I submit a 2019 8606 with this year’s taxes (plus 2020 8606)?
No.
Before I ask my question, let me start by saying a big ” Thank You ” for all the great content on this website and on the YouTube channel. It has really helped me gain knowledge regarding Backdoor Roth IRA.
I first came across concept of Backdoor Roth IRA in May 2020. By that time I had already filed my taxes for year 2019 and had got my refund in my bank account. However, because of COVID-19 situation, the deadline to file taxes for year 2019 was extended to 15 July,2020 instead of 15 April,2020. Hence the last date to contribute in my traditional IRA and then convert that money to Roth IRA for year 2019 was also 15 July,2020. I went ahead and exactly did that. I contributed $6000 to my traditional IRA account for year 2019 and converted that money to Roth IRA on or before 15 July,2020.
In October 2020, I made the $6000 contribution to my traditional IRA account for year 2020 and converted that money to my Roth IRA account.
In both the transactions, I immediately converted money from Traditional IRA to Roth IRA the very next day and my account balance in traditional IRA on 31 December,2020 was $0. I do not have any other IRA accounts except traditional IRA and Roth IRA. I have never made any contributions to my traditional IRA before May 2020 so last year was the first time I ever contributed in my traditional IRA.
My questions are:
1) For this year when I am filing tax returns for year 2020, should I add basis of $6000 in my form 8606 ? Will my form 8606 look something like image in this section – ” 2021 Form 8606 (must fill out parts I and II)” ? (This section is referred from this article)
2) Before starting any of these contributions, I had already filed tax returns for year 2019. That means I have not filed form 8606 for year 2019 obviously. What can be done regarding this ? Can I file that form with tax returns of year 2020 and will it look something like image in this section – ” 2020 Form 8606 (only have to fill out part I)” . (This section is referred from this article)
1. Yes. Might want to go back and file a 2019 8606 documenting that contribution as well.
2. File it. I’d attach it to a 2019 1040X.
Thanks a lot for the prompt response !
I made a late contribution a few weeks ago for 2020 however I just had an appointment with my accountant and mentioned to him about making the contribution. He said that since I made the contribution in 2021 it would not be counted for 2020 despite explaining to him I’m eligible until April. Is there a way to submit the form myself? Don’t think I’ll be going back to him after this haha
Yea, fire him. Your 8606 needs to be included in your 2020 tax forms. Why pay an accountant to file a return you know will have to be amended because he doesn’t know how to do it?
Couldn’t agree with you more. Was disappointed. Would I amend my taxes after he submits it? If he can’t do it, I’ll figure it out and do it myself!
i have around $10,000 in my traditional IRA, what is the process in order to withdraw this capital or at least make some improvements to have higher yearly gains.
That’s a very vague question. Can you be more specific? I mean, the way you spend the money in your IRA is you have them transfer it to your checking account. They can withhold taxes for you if you want. If that process is unclear, call the IRA custodian (Vanguard, Fidelity etc) and they can help you do it.
If you want to “make improvements” that usually means changing investments. You simply put in an order to sell one investment and buy another.
I am using TurboTax Deluxe. TurboTax pulls in the 1099 R form from where you did your backdoor ROTH
However, TurboTax tries to make you pay taxes on the money that you put into traditional IRA and convert to a ROTH IRA.
It tries to make you explain why you should not have to pay taxes on that 1099 R. The way around this is to fill out form 8606 but turbo tax does not do this automatically.
Have the problem every year and keep forgetting how do you get the form 8606 to generate so that you do not have to pay taxes on the $7000 dollars that you put into the traditional IRA and converted to a ROTH IRA.
See that Finance Buff tutorial on BD Roth with Turbotax.
Thanks for the website and all the information. Hoping you might provided insight into a unique situation. I am trying to figure out how exactly to file everything correctly as to not be penalized. I’m using turbotax online.
Situation:
I intended to do a backdoor roth. Fidelity initially advised me incorrectly when trying to do the Conversion step and instead carried out a recharacterization. It has since been corrected and recharacterized back to the traditional but this step occurred after dec 31. Now i’m trying to untangle everything. Have spent several hours on the phone with both turbo tax and independent CPAs and i’m still confused.
Timeline/Background:
Nov 2020 — contributed $6k to traditional IRA, incorrectly recharacterized trad-> roth
Jan 2021 — realized mistake, recharacterized roth ->traditional to correct. money already invested and had some growth. fidelity folks figured out correct amounts to move
Jan 2021 — converted the funds trad-> roth through the backdoor.
So essentially for 2020 I have contributed $6000 to a traditional IRA and not converted
I have a 1099-R for the traditional showing a $6k gross distribution and a code of “N” in box 7
My 5498 for the traditional shows $0 in the traditional at the end of the year.
My 5498 for the roth shows a contribution of $6000.
Fidelity says I won’t get another 1099-r til next year to reflect the recharacterization from roth->trad
I have account letters reflecting both recharacterizations.
Any thoughts on the best way to handle this? I know that the actual backdoor conversion will be on 2021 taxes, but the rest I’m struggling with.
-My understanding of the paperwork as of now and how the IRS sees it is that it looks like I made a $6000 contribution to a roth that I am ineligible to make?
-Does having a 1099-r for the traditional with a “N” recharacterization code hurt me? If it wouldn’t have been recharacterized incorrectly, would I still have gotten this form with $6000 listed as a distribution?
-Will not having a new 1099-r for the roth->trad be an issue? Fidelity has told me the recharacterization letters can be used instead to prove the contribution is legitimate but I’m not so sure.
-Do I add/report a 1099 for the correction without actually having it yet, and if so what would it look like?
Thanks for any insight.
I agree, your 2020 8606 will show a $6000 traditional IRA contribution.
I wouldn’t worry about the rest. If the IRS starts asking questions, you have the answers it looks like to me. No, I wouldn’t add 1099s that I didn’t receive.
Hello! Thank you so much for posting this! I just wanted to run this by you to confirm! I contributed the max $6000 directly to my Roth IRA last year, 2020, in February, since I thought my MAGI would be the around the same the previous years. But this year, 2021, I calculated my MAGI was over the limit to make full contributions to my Roth. So last month, I recharacterized the 2020 contribution and all of its earnings into a Traditional IRA, then after that was done, did the Backdoor conversion a day later into my Roth.
On the 8606, I filled out lines 1-3 and 14 like how you specified in “Late Contributions to the Backdoor Roth IRA” the 2020 part I portion. I didn’t make a statement of the recharacterization when I filed my taxes. Will I get penalized? And also, since I did the Backdoor conversion this calendar year in 2021 of that original contribution in 2020, does that Backdoor count as a 2021 contribution? Meaning I can no longer do a Backdoor Roth for this year?
You didn’t make your contribution late. You made it in February 2020. You just did the conversion late. So line 4 should be zero. But otherwise, looks the same. I don’t know what happens if you don’t send in a statement. Maybe they’ll audit you/ask you questions, but I doubt there’ll be a penalty. No, the contribution is a 2020 contribution, not a 2021 contribution. You can still do a 2021 IRA contribution.
Thank you for responding! Do you know how long the statement has to be? I can just say “I did a recharacterization of my 2020 contribution?”
I’d probably include dates and amounts and maybe a reason why, but yes, stick to the facts. The shorter the better when communicating with the IRS. No more than a paragraph certainly.
Perfect! Along with the written statement, I would have to file an amended return with form 1040-X, just filling out Part III that I’m adding a statement for the recharacterization since I’m not changing anything else, correct?
Or because I did the recharacterization this year, I don’t have to include a statement with my 2020 tax return, only for 2021?
I would include the statement on my 2020 return.
That’s what I would do.
Ahh okay! I’ll complete form 1040-X and include a statement for 2020s tax return. Thank you!
I have a traditional IRA and a sep IRA with contributions both before December 31st. The traditional IRA was non deductible contribution, sepIRA was deductible. traditional IRA is only about 4% of the sep IRA amount. I made 2020 contribution to sepIRA last year, I havent made any for traditional IRA for 2020
If I rollover the sepIRA to an individual 401K now, contribute to traditional IRA for 2020 and do the backdoor roth before april 15 I would incur taxes because of the prorata rule. Is that correct? Since the traditional IRA portion is only 4% of the sep IRA amount; will I only then pay tax on 4% of traditional IRA contributions before december 31st tha/t is rolled over?
If I rollover the sepIRA to an individual 401K and contribute to traditional IRA for 2020 now, then do the backdoor roth after april 15 would I avoid the pro rata rule
No, if you roll the SEP-IRA into a 401k before the end of 2021, you won’t be pro-rated on your 2021 conversion which will be reported on your 2021 taxes. Doesn’t sound like you did a 2020 conversion, so no biggie.
Great post! So I have a rollover IRA (from previous employer), which is considered traditional IRA? I have deposited 6000 for the year of 2020 and would like to convert to a Roth. It came with a question asking how much income tax withholding percentage I’d like to withhold during the process of conversion, any good suggestions on what number to put?
Thank you!
Yes.
Don’t withhold because no taxes will be due if done properly.
Remember to do something about that rollover IRA before doing Backdoor Roths or you’ll get prorated.
Sorry I wasn’t clear about my question. So I deposited 6000 last year (which is after tax) to my rollover IRA (from previous employer) account. If I’d like to move all the money in rollover (6000 after tax and 43000+ pretax money) to roth, do I NOT withhold the tax? or pay tax prorated since majority of the fund is pretax money from my previous job?
If i need to withhold, then how much percentage should I do?
Thank you again!
You’ll owe taxes on the $43,000, but you don’t have to have anything withheld. You can pay those taxes from another pot of money so you maximize how much stays in the Roth IRA.
Hi,
I wanted to take advantage of the backdoor Roth IRA (I have contributing to my Roth IRA for the past few years and I am in the “phase out” range, hence I contributed $2,600 in 2020 and $2,500 in 2021), so I opened a Traditional IRA a week ago and made a non-deductible contribution of $4,400 for 2020 (the difference between the $7,000 max I am allowed to contribute to IRAs and the $2,600 I already contributed for 2020 in my Roth) to it with the intention of doing a backdoor conversion to my Roth right away.
However, when I called Fidelity, they told me I cannot do the backdoor conversion for 2020 in 2021, so now I am stuck with the 2020 Traditional IRA contribution and don’t know what the best way to “get rid of it” is. I also already filed the 2020 taxes before I made the 2020 Traditional IRA contribution. Does anyone know for sure that you cannot do a backdoor conversion for the prior tax year?
Good news! The person you talked to at Fidelity doesn’t know what they’re talking about. While they’re right that you can’t do a conversion “in 2020” (because it is no longer 2020), that doesn’t mean you can’t convert money that you contributed for the 2020 tax year whether you contributed it in 2020 or 2021. The conversion gets reported on your 2021 8606.
Just convert it all to a Roth IRA in 2021.
There is no limit on when you can do conversions. You could contribute every year for 20 years and then convert it all in one year if you wanted. You SHOULDN’T do that. But you CAN do that.
Thank you very much for confirming what I suspected 🙂 The conversion of 2020 TIRA contribution went through fine at Fidelity, so if their statement was true, I would have expected the transaction to not go through.
P.S. I wish I had run across your site/blog a lot sooner. It would have saved me lots of research time (and not only for this topic) and I would have made better investing decisions.
I already filed my 2020 taxes, but I am doing the 2020 nondeductible contribution to the Traditional IRA and the backdoor conversion to Roth after the 2020 tax filing. Can I just submit the 8606 form for 2020 without filing an amended return?
I think you should send it in with a 1040X. Don’t worry, it’s pretty easy to fill out especially when the only change is an 8606.
Thank you so much for the quick response! Just curious, but if the 1040X would be exactly the same as the 1040 I already filed, what would be the benefit of sending a 1040X along with the 8606? Is it just to make it easier for IRS to identify that the 8606 is being submitted for a return that is already filed? I filed using H&R and was thinking to just mail the 8606 to IRS along with a letter explaining why the 8606 is being filed after the 2020 return was filed.
There’s a spot on the 1040X where you explain what changed. That’s “the letter” you want to send in. Look at the 1040X and you’ll see what I mean. Look at Part 3:
https://www.irs.gov/pub/irs-pdf/f1040x.pdf
Hi I have a question:
Im a fellow in training, I just opened a Roth IRA and have funded it with $6000 towards 2020 contributions
For 2020, I am single and my MAGI is < $124,000, so I can contribute the full amount
1) For 2021, I anticipate my MAGI will be around ~124,000-140,000..if it is above ~140,000, I will need to use the backdoor method, correct?
2) If I need to use backdoor method, should I just create a traditional IRA now as well?
1. Yes
2. Whenever you’re ready to contribute. It only takes 5 minutes to open it.
A little confused about tax issues/advantages with backdoor Roth conversions.
So when you put money towards a traditional IRA it is of course tax deductible for the tax year for which it counted, up to the legal contribution limits.
When you convert $6000 of it towards a backdoor Roth, do you lose that tax deductibility on the $6000 or is it still in place since it was originally put in as traditional IRA funds?
Also, is there a point at which the $6k conversion is materially so small that it may not be worth it? Mid-late 40’s approximating $4M in retirement accounts (some recent pull back last month or two though), with expectations of >$10M IRA accounts at full retirement age. Is it worth it to bother in this scenario?
No, for high earners who have a retirement plan at work, a traditional IRA contribution is NOT deductible.
But if for some reason you got that deduction, then yes, you would pay taxes on the conversion.
I agree this isn’t worth a big hassle for you to do at your level of wealth. But if you don’t have a traditional, SEP, or SIMPLE IRA, why not?
Thank you for the information. I notice you stated this was your 9th pair. Do you have to open a new Traditional and Roth every year?
First off, thank you for your work and helping everyone navigate through the world of retirement financing.
I wanted to start contributing 6k to Roth IRA through the backdoor option for me and my wife separately.
But I came to find out today that she has an old 401k from previous employer that got rolled into traditional IRA and is sitting in bank A. I was going to open her accounts at Vanguard, but does her TIRA at the other bank matter? Does she have to have no active funds in any traditional IRA to do the backdoor conversion or is that irrelevant since the accounts are at different institutions?
This is probably a stupid question but I am very new to this.
Thank you very much!
Yes, it still counts even if it is in a separate IRA at a separate instituion.
It isn’t that she can’t do a conversion if she has pre-tax money in a traditional IRA, it’s that the conversion gets pro-rated and most people don’t want that to happen.
People sure do like Roth’s around here. Before you do any Roth conversion, IMO remember to first consider family HSA if you’re eligible given their advantages over Roth/tIRA/other retirement vehicles. You just ultimately need to use the funds for healthcare needs and there are no early withdrawal penalties when used for healthcare needs. If you have further resources for funding then the (backdoor) Roth is a good next option.
Another way to contribute to Roth IRA’s if you’re above the income threshold is to make a direct contribution to a Roth for which you’re not the beneficiary. I’ve been doing this for my teenagers for a few years now since they have earned income by working for our family business (their income also serves to lower our effective household tax rate). $6K/year Roth contributed to each of them starting over a decade younger than I started investing for retirement is one heck of a head start given the compounding benefit with starting so young. Given that they plan on professional education too, the contributions can probably continue over a decade so long as they continue to work, so they don’t have to delay retirement planning to an older age as many physicians (myself included) had to do.
You get to a point where you know you’ll have more than enough for retirement and the focus starts transitioning to legacy planning. The earlier you get to this point the better off your children (and estate) will be, and the more time you have to plan and execute estate directives, given annual contribution limits for retirement plans. Roth contributions for your children can be a part of that plan which comes at relatively little cost but can have huge impact over a lifetime of compounding. This tactic can also be extrapolated to Roth contributions to grandchildren when the time comes. While you personally don’t benefit directly from these Roth contributions, some very special people in your life will. Based on my specific resources, my goal is for each child to have a net worth of at least $250K-$500K upon completion of their education. Not that zero or negative net worth feeling I started with. The Roth accounts (contributions plus returns) can be a significant portion of that with the great advantage of being tax free upon withdrawal after age 59.5 for penalty free.
I would hope most of my readers could max out both HSA and Roth IRA(s) each year.
Technically YOUR CHILDREN contributed to their own Roth IRAs with their own earnings and you gave them a $6K cash gift. You didn’t contribute to their Roth IRAs because that would be illegal.
Most readers here can probably max out both, just making sure they remember to consider the HSA if eligible.
Are you saying the funds for our kid’s IRA’s can’t come annually from our accounts for deposit into their Roth accounts? Regarding who technically makes the contribution sounds like semantics, from what I understand it can be both a gift and a contribution, not mutually exclusive. Otherwise wouldn’t it then be a requirement that the Roth funds be withdrawn from the child’s own account? Practically speaking I have read many times on the internet that anyone (even a random friend) can make the contribution to the account. Also neither my accountant or Roth custodians (Vanguard prior and now Fidelity) have expressed any funding concerns.
This article from the Motley Fool, written by a CFP, specifically stated “anyone can make the contribution”:
https://www.fool.com/investing/2021/01/06/5-rules-for-opening-a-roth-ira-for-your-kid/
Fidelity says this:
“Convincing a child to hand over his or her hard-earned cash to invest in a Roth IRA may be challenging but remember that as long as the child has earned income to qualify for Roth IRA contributions it doesn’t matter where the contributions come from. As an alternative, you may want to consider an arrangement where you or another adult make contributions as gifts to reward the child for working, or one where the child contributes a portion of his or her earnings to the Roth IRA and you match that amount (assuming the total doesn’t exceed the lesser of the child’s earned income for the year or $6,000).”
https://www.fidelity.com/learning-center/personal-finance/retirement/turbocharge-childs-retirement
I saw this on zacks.com:
“No Money Tracking
As long as your adult child has enough compensation, the IRS doesn’t care whether she uses your gifted dollars or her compensation to contribute to her Roth IRA for the year. Suppose she has a part-time job that pays her $15,000 for the year and she spends all $15,000 on her basic needs. If you give her $5,000 more, she can put that money in her Roth IRA even though that $5,000 wasn’t compensation.”
If you feel differently or get different feedback from a CPA/tax attorney let me know I’ll reconsider how the Roths are funded or any other adjustment.
In the end, the point is about optimizing the appropriate use of Roth accounts, back door or otherwise for high earners (in this case the benefit is in the realm of estate planning rather than direct monetary gain for the “gifter”.
I don’t think that the account it comes from matters much (never heard of an audit looking at that), but mine do come out of my kids’ checking accounts into their Vanguard accounts. It’s just a technical point I was making so people understand that you can’t just contribute to your kid’s Roth IRAs, they actually have to have earned income equal to the contribution.