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.
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)
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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!
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.
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?