As the New Year begins, many a high-income professional who earns too much to make a direct Roth IRA contribution will use the backdoor to make a Roth IRA contribution of $6,000 or $7,000 (if age 50 or over). Although it can be straightforward, it can also be unnecessarily complex. Hence, this backdoor Roth FAQ.
This blog post was originally a forum post by “Peds,” a prolific participant and moderator on the White Coat Investor Forum. As someone who fields multiple questions a day on the topic at the end of one year and beginning of the next, I felt it would be great to push this list of frequently asked questions about the backdoor Roth to the general public.
If you have any questions, they’re likely answered multiple times in the blog posts featured at the beginning. Any lingering questions — over 40 of them — are answered (again, in many cases) in the FAQ that follows.
I thank Peds and The White Coat Investor for agreeing to let me polish this piece into a full-fledged blog post. I’ve added my comments in italics and added a few blog posts of my own to the list, but the remainder, sans some minor editing, is all the fine work of the occasionally snarky but spot-on Peds.
The 2021 Backdoor Roth FAQ
– !!! STOP. DO NOT PASS GO. DO NOT COLLECT $200 !!!
Read all the blog posts linked below. Do nothing until you understand the steps and know what accounts you have and your projected income for the year. Repeat, STOP and pay attention. Please ask questions here before you do anything if something is unclear.
General Backdoor Roth Overview
– So, what’s the point of all this?
You make too much money, fancy pants high earner, to get a tax deduction from a traditional IRA contribution. However, you can still make a non-deductible contribution. Nothing changes on your taxes, and you have more money in an IRA now. Good, it’s protected.
However, once it comes time to remove that money, the gains are taxed as income.
So you got no deduction on the way in, you did get tax free growth over the years, but the gains are taxed on the way out. Not the most efficient choice. [PoF: A number of cash value life insurance products have similar features, but with much higher fees.]
Now, you also make too much money to directly contribute to a Roth IRA.
Some history: Congress changed the law >10 years ago that removed the income restriction on conversions which was the holdup in the past. Now, you can contribute to the traditional IRA, the contribution is nondeductible, and then you can convert that money to a Roth IRA without any restriction based on income.
Since it was a non-deductible contribution, and a conversion is a taxable event, the taxes on money already taxed is…$0.
So now you still didn’t get the deduction on the way in, you still get tax free growth over the years, but now everything is tax free on the way out. Way more efficient.
But Peds, I want to save taxes because I am a high earner and OMG, taxes keep me from buying houses and Teslas. Why do I even bother with this?
Because you need all the sheltered space you can get. You fill up both workplace plans and IRAs. It’s not either/or. Protected money is the whole point.
Backdoor Roth Blog Posts
Physician on FIRE: Backdoor Roth IRA: A Step by Step Guide with Vanguard
White Coat Investor: Backdoor Roth IRA Ultimate Guide and Tutorial
The Finance Buff: Backdoor Roth: A Complete How-To
- The Marginal Value of the Backdoor Roth. Is it Worth the Trouble?
- Calculating the Value of Your Backdoor Roth Contributions
- The Backdoor Roth Point / Counterpoint: A Must-Do or Meh?
- 17 Ways To Screw Up A Backdoor Roth IRA
- How to FIX Backdoor Roth IRA Screw-ups
- Pennies and the Backdoor Roth IRA
- IRA Recharacterizations (I Should Have Back Door Rothed!)
- Celebrating Ten Years With The Backdoor Roth IRA
- Make Backdoor Roth Easy On Your Tax Return
- Backdoor Roth: Planned vs Unplanned
- How To Report Backdoor Roth In H&R Block Software
- How to Report Backdoor Roth In FreeTaxUSA
- How To Report Backdoor Roth In TurboTax
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Your Backdoor Roth Questions Answered
– I/spouse have an existing traditional IRA/SEP IRA/SIMPLE IRA and I want to…
STOP. [PoF: Read the first post above. You will have issues with the pro rata rule.]
– Do I need to open a traditional IRA and Roth IRA?
Yes, you have to create these accounts.
— Can I use old accounts?
Yes. Makes it easier.
[PoF: I’ve been using the same accounts for years.]
— Won’t my traditional IRA disappear now that it’s zero?
No, the account won’t close afterward.
[PoF: I can confirm this is true with Vanguard.]
— So every year I have to open new accounts?
No, you’ll use the same ones next year. Or open new ones; go crazy.
– I heard I want to dollar cost average, what time frame should I use?
No. Lump sum, and lump convert immediately. [PoF: You may have to wait up to about a week before the money is available. See my tutorial for Vanguard brokerage IRA accounts.]
– I don’t have $6,000 yet. should I add money over X period of time as I save up?
No. Save up, then lump sum, lump convert immediately.
– My method involves daily contributions of $16 / some other equally crazy scheme, etc… Is this fine?
No. Lump sum, lump convert immediately.
[PoF: I agree with the KISS principle. Keep it simple, silly.]
– Wow, haven’t you guys heard about this step doctrine thing?
Please google TCJA.
[PoF: This was a theoretical concern in the past, but footnotes 268, 269, 276, and 277 of the Conference Committee’s explanatory report on the Tax Cuts and Jobs Act provided clarity and validated the backdoor Roth IRA contribution.]
– I sent money in, but it won’t let me do anything yet?
Yes, it has to settle. Yes, you have to wait. Yes, you’ll have to come back and then convert it when it’s ready.
– I want to invest in stocks/bonds/BTC/TSLA before converting. What do I pick?
No, just use a money market fund.
– My account grew to $6,XXX.XX. What do I do/is it too much/do I only convert $6,000, etc… ?
Yes, convert it all. Choose 100%. Gains are taxed.
– But Peds, you said “no taxes” and now you say I am getting taxed. Ugh… I hate taxes!
Assuming you converted in a matter of days, you will have <$2 in this current interest rate environment. In the 24% bracket, that’s $0.48 in tax.
Haven’t you noticed the tax forms always round? So that’s $0 in tax, still.
– My account shrunk to $5,XXX.XX, what do I do/can I add more/should I wait till it comes back?
I said to use a money market fund. No, you cant add more as you already hit the $6,000 maximum. Convert 100%.
– Isn’t the market going to plummet (insert whatever reason here) / shouldn’t I wait to do the Backdoor Roth?
Doesn’t matter. It’s $6,000. This isn’t a lot of money. [PoF: Relatively speaking, for someone who earns enough to have to use the backdoor.]
A 50% drop ($3,000) will be eclipsed next year by a 200% contribution (another $6,000).
[PoF: I’ll add that money is fungible. You can choose to invest this money or not invest it (by leaving it in a money market fund) just like you can with the rest of your money, regardless of where it’s held. This should not be construed as an endorsement of market timing; I’m just stating the obvious.]
– I have $X.XX leftover after the conversion, what now?
I told you to do 100%. Convert it again; it doesn’t matter if it’s twice. Yes, you’ll pay tax on it. Make sure you select 100% next time.
– But I already contributed to my 401k/401a/403b/gov 457/non-governmental 457(b) / SEP IRA / SIMPLE IRA / grandma’s retirement party fund. Can I still contribute to an IRA?
Yes, IRAs are individual. Nothing affects the contribution limit of $6,000 per person per year.
– But I did an IRA / 401(k) /403(b) /457(b) /etc… rollover / conversion already. Do I still get 6,000?
Yes, IRAs are individual. Nothing affects the contribution limit of $6,000 per person per year.
– No, you don’t understand, Peds. I have to rollover more than $6,000, so am I limited to $6,000 because that’s the limit?
No, conversions and contributions are not the same things. You can rollover/convert $1,000,000 and still contribute $6,000. Nothing affects the contribution limit of $6,000 per person per year.
– My spouse has X problem; can I still do my own?
Yes, IRAs are individual. Your spouse does not affect you and vice versa.
[PoF: That is to say that your spouse’s problem does not affect your ability to do the backdoor Roth. As far as your spouse’s problem affecting you in a myriad of other ways, your mileage may vary.]
– It asks what year I want to contribute for?
Please choose the correct year.
– I just did 2020, when can I do 2021?
There is no waiting period. You can do it immediately. Lump sum, lump convert immediately.
– I haven’t done 2020, can I do 2021 at the same time?
You can do them at the same time until April Tax Day. Lump sum, lump convert immediately.
– When can I do 2021?
Until 2022 April tax day. Lump sum, lump convert immediately.
– I haven’t done it for 2019, when can I do it?
– I will make less than the limit. What should I do?
Nothing. Normal Roth IRA.
[PoF: As long as you are at least 110% sure your income will be far below the IRS limits for contributing directly to a Roth IRA. For 2020, that ability begins to phase out for single filers at a modified adjusted gross income of $124,000 and at $196,000 for those who are married filing jointly. The numbers for 2021 are $125,000 and $198,000.]
– I will make more than the limit. What should I do?
Everything. Backdoor Roth IRA.
– I don’t know how close I’ll be to the limit. What should I do?
Anyone can do a backdoor Roth IRA. It just involves completing the steps and submitting the forms. The IRS doesn’t care if you make extra work for yourself. But it saves you a huge hassle if you were wrong. Do a preemptive backdoor Roth IRA.
– I am in the phase out limit, should I calculate and contribute the exact amount?
No. Do a preemptive backdoor Roth IRA and always contribute the max 6K.
– Wait. I was above the limit and did a direct contribution What now?
– Wait. I was above the limit the past few years and I/spouse/accountant/CPA/baby Yoda, etc… didn’t catch it. What now?
You need to fix all those years, re-characterize, file forms, pay tax, etc… because you didn’t qualify for a direct Roth contribution and you don’t want the IRS finding out and penalizing all that money.
– When I choose convert/exchange,etc… a warning pops up that this is taxable. I hate taxes, Peds. You said “no taxes” multiple times now, ugh… taxes, what do I do?
You are using a non-deductible traditional IRA aka post-tax money, therefore no taxes owed except for gains. This is a blanket statement as all traditional IRA to ROth IRA conversions are taxable events.
– When do I file form 8606, the same week/month, etc…?
You file with your taxes, so next year.
– Wait. My past tax returns never had a Form 8606. What now?
Assuming you did the correct process, just send in form 8606 for the missing years.
– I/spouse have an existing inherited IRA, what now?
Doesn’t matter. It’s not counted in pro-rata since it’s technically not yours.
– I haven’t earned $6,000 yet. Can I still contribute Jan 1?
As long as in the calendar year you and/or spouse earn $6,000, you can contribute anytime. The IRA doesn’t know what date you got there.
– I don’t work but my spouse does, can I contribute?
Yes, while IRAs are individual the qualified income can be from spouses.
– I’m giving my kid money for picking up their toys. This is a full-time job, in my opinion. Can they open a Roth IRA?
No. Please look up the IRS definition of earned income.
– I am old(er) and can do $7,000. Can I do it all?
Yes, over 50 gets an extra $1,000 as a catch-up.
– Isn’t the market closed on January 1?
….Sorry, what’s your question….?
[PoF: You can enter your contribution on January 1, and it may not be credited until the next day and may take up to a week to settle, depending on the brokerage and account type. But you can absolutely begin the process on January 1st.]
Any further questions? I hope not!
But if you’ve got them, I’ll direct you to the original forum post, which is a great place to learn more. Your question may have already been answered there if it hasn’t been answered here!