In 2020, I made my eighth pair of “Backdoor Roth” IRA contributions with Vanguard. If you’ve heard of the Backdoor Roth IRA, that’s great! You’ve been paying attention.
If not, I’ll give you a brief overview, precise instructions on how to do it yourself, and a number of links to additional articles with more complete descriptions of the history and important caveats.
This post has been updated with fresh screenshots from my 2020 contribution and conversion, which were completed on January 2nd and January 3rd (Roth IRA mutual fund account / spousal IRA) and January 5th (Roth IRA brokerage account / my Roth IRA).
I like to contribute early in the year to start the tax-free earnings as soon as possible, but you have until Tax Day in mid-April, 2021 to complete a 2020 Backdoor Roth contribution.
Why am I posting this for a second time in 2020? If you’ve never done this before and you’re reading this article before July 15th, 2020 you can still do this for 2019. Normally, that window is closed mid-April, but circumstances have led to a three-month extension.
Vanguard is the company I use, and one that tends to be favored among many index fund investors, so that’s what you’ll see here. The process should be similar with other brokerages, but the screens will look different.
Backdoor Roth IRA 2020: A Step by Step Guide with Vanguard
Backdoor Roth IRA: An Overview
Money contributed to Roth accounts does not result in a tax deduction, unlike contributions to tax-deferred accounts. Both Roth and tax-deferred accounts benefit from tax-free growth, unlike a taxable account that is subject to tax drag (which can be minimized). The Roth dollars, unlike tax-deferred dollars, will not be taxed when withdrawn.
One of the first world problems of earning a solid income is the inability to contribute directly to a Roth IRA or tax-deductible IRA.
A modified adjusted gross income (MAGI) of $206,000 for a couple filing jointly, or $139,000 for an individual makes you ineligible to contribute to a Roth IRA in 2020. Phaseout ranges where you can make a smaller Roth contribution (less than $6,000) start at $196,000 and $124,000 for couples who are married filing jointly and single filers, respectively.
Many physicians are thus excluded from making either deductible IRA contributions or direct Roth IRA contributions. If your income might put you into or above those phaseout ranges, you’re better off using the backdoor, just in case. There’s nothing wrong with making your Roth contribution the hard way and finding out later that you didn’t need to take the extra steps. You won’t have to change a thing.
Now, understand that a high income doesn’t mean you can’t contribute directly to a Roth account of some kind. You may have a Roth option within your 401(k) or similar account, although I would argue you’re probably better off with the tax deduction offered by making tax-deferred 401(k) contributions if you’re in the 32% or higher tax bracket.
Another important distinction is that a high-income does not prevent you from making Roth conversions. The income limits were lifted in 2010, and I took advantage by making a Mega Roth conversion when it was believed the income limits would be reinstated. However, there are still no income limits, and hence, the backdoor remains wide open.
The income limits for a traditional tax-deferred IRA contribution are even lower than the Roth contribution limits. If you participate in a workplace retirement plan, you won’t be eligible to contribute as an individual earning more than $75,000 or as a couple earning more than $124,000 in 2020. The deduction actually begins to phase out at a MAGI of $65,000 for single filers and $104,000 for married couples filing jointly.
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Before Attempting a Backdoor Roth
While income limits are a non-issue for the backdoor, there exists one important prerequisite to be able to properly execute the backdoor Roth.
You cannot have tax-deferred money in an IRA in your name.
That includes traditional IRA, SEP IRA, and SIMPLE IRA, but does not include 401(k), 403(b) or similar accounts. If you do hold tax-deferred IRA dollars, you’ll be subject to taxes when making your conversion per the pro-rata rule.
If you do have these types of accounts, you’re not hosed, but you need to have a strategy to move that money elsewhere or you can forget about the backdoor Roth.
If the balances are small and you can afford the taxes on the conversion, you can convert it all to Roth and just pay tax on the conversion. This could be a good idea for those in lower tax brackets — residents and students, for example.
Another option for employees may be to roll the IRA into an employer’s 401(k) plan. Not all plans accept rollovers, but mine does, and this was the route I chose with my SEP-IRA a few years ago. Fortunately, my 401(k) offers institutional Vanguard index funds. If I had lousy options, a rollover might not have been worthwhile.
It might also a good idea to avoid having a SEP-IRA in the first place by putting your independent contractor earnings into a solo 401(k) instead. The White Coat Investor covers some of the advantages in this article.
One way employees without a business of their own create one is by obtaining an EIN for a survey-answering business. Earning just a little 1099 money on the side qualifies you as a business owner, and you can open an individual 401(k) a.k.a. solo 401(k) for the business.
As long as the plan accepts rollovers (many do), you’ll be able to roll over traditional IRA, SEP and SIMPLE IRA money into it to circumvent the pro-rata rule and associated taxation when attempting the backdoor Roth.
For healthcare professionals, I’ve found that the simplest side business is one in which you answer medical surveys for dollars. I’ve got a great overview of a handful of survey companies here.
Here’s how I make my backdoor Roth conversion with Vanguard:
Step 1: Make a non-deductible IRA contribution.
If you haven’t done so already, you’ll need to open a Traditional IRA. I won’t walk through all the steps, but it should be straightforward. You’ll start by selecting “Open an account” from the top of the page, leading you to a page that looks like this.
Since I opened mine years ago, I start by making a contribution to my existing IRA, an account that Vanguard thankfully leaves open, even when the balance is zero.
Start by going to My Accounts -> Balances & Holdings.
Open your Traditional IRA account, select “Buy and sell” then “Buy Vanguard Funds”
You may be presented with a screen that looks like this if you don’t have money waiting in a Vanguard settlement fund. Go ahead and click on “Contribute to IRA.”
Next, you’ll tell Vanguard where the money is going (and where it’s coming from such as your checking account or a money market). I invest my non-deductible IRA contribution in the Prime Money Market Fund so day-to-day volatility is a non-issue.
I’ve selected Traditional IRA, and entered $6,000. If I were age 50 or older, I could contribute $7,000. You’ll be asked to consent to the investment you’re making.
Vanguard now wants to know where the money is coming from. For 2019, knowing I’d be investing in my Roth IRA shortly, I let the late-December dividends from my taxable account stay in my Federal Money Market fund, and there was enough there to fund the non-deductible IRA contribution.
Next, you’ll have a chance to review and submit. Look over everything to be sure everything looks right.
In 2020, I funded the Traditional IRA contribution via an ACH transfer from my bank account. The screen looks a bit different.
You’ll be asked to consent to electronic delivery of the prospectus if you’d opted to go paperless for these, which I recommend you do to save some trees.
Next, click Submit and Vanguard will politely thank you.
You should also receive an e-mail confirmation.
Note: In recent years, all new IRA accounts at Vanguard have been “brokerage accounts” as opposed to “mutual fund accounts.” There are several differences. The brokerage accounts allow you to purchase individual stocks and funds from other brokerage companies.
The brokerage account also has a settlement fund and a number of people have run into delays of up to 7 days when funding a brokerage account IRA via electronic bank transfer, waiting for the funds to “settle.”
Even when funding directly from a Vanguard money market fund in a taxable (non-qualified) account to their IRA brokerage accounts, friends of mine are seeing delays.
If you have been with Vanguard for some time, I recommend you keep the mutual fund account if prodded to make the transition to a brokerage account unless you are planning on investing in something other than Vanguard mutual funds in the account.
Eventually, all accounts may be transitioned to brokerage accounts, but I’d hang onto the mutual fund account as long as they’ll allow it.
Out of curiosity (and also to appease Vanguard which bombarded me with a popup when I logged in stating that my account needed the update), I transitioned my Vanguard Traditional IRA mutual fund account to a brokerage account late in 2019. I left my wife’s account alone, so it remains a mutual fund account.
As of January 3, 2020, my wife’s backdoor Roth conversion was complete, whereas I had to wait another day or two before my funds were available to be converted.
Step 1.5: Wait?
There is a thing called the “step transaction doctrine” that had some people believing it’s best to do nothing for anywhere from one statement cycle (a month) to a full year. Most people move on to step 2 without much of a waiting period, and I’m not aware of anyone having issues with the IRS after doing so. For more on the subject, see this article from Ann Marsh or this recent thread at Bogleheads.
In 2018, Congress officially blessed the steps of the backdoor Roth as allowed under current law. See forum thread and links in the White Coat Investor Forum.
Step 2: Convert to Roth (Mutual Fund Account)
If your Traditional IRA is designated as a mutual fund account, follow these instructions that immediately follow.
I move on to Step 2 with the Traditional IRA Mutual Fund Account the day after contributing. Navigate to “My Accounts” “Balances and holdings”
Scroll to your Traditional or Roth IRA (or open a Roth account if you don’t have one). Click on “Retirement contributions and distributions.”
On the next screen, be sure to select the correct tax year. Vanguard defaults to the previous year. If you’re making your 2020 Backdoor Roth contribution, be sure to select Tax Year 2020.
The screenshots below are from last year’s mutual fund account contribution. Nothing has changed but the dates.
Look for the dropdown menu in the lower right labeled “I want to…” and select Convert to a Roth IRA.
Next, we tell Vanguard where the money is coming from (Traditional IRA) and where it’s going (Roth IRA). I chose the REIT fund since that is a little underweight based on my desired allocation.
You’ll be warned that a conversion is a taxable event. This isn’t true in this case because the initial IRA contribution was a non-deductible contribution. This can safely be ignored.
New this year is a warning that the contribution cannot be reversed. Tax Reform has eliminated the ability to recharacterize (undo) Roth conversions.
Since it’s not actually a taxable event, do not withhold any federal income tax.
Click “CONTINUE” one last time.
Click “Submit,” and you’re done!
Vanguard will say thank you and send you an email of the transaction submission.
You’ll also be able to view the transaction in your Transaction history.
If you still have the mutual fund account, I recommend hanging on to it as long as you possibly can. It makes this process shorter and quicker. If you haven’t yet made the transition, you don’t need to read the instructions for Brokerage Accounts and can jump to the next step.
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Step 2: Convert to Roth (Brokerage Account)
If you completed step 2 with a mutual fund account, you can skip this section.
A business day or two later (or possibly up to 7 days later) after making the initial non-deductible IRA contribution, return to My Accounts -> Balances & Holdings. Your Traditional IRA Brokerage Account should have a “Convert to Roth IRA” on the right hand side of the available actions. Click it.
If you try to convert the day after making the contribution, you may run into a screen that looks like this.
This is what I saw on 01/03/2020. I did not check on 01/04, but on 01/05, I was able to convert despite the “Date Available” listed as 01/09.
If you’re good to go, you’ll get to the “Convert to a Roth Brokerage IRA” screen. You’ll be warned that this cannot be undone.
Choose to convert all of the account to an existing Roth IRA. If you don’t have one yet, there’s a link to open a Roth IRA.
You’ll also be asked on this screen to make a tax withholding choice. This is a non-taxable event so we won’t withhold any taxes and there’s no need to send anyone a notice.
Next, you’ll have an opportunity to look everything over before submitting. Doublecheck your work, but if you’d followed the instructions thus far, it should be pretty straightforward.
You’ll get a confirmation.
You’re done now… sort of.
With the mutual fund account setup, we were able to select the target mutual fund in the Roth IRA for our $6,000 to be invested in. We were not able to do that directly with the brokerage account. Thanks again for the “upgrade,” Vanguard!
At least we were able to move our “unavailable shares” from the Traditional IRA Brokerage Account to the Roth IRA Brokerage Account. Believe it or not, we can also choose where we’ll invest those shares now, too.
Click on “Buy and sell” -> “Vanguard Funds.”
Tell Vanguard where the money is going and where it’s coming from.
Next, if you like trees, you may be given the option to “Consent to electronic delivery of fund prospectus. I always give my consent. This post is long enough without that screenshot, so we’ll skip it.
Finally, review and submit.
Vanguard thanks you and gives you a confirmation. You may also receive confirmations via email and text if you’ve set those up.
Step 2.5: Repeat for Spouse (if you’ve got one)
If you’re married, your spouse can also do the backdoor Roth, even if he or she has no earned income. You must have at least $12,000 of earned income between the two of you, but you wouldn’t be doing this if you didn’t.
Step 3: Fill out Form 8606 in your 1040
The IRS has instructions here and the form here. I see no need to repeat them. The Finance Buff tells us what it should look like in this post, which includes instructions for TurboTax, H&R Block, and Taxact.
If you have additional questions, you may find answers in the following posts.
- White Coat Investor: Backdoor Roth IRA Tutorial
- White Coat Investor: 17 Ways to Screw Up a Backdoor Roth IRA
- Michael Kitces: How To Do a Backdoor Roth IRA (Safely) and Avoid the IRA Aggregation Rule and Step Transaction Doctrine
- Vanguard: The benefits of a “backdoor” Roth
- Morningstar: Backdoor Roth IRA? Avoid These 6 Mistakes
Looking for additional investment opportunities now that you’re maxing out your tax-advantaged space? Look to my Crowdfunded Real Estate Resource Guide.
For more information, be sure to check out additional articles on the Backdoor Roth:
- Vanguard Backdoor Roth 2019: a Step by Step Guide
- The White Coat Investor Backdoor Roth Tutorial
- 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?
Is the Backdoor Roth Worth the Trouble?
I would say “Yes.” If you’re considering the backdoor Roth, the $6,000 or $12,000 most likely takes the place of a portion of your investments that would otherwise be invested in a taxable account.
As long as the money remains in a Roth account, it will grow without tax drag. Currently, my tax drag is nearly 0.6%, but with the right investments (index funds) and an ability to land in the 0% capital gains tax bracket in early retirement, tax drag can be quite close to zero.
Also, as a taxable account appreciates, you can end up with substantial unrealized gains, which may eventually force you into a higher tax bracket as you realize those gains to have spending money in retirement.
Clearly, Roth money is more valuable from a tax perspective than money in a taxable account. I see no reason not to take advantage of this opportunity, as long as it exists, unless you have IRA money that would subject to the pro rata rule, and no good rollover options (such as an employer’s or solo 401(k)).
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Have you taken advantage of the backdoor Roth? What’s holding you back?