Backdoor Roth IRA 2019: a Step by Step Guide with Vanguard

This year, I made my seventh pair of “Backdoor Roth” 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, 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 2019 contribution and conversion, which were completed on January 3rd and 4th, 2019. 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, 2020 to complete a 2019 Backdoor Roth contribution.

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 2019: a Step by Step Guide with Vanguard

 

Backdoor Roth: 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 The Roth dollars, unlike tax-deferred dollars, will not be taxed when withdrawn.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 $203,000 for a couple filing jointly, or $137,000 for an individual makes you ineligible to contribute to a Roth IRA in 2019. Phaseout ranges where you can make a smaller Roth contribution (less than $6,00) start at $193,000 and $122,000 for married couples and individuals, 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.

Now, 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 contributions if you’re in the 32% or higher tax bracket.

 

Related: Should You Invest in a Roth or Traditional 401(k)?

 

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 $74,000 or as a couple earning more than $123,000 in 2019.

 

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 surveys that take the least amount of time and pay well per question asked come from InCrowd Answers.

 

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.

Open your Traditional IRA account, select “Buy and sell” then “Buy Vanguard Funds”

 

Vanguard_Backoor_Roth_2019_01

 

 

 

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.

 

How much interest are you earning in your checking and savings accounts? Explore accounts offering 20x what many banks are offering. High Interest Savings Accounts

 

Vanguard now wants to know where the money is coming from. 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’s enough there to fund today’s non-deductible IRA contribution.

 

 

 

 

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, you’ll have a chance to review and submit. Look over everything to be sure everything looks right.

 

 

 

Alternatively, if you’re funding the transaction via Electronic Bank Transfer (as I did in 2018 in the screenshot below), the screen may look like this:

 

Backdoor Roth 2018 _04

 

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’ll hang onto the mutual fund account as long as they’ll allow it.

 

 

Next, click Submit and Vanguard will politely thank you.

 

 

Vanguard_Backoor_Roth_2019_16

 

 

 

 

You should also receive an e-mail confirmation.

 

 

 

 

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.

[Update: Congress officially blessed the steps of the backdoor Roth as allowed under current law in 2018. See forum thread and links in the White Coat Investor Forum.]

 

Step 2: Convert to Roth

 

I move on to Step 2 the next day. Navigate to “My Accounts” “Balances and holdings”

 

 

 

Backdoor Roth 2018_16

 

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 2019 Backdoor Roth contribution, be sure to select Tax Year 2019.

 

Note: if you’ve never done the Backdoor Roth, and you’re financially able, now is a great time to make one contribution for 2018 and another for 2019. If you’ve got an eligible spouse (and by eligible I’m referring to backdoor Roth eligibility), the two of you can sneak $23,000 into Roth accounts this year as long as you complete the 2018 contribution by mid-April, 2019.

 

 

 

 

 

Look for the dropdown menu in the lower right labeled “I want to…” and select Convert to a Roth IRA.

 

 

Vanguard_Backoor_Roth_2019_09

 

 

 

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.

 

 

Vanguard_Backoor_Roth_2019_14

 

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.

 

 

 

 

Step 2.5: Repeat for Spouse (if you’ve got one)

 

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.

 

Additional Resources

 

If you have additional questions, you may find answers in the following posts.

 

Looking for additional investment opportunities now that you’re maxing out your tax-advantaged space? Look to my Crowdfunded Real Estate Resource Guide.

 

Is the Backdoor Roth Worth the Trouble?

 

I would say “Yes.” If you’re considering the backdoor Roth, the $5,500 or $11,000 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)).

 

Was this helpful? Please consider subscribing to this site. I’ll give you a spreadsheet full of useful and fun (yes, I said spreadsheet and fun in the same sentence) calculators, and you’ll know when new posts are published.

 

For more information, be sure to check out additional articles on the Backdoor Roth:

 

 

 

Have you taken advantage of the backdoor Roth? What’s holding you back?

415 comments

  • Gary Jenkins

    Can I transfer my total account balance from a roth in one bank to a existing Vanguard roth and also perform a backdoor roth in same year?

    I do the backdoor Roth each year using your instructions on this site (which are awesome by the way!!) but recently realized my wife has around 20k in a managed roth with a bank that has been doing nothing and charging her a lot for having the roth.

    I want to get her out of this situation and also do my usual backdoor roth in 2019 if possible.

    Any advice here would be much appreciated.

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  • Jon L

    I’ve only recently found out that there is an income cap when using a Roth IRA so I’ve been looking at the back-door Roth. This article has been extremely helpful!

    I am married and with our combined gross income we are currently not past that threshold but with our end of the year bonuses we might be (most likely somewhere between $193-$203k). I’ve already contributed $2,400 into my Roth IRA this year prior to knowing the income cap. What would be our best option? Would we still be able to do the back door Roth for the remaining contribution amount ? Only I have contributed to my Roth IRA this year. Thanks for your help!

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  • George

    Question regarding IRA to Roth conversion and back-door Roth conversion.
    In order to start doing the back-door Roth conversions, I first need to convert $36k I have sitting in my traditional IRA today of which all the contributions were non-deductible but has about $8k in gains.
    I decided to go ahead and convert the entire IRA balance to a Roth in 2019 and both accounts are in Vanguard which makes it easy.
    I’m assuming that the $8k will count as income in 2019.
    Now I’m also wondering if I could do a back-door roth contribution this same year.
    Meaning after my initial conversion of the $36k, i then contribute another $7k non-deductible to that same IRA and convert it to the IRA the next day.
    Will my subsequent back-door conversion be somehow taxed because of the prior taxable gain on the original conversion the same year? Should I wait until next year to start the back-door conversions?

  • Frenia

    In terms of executing a back door roth account, your article states You cannot have money in a tax deferred IRA in your name. That includes traditional IRA, SEP IRA, and SIMPLE IRA, but does not include 401(k), 403(b) or similar acounts. If you do hold tax deferred IRA dollars, you’ll be subject to taxes when making your conversion per the pro-rata rule.

    Does that mean you (or anyone with a converted roth IRA) are subject to taxes per the pro-rata rule every year? If no, how do you avoid it?

    • No. It’s only an issue if you have tax-deferred money in an IRA and you make a conversion to Roth.

      Roth IRA money will never be subjected to tax again (under current tax code, anyway). I realize that could be stated a bit more clearly in the text.

      Best,
      -PoF

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