Backdoor Roth IRAs are a frequently-discussed topic on physician blogs and social media sites. But most conversations assume you understand basic investing concepts that many novice investors don’t. I’ve written this post as a reference guide for anyone who needs help with the mechanics on how to set up a backdoor Roth IRA.
Before you start, I recommend you read Explaining Backdoor Roth IRAs to ensure you fully understand the concept. Next, follow the below steps. Each spouse will need to have his/her own accounts (2 spouses = 4 accounts).
For illustration purposes and so you are aware of the type of information you’ll need to open the accounts, I’ve linked to the relative forms at TD Ameritrade, where we custody our clients’ accounts. In most cases, you can open all these accounts online.
Step 1: Traditional IRA (TIRA)
- Open a TIRA (Traditional IRA) online at your choice of custodian.
- If you already have a TIRA account and it holds pre-tax contributions, read to the end of this post.
- This is a pass-through account only. The balance will be zero most of the year.
Step 2: Roth IRA
- Open a Roth IRA with the same custodian as your TIRA (for simplicity – can use 2 different custodians if you prefer).
- If you already have a Roth IRA in your name, you don’t need to open a second account.
Step 3: Deposit the annual contribution limit ($6,000 in 2019 or $7,000 if you’re age 50+) in your TIRA
- You must deposit cash, no investment transfers allowed.
- Do not invest this money but leave it in cash.
- You have until 4/15/x1 to deposit your contribution for the year ended 12/31/x0.
- If you deposit your contribution between 1/1/x1 and 4/15/x1, you can contribute for both year x0 and x1 at the same time.
Step 4: Roth conversion
- This is the “backdoor” part: You may need to wait up to 5 days for your check to clear.
- You’ll then convert the balance in your TIRA to your Roth. A “conversion” is a transfer of some or all of the funds in your TIRA to your Roth. Your custodian will have a form for you to fill out to make this transfer.
- The sooner you convert, the sooner you’ll be able to invest your money, however…
- You can wait as long as you want to convert – days, months, or years.
- NOTE- there has been much discussed about the step-transaction doctrine and the danger of backdoor Roth’s. In 2018, the IRS officially sanctioned backdoor Roth’s.
Step 5: Invest your Roth funds
- It’s finally time to invest! Buy your chosen mix of mutual funds and/or ETFs or ask your financial planner for a recommended portfolio.
Step 6: File Form 8606
- This is part of your annual income tax filing. You must file it for every year that you either contribute to a nondeductible TIRA and/or convert to a Roth IRA (steps 3 and 4 above).
- Nondeductible TIRA contributions are reported on the tax return corresponding to the year for which you are contributing, i.e. you can contribute for the year ending 12/31/x0 from 1/1/x0 to 4/15/x1.
- Roth conversions are always reported on a calendar year basis. If you convert any day between 1/1/x1 and 12/31/x1, you will report on your 20×1 tax return.
- If you forgot to file an 8606 in the past, the IRS will allow you to file missed years as a standalone form, one for each year. There is supposed to be a $50 penalty for each late form, but, to the best of my knowledge, the IRS has not assessed it.
- When should I do the backdoor Roth maneuver? We recommend as early in the year as possible.
- Can I contribute monthly rather than all at once? If you do this, I recommend monthly TIRA contributions (Step 3) with an annual conversion (monthly conversions will be tedious).
- Do I have to convert (Step 4) immediately? You can wait as long as you want. Remember, though, that any growth while the money is sitting in the TIRA will be taxed when you convert.
- My TIRA earned a few cents/dollars before I converted. What should I do? Convert that, too. You’ll pay tax on any growth, which should be minimal.
- I’ve been making backdoor Roth contributions but didn’t file Form 8606. Am I in trouble? No, but you need to get that caught up. You can file form 8606 as a standalone form for all past years that you or your CPA missed. Do not overlook doing this. It is a verification with the IRS that you have “basis” in your Roth IRA. (Basis is the value of TIRA contributions that you did not deduct on your income tax return.)
- I contributed directly to a Roth and now I’m going to make too much to qualify. What do I do? You have 2 options:
- Contact your custodian and ask that the Roth contribution be re-coded to a TIRA contribution, or
- Recharacterize the Roth contribution to a TIRA. Then convert.
- I don’t know if I’ll make too much money this year to be able to contribute to a Roth IRA or if I’ll have to use a backdoor Roth. What should I do?
- Use the above backdoor Roth process. Anyone with earned income can contribute to a TIRA and then you’ll know you won’t have to reverse an invalid Roth contribution.
- Can I do a backdoor Roth if I already have an IRA? Actually, the answer is “yes”. You’ll pay pro-rata taxes, which are simply a prepayment of future taxes on your IRA. And Michelle has more tips for you in her vlog.