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A Backdoor Roth is a two-step process for contributing to a Roth IRA when your income exceeds the income eligibility limit for Roths. There is no income limit for making nondeductible contributions to a Traditional IRA, nor for converting a Traditional IRA to a Roth IRA.
|Two terms need to be understood when doing backdoor Roths:
Traditional IRA, as used on this page, refers to each of a person's non-Roth IRAs, that are also not Inherited IRAs. These include Traditional IRAs, Rollover IRAs, SEP-IRAs, and SIMPLE IRAs, including those held at different custodians.Basis is the amount of nondeductible contributions remaining in the Traditional IRAs. (need IRS defn and citation)
|Read this comprehensive tutorial: Backdoor Roth: A Complete How-To, by forum member tfb.|
When you do a Backdoor Roth, you first make a nondeductible contribution (i.e., already taxed) to a Traditional IRA. After that transaction has been completed (usually in one business day), you do a Roth conversion.
However, your pre-existing Traditional IRAs will likely be entirely deductible contributions and their pre-tax earnings. When you make a Roth conversion, you cannot limit your conversion to just your nondeductible contribution. (need another reference) When filing your income taxes, the money you converted will be representative of all the money in all of your Traditional IRAs, regardless of which account the Roth conversion money came from. (need better source)
For example: If your nondeductible contribution is only 25% of all the money in your Traditional IRAs, then only 25% of your Roth conversion amount will be tax-free. The remaining 75% of your Roth conversion amount will represent the deductible (pre-tax) money across all of your Traditional IRAs. Consequently, you will owe tax (at your current income tax rate) on 75% of your Roth conversion amount (see example below). If you can transfer your pre-tax IRA funds to a solo 401(k), employer-sponsored 401k, or 403(b), then they will no longer be subject to taxation during the Roth conversion process.
However, in the cases where part of the conversion amount was taxed, some of your basis is considered to have been converted tax-free while some still remains with the rest of your Traditional IRAs. Some of this basis will hang around until all of your Traditional IRAs (as defined here) are empty and you will have to file Form 8606 each year until then.
To do a backdoor Roth, first make a regular contribution to a Traditional IRA with your IRA custodian. You do not need to tell the custodian whether the contribution is deductible or not; it is just treated as an IRA contribution. (The custodian does not know (or care) if any contribution is deductible or not. That is known only to you, the IRS (and your state, if you file state income taxes), and your tax preparer. In fact, you can change your mind as to any contribution being deductible or not, up until the time you file your tax return.)
Non-deductible simply means that you do not deduct the IRA contribution on your 1040 tax form (the transaction is recorded on form 8606 instead and submitted with your tax return). This nondeductible contribution will be called your "basis" if you don't yet have any or be added to your existing "basis", when you prepare your taxes. One important thing to know about your basis, is that it does not grow, except by making additional nondeductible contributions. All the growth for the Traditional IRA will instead be pre-tax.
As soon as the contribution posts, convert to a Roth IRA. The Roth account may be an existing or new account. Accomplish this transaction by selling the shares in your Traditional IRA and using the funds to buy shares (or merely deposit cash) in a Roth IRA.[note 1]
If you didn't have any pre-existing Traditional IRAs and your contribution was nondeductible, you pay tax only on the growth above the amount contributed. If you held the Traditional IRA for only a few days, the tax should be minimal.
If you had pre-existing Traditional IRAs, and your contribution was nondeductible, the contribution amount is considered your basis and it will be pro-rated over all conversions and withdrawals, until the Traditional IRAs are empty.
If you have any other Traditional IRAs, the taxable portion of any conversion you make is prorated over all your IRAs; you cannot convert just the non-deductible amount. In order to benefit from the backdoor, you must either convert your other IRAs as well (which may not be a good idea, as you are usually in a high tax bracket if you need to use the backdoor), or else transfer your deductible IRA contributions to an employer plan such as a 401(k) (which may cost you if the 401(k) has poor investment options).
Because IRAs are Individual accounts, the IRA holdings of one spouse do not affect the proration of the other spouse's conversion, even when filing MFJ.
For example, suppose you have just created a new traditional IRA, and you add $5,000 of non-deductible contributions to it. You'd like to convert this IRA to a Roth IRA via the backdoor.
Suppose you also have another traditional IRA with $15,000 in deductible pre-tax contributions. These contributions may have come from a 401(k) rollover, or from standard deductible traditional IRA contributions from earlier years when you were eligible to make deductible contributions to a traditional IRA.
To compute the tax due, you would need to take $5,000 and divide it by $20,000 (the total value of all your traditional IRAs), to get the percentage of the conversion that will be tax-free. In this case, it is 25%. Therefore, the other 75% of your conversion--in this case, $3,750--would be taxable.
This can be viewed with the following formula:
C = Amount to Convert to Roth
B = Balances of all pre-tax IRAs
TF = The percentage of the amount you're computing this would be tax-free
TF = 100 * [ C / (C + B)]
Using the numbers from the case study above results in:
100 * [ 5,000 / (5,000 + 15,000) ]
which is 25%.
If the $15,000 traditional IRA could be transferred into a 401(k), then the formula becomes:
100 * [ 5,000 / (5,000 + 0) ]
which is 100%, meaning that 100% of the conversion amount ($5,000) is tax-free.
- Vanguard buy / sell account transactions are implemented as a fund exchange. Go to the traditional IRA and select "Exch" which is listed next to "Buy" and "Sell." Identify the shares to be sold. Then select the Roth account on the right hand side, and select the destination fund.
- Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs)
- ? "caution" section on backdoor Roth wiki, by forum member The529guy, direct link to post.
- Rollovers of After-Tax Contributions in Retirement Plans, IRS, viewed August 7, 2016.
- Bogleheads® forum topic:
- Bogleheads® forum post: , a step-by-step backdoor Roth conversion made easy, by forum member Duckie.
- The Backdoor Roth IRA: A Complete How-To, by tfb (forum member)
- BackDoor Roth IRA Tutorial, by Jim Dahle (forum member EmergDoc)
- The benefits of a "backdoor" Roth, by Vanguard