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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:
ND = Amount of Basis remaining from the previous year plus Non-Deductible contributions made for the year
SB = Sum of the Balances of all the traditional IRAs[add link to defn at top] at year-end plus the amount converted
TF = The percentage of the amount you convert (or withdraw) in the the year that would be tax-free
TF = 100 * ( ND / SB )
Example 1. Anna has no Traditional IRAs. She knows she will pay the same amount of tax on $6,000 of her high income (for 2019) whether she deposits it into her taxable account or puts it in a Roth (but she is ineligible to contribute to the Roth directly). So it is a no-brainer to her to put it in a Roth where it can grow tax-free. She opens up a new Traditional IRA and deposits $6,000 (for 2019) in it and will declare it as a non-deductible contribution when she files her taxes. A few days later, she converts all of it to her Roth. The tax-free amount of the conversion is:
TF = 100 * [ 6,000 / 6,000 ] which is 100%.
Example 1a. Anna made the contribution right before a holiday and forgot to convert the following business day. When she remembered it, the traditional IRA balance had grown $60. So now she has a basis of $6,000 and the account value is $6,060. The tax-free amount of the conversion is:
TF = 100 * [ 6,000 / 6,060 ] which is 99%.
If she converts it all, she will pay taxes on 1% of the conversion amount ($60). Although there is rounding in the percentage, she will be able to subtract her new basis ($6,000) from the converted amount. There will be no basis left.
If she only converts the $6,000, 99% of the $6,000 basis ($5,940) will have gone with the converted amount and 1% of the basis ($60) will remain with the Traditional IRA. So she would still need to pay taxes on the $60 that was converted but is not tax-free. Next year, she can convert the remaining $60 tax-free since it has a $60 basis, assuming there is no growth.
Example 1b. Anna made the contribution right before a holiday and forgot to convert the following business day. When she remembered it, the traditional IRA balance had fallen $60. So now she has a basis of $6,000 and the account value is $5,940. The tax-free amount of the conversion is:
TF = 100 * [ 6,000 / 5,940 ] which is 101%.
If she converts it all, she will pay no taxes on the conversion and the remaining basis ($60) is lost. However, if she leaves a dollar in the account and converts $5,939, she will use up $5,939 of her basis and leave $1 in the account with the remaining $61 basis. This will be useful if she has future growth (or a deductible contribution) in her Traditional IRA since $61 of it can be converted tax-free.
Example 2. Ben has $50,000 in his Traditional IRA (his only pre-tax IRA) and has some taxable money he can use to pay the conversion taxes, but not enough to convert the entire account. He also is not eligible to contribute to a Roth directly but wants to do a backdoor Roth (after reading this wiki). It will be his first time for a backdoor Roth and he thinks he also will need to do one in the following years.
(to be continued)
- 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)
- Bogleheads® forum post: . 07 Jul 2014
- 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) <<- member WhiteCoatInvestor (verify if one word)
- Ways to Screw Up a Backdoor Roth IRA, by Jim Dahle (forum member EmergDoc) <<- member WhiteCoatInvestor (verify if one word)
- The benefits of a "backdoor" Roth, by Vanguard