How exactly do you make back door Roth contributions?

[Anonymous]

I see this mentioned a lot on here. How exactly does it work? Who is this right for? Highly compensated people who don't qualify to make Roth contributions because of income phaseouts?

So if I earn over the limit to qualify for a Roth, I can still do it, is that right? Meaning, I can make a nondeductible traditional IRA contribution and then immediately convert it to a Roth IRA, and I pay no income tax on the conversion since the traditional IRA was funded with after-tax money? What kind of record keeping do I need to do/what tax forms must I file? How do I ensure there's no growth on the traditional IRA so that I don't end up taxed on conversion? Do you do everything in one fell swoop?

Thanks for any info. Just seems like everyone and their grandma on here is doing these. I never have.

[Anonymous]

+1 i was just thinking the other day that i need a step by step guide for this. I don’t understand- are you supposed to convert once a year? Once opportunistically?

[Anonymous]

https://www.whitecoatinvestor.com/backdoor-roth-ira-tutorial/

[Anonymous]

Anonymous wrote:+1 i was just thinking the other day that i need a step by step guide for this. I don’t understand- are you supposed to convert once a year? Once opportunistically?

I do it every year in January. Make the traditional IRA contribution on a Monday, it settles on Tuesday, on Wednesday I do the conversion of the full amount to the Roth, it settles on Thursday and I put it into my (already existing) Target Retirement fund. It's very easy at Vanguard.

https://www.physicianonfire.com/backdoor/

You will get the appropriate tax forms at the end of the year. It is a bit confusing because you have to show the traditional IRA contribution as well as liquidating it (for conversion), and that's an option on the tax software- there is an "exceptions" box checked on the form that allows you to indicate that the liquidation happened for conversion purposes. That way the tax software flags the original contribution as not tax deductible, and also flags the liquidation as not penalized. The system kicks out a few forms but the net tax impact is zero. Last year I had a few dollars of gains because of the couple of days pause between contribution and conversion, so that got taxed.

[Anonymous]

OP. I'm high income ($1M) and I love Roths. I max out my Roth 401(k) every year and I don't care how valuable the deduction is for the traditional; I want as much of that magic Roth money as I can accumulate. So why am I not doing back door Roth? Sounds too good to be true. Why is there even an income limit to Roth IRA contributions if you can so easily get around it?

Isn't there some pro rate rule too - like if I have other big traditional IRAs, I have some tax consequence to conversion?

[Anonymous]

Anonymous wrote:OP. I'm high income ($1M) and I love Roths. I max out my Roth 401(k) every year and I don't care how valuable the deduction is for the traditional; I want as much of that magic Roth money as I can accumulate. So why am I not doing back door Roth? Sounds too good to be true. Why is there even an income limit to Roth IRA contributions if you can so easily get around it?

Isn't there some pro rate rule too - like if I have other big traditional IRAs, I have some tax consequence to conversion?

Traditional IRAs have a limit, but it's not a limit that includes your 401k. Those are two separate retirement avenues.

The "backdoor" roth means you opened a traditional IRA then converted it to a roth IRA. Why is do we have a backdoor roth? Thank the wealthy politicians. They are always looking for ways to help wealthy people.

We have roth and 401k, and have used the backdoor roth before.

[Anonymous]

Anonymous wrote:OP. I'm high income ($1M) and I love Roths. I max out my Roth 401(k) every year and I don't care how valuable the deduction is for the traditional; I want as much of that magic Roth money as I can accumulate. So why am I not doing back door Roth? Sounds too good to be true. Why is there even an income limit to Roth IRA contributions if you can so easily get around it?

Isn't there some pro rate rule too - like if I have other big traditional IRAs, I have some tax consequence to conversion?

It is too good to be true and probably shouldn't be legal, but definitely is

And yes the pro rata rule makes it really complicated if you have other IRAs. Could easily not be worth it in that case.

[Anonymous]

OP again. Ok I think I figured it out; thanks google. This isn't going to work for me because I have $600k in a traditional IRA.

Found this article:
https://www.fidelity.com/learning-center/personal-finance/backdoor-roth-ira#:~:text=Cons%3A,tax%20bracket%20for%20the%20year.

It says:
How do you calculate your taxable percentage with the pro-rata rule?
- (non-deductible amount) / (total of all non-Roth IRA balances) = non-taxable percentage.
- (amount to be converted to Roth IRA) x (non-taxable percentage) = amount of after-tax funds converted to Roth IRA

In other words, "you don't get to cherry pick and only choose to convert your nondeductible contributions...because the IRS uses the IRA aggresgation rule when calculating taxes owed on a conversion, which means it views all your traditional IRAs as a single tax entity."

So let's say I make a $7,000 nondeductible IRA contribution this year and I immediately convert it to a Roth. My pre-tax traditional IRA is worth $600k, so with the nondeductible contribution it's worth $607k. The $7k is 1.1% of the total balance, meaning that 98.9% of my conversion is going to be taxable. Or $6,923. So I'm not causing myself to have to pay income tax on an extra $6,923 just so I can do a back door Roth. Makes no sense.

I knew it had to be too good to be true. So all these posters crowing about back door Roths and always making it seem like you're dumb if you don't do it either a) have no other traditional IRAs, b) don't know the rules or c) paying a whole lot of unnecessary taxes.

[Anonymous]

First step is to set up an IRA. You can do this with any brokerage. I chose Vanguard. If you already have an IRA, use that. If you have multiple IRAs, you must consolidate them.

Your IRA will either be a Roth or a traditional. Anyone can set up a traditional IRA, but a Roth has income requirements. You qualify for a Roth if you make less than 153k (single) or less than 240k(married). The advantage of a Roth is that you pay taxes now, not in the future (when taxes will likely be higher). The “backdoor” process is a well-known legal loophole for people who make too much money to qualify for a Roth, enabling them to convert traditional IRA contributions to a Roth contribution.

Second step of the backdoor process is to contribute to your traditional IRA. When you contribute, leave the funds in cash or money market for now. There are IRS limits to how much you can put in each year: 7k per year if you are under 50, 8k if you are older than 50.

Third step is to use your IRA provider to transfer that traditional IRA contribution to a Roth IRA. The process depends on your provider. Since I chose Vanguard, here is the process for Vanguard: https://youtu.be/S75yfnDHN3M?feature=shared

As part of this third step, you will pay taxes on those contributions.

The fourth step is to invest your contributions in your Roth IRA after the funds have settled.

That’s how you do it.

[Anonymous]

Vanguard can do automatic conversion.

[Anonymous]

Anonymous wrote:OP again. Ok I think I figured it out; thanks google. This isn't going to work for me because I have $600k in a traditional IRA.

Found this article:
https://www.fidelity.com/learning-center/personal-finance/backdoor-roth-ira#:~:text=Cons%3A,tax%20bracket%20for%20the%20year.

It says:
How do you calculate your taxable percentage with the pro-rata rule?
- (non-deductible amount) / (total of all non-Roth IRA balances) = non-taxable percentage.
- (amount to be converted to Roth IRA) x (non-taxable percentage) = amount of after-tax funds converted to Roth IRA

In other words, "you don't get to cherry pick and only choose to convert your nondeductible contributions...because the IRS uses the IRA aggresgation rule when calculating taxes owed on a conversion, which means it views all your traditional IRAs as a single tax entity."

So let's say I make a $7,000 nondeductible IRA contribution this year and I immediately convert it to a Roth. My pre-tax traditional IRA is worth $600k, so with the nondeductible contribution it's worth $607k. The $7k is 1.1% of the total balance, meaning that 98.9% of my conversion is going to be taxable. Or $6,923. So I'm not causing myself to have to pay income tax on an extra $6,923 just so I can do a back door Roth. Makes no sense.

I knew it had to be too good to be true. So all these posters crowing about back door Roths and always making it seem like you're dumb if you don't do it either a) have no other traditional IRAs, b) don't know the rules or c) paying a whole lot of unnecessary taxes.

I did a backdoor Roth by converting my entire IRA into a Roth IRA. It wasn't as large as yours, but I did have to pay taxes on the $200,000 that I converted. That cleared the way for yearly backdoor Roths. I used capital gains from sale of stock to fund the taxes.

[Anonymous]

I think the key on back door roth ira is that you need to start when you are young, so that you haven't accumulated a traditional ira. That clearly doesn't work for older folks who were working before the advent of the roth ira, but it does work for people who are starting work now. I'm somewhere in between on the timescale and I had about $20K in a traditional IRA when I learned about the backdoor roth ira. I made a point to convert to a roth ira when I was in grad school and so had no meaningful income. The taxes, while small in retrospect, felt painful while a penniless grad school, but it's worked out nicely.

[Anonymous]

Anonymous wrote:I think the key on back door roth ira is that you need to start when you are young, so that you haven't accumulated a traditional ira. That clearly doesn't work for older folks who were working before the advent of the roth ira, but it does work for people who are starting work now. I'm somewhere in between on the timescale and I had about $20K in a traditional IRA when I learned about the backdoor roth ira. I made a point to convert to a roth ira when I was in grad school and so had no meaningful income. The taxes, while small in retrospect, felt painful while a penniless grad school, but it's worked out nicely.

Exactly this.

[Anonymous]

Anonymous wrote:I think the key on back door roth ira is that you need to start when you are young, so that you haven't accumulated a traditional ira. That clearly doesn't work for older folks who were working before the advent of the roth ira, but it does work for people who are starting work now. I'm somewhere in between on the timescale and I had about $20K in a traditional IRA when I learned about the backdoor roth ira. I made a point to convert to a roth ira when I was in grad school and so had no meaningful income. The taxes, while small in retrospect, felt painful while a penniless grad school, but it's worked out nicely.

Yes, this. I put into a traditional IRA only once or twice because the accountant who did my parents' taxes told me to do it to get a bigger tax return and I didn't understand. Then I did a conversion and started doing Roth IRA. I keep a penny in my traditional IRA.

[Anonymous]

You need to file an 8606