In 2021, I made my ninth pair of “backdoor Roth” IRA contributions with Vanguard. It’s a great way for high-income professionals to contribute to a Roth IRA when earning “too much” to contribute directly to a Roth IRA.
I’ll give you a brief overview, precise step-by-step instructions on how to do it yourself, and a link to a backdoor Roth FAQ that should answer any lingering questions you have.
This post has been updated with fresh screenshots from our 2021 contributions and conversions. I transitioned to a “brokerage IRA account” as requested by Vanguard, while my wife’s account remains a “mutual fund IRA account.” The latter makes things quicker and easier, although now, there only seems to be a one-day difference between the two different processes for the different account types.
I like to get ours done early in the year to start the tax-free earnings as soon as possible, but you have until Tax Day in mid-April, 2022 to complete a 2021 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 screenshots will obviously look different.
Backdoor Roth IRA: 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 The Roth dollars, unlike tax-deferred dollars, will not be taxed when withdrawn.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 a tax-deductible IRA.
A modified adjusted gross income (MAGI) of $208,000 for a couple filing jointly, or $140,000 for an individual makes you ineligible to contribute to a Roth IRA in 2021. Phaseout ranges where you can make a smaller Roth contribution (less than $6,000) start at $198,000 and $125,000 for couples who are married filing jointly and single filers, respectively.
Many physicians are thus excluded from making either deductible IRA contributions or direct Roth IRA contributions.
If there’s even a tiny chance your income might put you into or above those phaseout ranges, you’re better off using the backdoor, just in case. There’s nothing wrong with making your Roth contribution the hard way and finding out later that you didn’t need to take the extra steps. You won’t have to change a thing.
Now, understand that 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 401(k) contributions if you’re in the 32% or higher tax bracket.
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 the ability to make 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 $76,000 or as a couple earning more than $125,000 in 2021. The deduction actually begins to phase out at a MAGI of $66,000 for single filers and $105,000 for married couples filing jointly.
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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 a traditional IRA, SEP IRA, or SIMPLE IRA in your name.
The list 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 on 12/31 of the calendar year in which you made the Roth conversion, 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. Note that inherited IRAs are a non-issue.
If the balances in your IRA or IRAs 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 side business is one in which you answer medical surveys for dollars. I’ve got a great overview of a handful of survey companies here.
Completing the backdoor Roth with Vanguard:
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.
I will break this down into two distinct tutorials: one for a brokerage IRA account (all newer accounts) and a second for older mutual fund accounts that have not transitioned. By this time next year, we might all have brokerage accounts, but for now, the process is a bit simpler with the mutual fund account. Hang onto yours if you’ve got one!
Brokerage Account Backdoor Roth Step 1: Make a Non-Deductible IRA Contribution
After logging in, I point to My Accounts -> Balance & Holdings
Find your Traditional IRA brokerage account, and click the arrow to the right of “Buy and Sell,” and select “Buy Vanguard funds.”
Vanguard asks if it’s a rollover from another tax-deferred account. It’s not. Select “no” in the new blue color.
Towards the bottom, you’ll choose the YEAR for which you want this contribution to count. This is a 2021 backdoor Roth tutorial, so I put the $6,000 into the 2021 slot.
Since I already made a 2020 contribution of $6,000, that text entry field is unavailable to me, and for good reason. If you have not yet made a 2020 contribution, you can do so until Tax Day in mid-April of 2021. And you have until mid-April of to make your contribution for 2021.
If you’ve not done it for either year, you could contribute for both years now. If you’re age 50 or older and still have earned income, you get $7,000 per year to contribute.
Tell Vanguard where this money is coming from, continue, and you’ll be asked to review and submit. This is a good time to doublecheck that you’re making the contribution for the desired tax year.
You’ll get a confirmation and a polite “Thank you” from your friends at Vanguard. Note that in the lower left, you’re told that you have $6,000 in funds available to trade. This isn’t exactly true.
As you can see, the contribution was entered on 1/1/2021, but due to the holiday weekend, the first business day was 1/4/2021.
Brokerage Account Backdoor Roth Step 2: Convert to Roth IRA
Before the Tax Cuts and Jobs Act went into effect in 2018, some people worried about something called the “step doctrine” and that it may be best to wait a while before making the Roth IRA conversion.
This theoretical concern was put to rest with footnotes 268, 269, 276 and 277 of the Conference Committee’s explanatory report on the Tax Cuts and Jobs Act that provided clarity and validated the backdoor Roth IRA contribution.
As I’ve always done, I convert as soon as Vanguard will let me. Now I do so with zero concerns about the step doctrine.
On Monday, 1/4/2021, I logged in to see if I could convert my non-deductible IRA contribution to my Roth IRA. No dice.
Note that the only thing that makes your traditional IRA contribution non-deductible is what you report to the IRS. Vanguard doesn’t know what your 1040 looks like. Form 8606 becomes important at tax time, but there’s no checkbox at Vanguard to indicate that you won’t be deducting this contribution.
I tried again the next day, and got the same result.
On Wednesday, 1/6/2021, I was able to move forward. This process was one day quicker with the mutual fund account, but at least I didn’t have to wait until 1/11/2021 like some of the screens made it seem I might.
Yes, it still says I have unavailable shares, but when I click “Convert to Roth IRA,” magically, I am able to do so.
Scrolling down the page, we choose to “Convert all of the account.”
Further down yet, we are converting a non-deductible IRA contributions. Since we’ve already paid tax once on this money, the conversion shouldn’t cost us anything. Again, Vanguard doesn’t know that.
Confidently select the checkbox that states you will not elect to withhold federal and state income taxes. Continue on to the next screen.
The next screen simply reports back what we’ve selected. Look it over and submit your Roth conversion.
The confirmation screen will look much like the last one. If for some odd reason, you plan to leave the money in a money market fund, you can be done. But that would be silly.
In the next step, we’ll invest that money.
Brokerage Account Backdoor Roth Step 3: Invest in the Roth IRA
On the third business day of the year, I was able to complete the Roth conversion, but if I were to stop there, the money would be sitting in cash with a measly interest rate that won’t even keep up with inflation.
A Roth IRA is a good place to hold assets that are tax-inefficient (have high dividend yields) or would be expected to appreciate in value substantially.
REITS fit the bill for me, and I will direct my $6,000 to Vanguard’s VGSLX, the REIT Index Fund.
Immediately after completing my Roth conversion, I go back to Accounts & Balances, and I see that my $6,000 Roth conversion money is now available to trade, along with $1.01 in spare change that’s been sitting there for a while.
Once again, Vangaurd tells me that “This account has unavailable shares.” This can be ignored for our purposes; it doesn’t hamper our ability to invest.
Click on “Buy and Sell” and then “Buy Vanguard funds.”
This should be a familiar-looking screen. I choose my REIT index fund on the left with my settlement fund (money market) being used to fund the purchase.
It says “Review and submit.” You know what to do.
And we’re done!
Next, I’ll go over the (fewer) steps required for those who still have mutual fund IRA accounts. If you don’t need to see these steps, skip ahead to spousal Roth IRA.
If you have been grandfathered in with a mutual fund account and have resisted the many popups encouraging you to transition your IRA to a brokerage account, I commend you.
The following tutorial is for you, mutual fund IRA account holder, and it’s a bit easier than the precess detailed above.
To get started, log in and click on your Traditional IRA.
You want to Transact, and you can select “Buy” in one of two places.
This next screen will look familiar if you reviewed the brokerage account instructions. This contribution will not be a rollover, so select “No” with a blue circle toward the top.
For some reason, the money market fund we’ve used before is closed to new purchases, so we’ll select a different money market fund.
I select the Federal Money Market, click “ADD” in the lower right corner, and move on.
In the next screen, we choose in which tax year we want our contribution to be applied. I select 2021 since I made my 2020 contribution a year ago.
In this case, the money will be coming from our checking account. If I had left our 4th quarter dividend distributions from our taxable brokerage account in the settlement fund, I could have used those funds.
On the next screen, doublecheck that you’ve selected the correct year for your contribution.
Once you submit, your non-deductible traditional IRA contribution is confirmed. As mentioned above, Vanguard doesn’t know whether or not this contribution will be deducted on your 1040. That’s between you and the IRS, but it will not be deducted as it is an after-tax contribution, and it will be reported on Form 8606.
Mutual Fund Account Backdoor Roth Step 2: Convert to Roth IRA & Invest
Going back to Balances & Holdings on the next business day, we can see that our Traditional IRA has a balance of $6,000 in the money market fund.
Click on “Retirement contributions and distributions.”
On this next screen, you’ll make two selections. You want to convert your 2021 contribution, so select that in the upper left.
In the lower right, let Vanguard know that you want to “Convert to a Roth IRA.”
We let Vanguard know that the money is going from the Traditional IRA to the Roth IRA. Also, I select the only fund we have in this Roth IRA, the REIT index fund, VGSLX.
Since it’s a non-deductible contribution, we won’t owe any tax on the conversion, assuming you followed the directions and put your contribution into a money market fund and converted as soon as possible.
If you waited a while or chose a more volatile fund, you could have some dollars in earnings. If so, convert it all, and you may owe a few dollars in taxes, but not enough to make withholding necessary.
The warning that this is a taxable event than cannot be changed is nothing to be concerned about, and it can be dismissed. Read it and carry on.
Your Roth conversion is complete, and your money will be invested in the fund you chose. There will be some alerts below the confirmation, but nothing to be concerned about.
Spousal Roth IRA
If you’re married, your spouse can also do the backdoor Roth, even if he or she has no earned income.
You must have at least $12,000 of earned income between the two of you (or $13,000 or $14,000 if one or both of you is at least 50 years old), but all of the income can come from one person.
Note that for pro rata rule issues, your IRA accounts don’t affect your spouse’s ability to do the backdoor Roth, and your spouse’s IRAs don’t affect yours.
Fill out Form 8606 in your 1040
At tax time, you will report these moves in IRS From 8606.
The IRS has instructions here and the form here. I see no need to repeat them. If you use tax software, instructions on filling them out with TurboTax and others can be found on the Backdoor Roth FAQ.
If you have additional questions, your question is almost certainly among the 40+ questions answered in the all-encompassing Backdoor Roth FAQ. I strongly encourage you to check there first before asking a question below.
Looking for additional investment opportunities now that you’re maxing out your tax-advantaged space? Look to my Real Estate Investing Resources.
For more information, be sure to check out additional articles on the Backdoor Roth:
Is the Backdoor Roth Worth the Trouble?
I would say “Yes.” If you’re considering the backdoor Roth, the $6,000 or $12,000 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)).
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Have you taken advantage of the backdoor Roth? What’s holding you back? Don’t forget to view the Backdoor Roth FAQ!