Financial Planning for Doctors

Have you ever wondered, “How do I make my first Backdoor Roth IRA?” Look no further if you need a step by step tutorial with pictures for your first Backdoor Roth IRA contributions, this post is here to help.  We will run through how it works at Vanguard, though it is likely similar at other investment companies as well.

After following some other tutorials on performing a Backdoor Roth IRA, I unfortunately ran into several snags. It was my very first time and most of the tutorials that I found were for people who already had a Roth IRA set up.

It was not straightforward at all, but performing a backdoor Roth IRA conversion is vital to building wealth for high-income earners.

What is a Backdoor Roth IRA?

Before we get to the step by step process, let’s make sure that we don’t leave anyone behind.  A “Roth” investment is a post-tax investment that grows tax-free and will never be taxed again.  It is the last money many people touch in retirement, and it is the best money to leave to heirs as a Stretch Roth IRA.

However, if your income is too high (more on that below), you cannot place money directly into a Roth IRA.  So, you must first contribute the money to a Traditional IRA -which can be done regardless of your income – and then convert it to a Roth IRA.  Since conversions have no income limit, there is no problem with this move.

This loop hole (contributing to a Traditional and converting to a Roth) is called the Backdoor Roth IRA.

When Should I Contribute to a Backdoor Roth IRA?

The answer is pretty simple.  After you have maxed out all of your pre-tax retirement space, a Backdoor Roth IRA should be your next step!

Today, we will discuss exactly how to set up your first Backdoor Roth IRA at Vanguard.  If it’s your first time performing a Backdoor Roth IRA, you may want more information after reading through this post on how to perform $24,000 in one year (if married) or $12,000 (if single).  If that’s you, read my post on contributing more than $6,000 per person in your first year.

Necessary items to note prior to starting tutorial

The contribution limits to an IRA increased for 2019 is $6,000 annually for a single person, which means it is $12,000 for a married couple.  You can still contribute $6,000 for a spouse who does not earn an income.

For starters, check to see if you make too much to contribute straight into a Roth IRA.  This is directly from the IRS for the 2019 tax year:

If your filing status is…And your modified AGI is…Then you can contribute…
married filing jointly or qualifying widow(er)

 < $193,000

 up to the limit

> $193,000 but < $203,000

 a reduced amount

 >  $203,000

 zero
married filing separately and you lived with your spouse at any time during the year

 < $10,000

 a reduced amount

 > $10,000

 zero
singlehead of household, or married filing separately and you did not live with your spouse at any time during the year

 < $122,000

 up to the limit

 > $122,000 but < $137,000

 a reduced amount

 > $137,000

 zero

A few other things:

First, you do have to pay tax on any money you make while your money sits in the traditional IRA account when you convert it to the Roth IRA.  Unfortunately, I was paid a dividend from the settlement fund because it took me too long to figure it out.  Hopefully, this tutorial will prevent this for you.

Second, do NOT elect to withhold taxes when you make your conversions.  Vanguard defaults to this, but some other websites do not and suggest you withhold 10%.  Don’t do it.

Finally, wherever it is an option you should likely choose to reinvest the dividends earned from the account.

Step by Step Tutorial for First Backdoor Roth IRA

Step 1. Navigate to Vanguard Website 

The first step is the most intuitive.  Head on over to the Vanguard personal investor website.

Step 2A.  Open an Account

Locate the “Open Account” at the top of the screen (Red Arrow).

Backdoor Roth

Step 2B. Click “Open a New Account” for a Traditional IRA

Backdoor Roth

Step 2C.  Choose Funding Source for Backdoor Roth IRA

Most people will choose to wire money from their bank (Red/Black Arrow show in image below).  However, if you are doing something different, then select the appropriate option for you.

Backdoor RothStep 3. Fund your Vanguard account

The next few step towards your Backdoor Roth IRA is very intuitive.  You can either 1) send vanguard a check or 2) give them your financial information.

Fill out the remaining appropriate information. When you type in  (and select) your bank.  Then select “individual” and it will look like the image below.  Fill out this screen and the next four screens thereafter. Again, this part is intuitive.  It also involves personal information, which is why you won’t see a screen shot from me!

Backdoor Roth

Step 4. Review and Sign & Wire the Money

Use your banking account and routing numbers from a check to wire money to Vanguard. You will have selected a traditional IRA during the process.  Go over everything one last time (Review) and then sign the documents.

Step 5.  Register for an account

Make a username and password, etc.  This gives you web access to your Vanguard account.

For me, this is where the Backdoor Roth IRA process started to get confusing.

Your money gets transferred to a “settlement fund” inside of your traditional IRA.  The settlement fund is in the Vanguard Federal Money Market Fund.

This settlement fund will hold your money (i.e. prevent you from using it) that you wired from your bank account for up to 7 days.  You cannot do anything with your money until it clears.  You simply have to wait.  Sorry.  If you try before it has cleared it will tell you that you have “no available shares.”

This settlement account is a Brokerage account.  This is a controversial topic on the Bogleheads forums. Some say that it may be a good thing because it simplifies the amount of tax paperwork you receive.  Others say it has made the process unnecessarily complicated.  As far as I am concerned, it is what it is.

Important Note: At this point, you have NOT opened a Roth IRA account into which you can convert your traditional IRA funds through the backdoor.

Step 6. How Long Should I Wait to Convert a Backdoor Roth IRA?

Any post on the backdoor roth IRA would not be complete without mentioning the Step Transaction Doctrine.  Some people feel that you should wait some amount of time before you convert your traditional IRA money to Roth IRA money.  Why? Because you need to show that your original intent was not to contribute to a Roth IRA since high-income earners are forbidden from doing this.

Personally, I think this is nonsense. I convert from the traditional to the Roth IRA account as quickly as it will let me.  There is a ton of precedence here. In addition, recent law basically highlights how backdoor roth IRA’s are okay in the government’s eyes.

Why Should I Ignore the Step Transaction Doctrine?

First, no matter how long you wait the Step Transaction Doctrine says that multiple steps taken in a financial decision can be viewed as a single step.  Therefore, if you don’t qualify via the rules above, then you shouldn’t qualify even via a Backdoor method regardless of how long you wait.

Second, Backdoor Roth IRA’s have been occurring since the rules changed around 2011.  It is widely publicized and no one has ever mentioned or publicized being audited or fined by the IRS for completing this widely known mechanism for funding a Roth IRA.

Finally, If you are deciding to do a backdoor Roth conversion this year, you are likely going to do it next year.  And the next year.  And so on.  So, how can you justify that you “didn’t plan” to perform the Roth conversion in the first place when you have done it for multiple consecutive years.  Clearly, this has become a pattern for you.  Again, even if it was for one year, the step transaction does not protect you.

With all of that said, I would wait as little time as possible, because you want to avoid your traditional IRA from making money (which apparently includes dividends… don’t ask me how I know).

If you make more than $1, your 8606 tax form becomes less clean, but it isn’t the end of the world.

Step 7.  Open a Roth IRA for your Backdoor Roth IRA Conversion

This is the key part that is not intuitive on Vanguard.

If you click the “convert to Roth” button (red/black arrow shown below) and have not opened a Roth IRA account at Vanguard it will tell you that you have “no account” available to make this transaction.  It doesn’t tell you why.  It just tells you that you can’t convert to Roth because you have no available account.

[Note my traditional IRA shows zero funds because I have already performed the conversion at this point]

Backdoor Roth

In order to avoid this very annoying screen, you need to do the following:

  1. Click “Open an Account” under “My Accounts” as shown in the image below (red/black arrow)
  2. You will go through a similar process (select that you are already registered at Vanguard) that you went through above to set up another account, except it will be a Roth IRA this time and will be a lot faster this time because Vanguard already has most of your information.
  3. The key to this step is to NOT fund the Roth IRA.  Make the selection to “add money later.”  In other words, open a Roth IRA account with Zero dollars in it.

Backdoor Roth

Step 8.  Now convert to Backdoor Roth IRA

This is the part where you actually answer the question, “How do I make my first backdoor roth IRA?”  Unfortunately, you have to do all of the steps listed before in order to do this.

After you have both a traditional IRA account (with hopefully $6,000 in it), you can now convert to your open (but not yet funded) Backdoor Roth IRA account.  This will transfer the money into an identical Vanguard Federal Money Market Settlement Fund.  In other words from your traditional IRA Settlement Fund to your Roth IRA Settlement Fund.

Step 9.  Exchange the funds to a Mutual Fund

Now, you can finally select the “Exchange” function and choose the fund of your heart’s desire once it is in the Roth IRA account settlement fund.  This can be done through either of the red/black arrow functions (Buy/Sell or Exchange).  They both accomplish the same exchange function.  Once you have selected this the next screen is intuitive.  Transfer “all shares” to your chosen fund.  In my case, I chose the Total Stock Market Index (and later changed it to a REIT index fund)

[Unfortunately I made $1.68 on dividends because it took me 10 days to figure out this process because of its non-straightforward process.  This is why I set about writing this lengthy post].

Backdoor Roth

Step 10.  Download a Net Worth Tracking Program

Personal CapitalI think that following your networth is really helpful.  It provides encouragement for you to stick to the plan.  The one that I use and like the best is Personal Capital.

You can add all of your assets (retirement accounts including backdoor Roth, 401K/403B, cash/savings, etc) as well as any debts you may have (like your mortgage or car loans….oops).

Either way, find a program that works for you.  I think it really does help.

(Optional) Step 11.  Rinse and Repeat if married

If you are married, now repeat this process for your spousal Roth IRA conversion.

Take Home: First Backdoor Roth IRA

I hope that this Backdoor Roth IRA guide was helpful!

I had a hard time figuring this out on my own and ended up making money prior to my conversion because it took too long.  Don’t forget to report your contributions on tax form 8606 (tax form in April for tax year for contributions) and your conversions on your 8606 (in actual calendar year conversion was performed)!  Any accidental gains are reported on your 1040 for the appropriate tax year.

Feel free to check out my other post, which covers how first time backdoor Roth’ers can contribute and convert $12,000 per tax person ($24,000 for a married couple) in one calendar year.

Hopefully, you could now give your own Backdoor Roth IRA tutorial? Was this helpful?  Anything I left out?  Leave a comment or question below!

TPP

37 thoughts on “Backdoor Roth IRA: A Step by Step Guide at Vanguard”

  1. hi- philosopher- this post was very helpful!

    have you posted this (Cliffhanger: A new post coming later in January 2018 will go cover how first time backdoor Roth’ers can contribute and convert $11,000 per tax person ($22,000 for a married couple) in one calendar year) yet?

    I am a first time backdoor rother and want to contribute and convert $22K for my wife and I

    thanks in advance!

  2. Thanks for consistently providing valuable information. A question regarding backdoor-Roth at Vanguard. Already have a 2018 tIRA converted to a BackDoor Roth at Vanguard Does a new tIRA and a new Roth account has to be set up each year or can the same account(s) be used each year going forward. Gather that the IRS considers only one Roth for annual tax purposes and am guessing a new tIRA (account) has to be opened each year, but not a Roth account!? Also, would like to transfer the 2017 backdoor Roth from another firm to Vanguard in Feb /March 2018 (Convenience, Fees and advantage of Admiral Funds). Can the same 2018 Roth at VG (account) be used to transfer in the 2017 Roth from the other institution and if so any caveats. Appreciate your thoughts.

    • 1) you can use the same account. Your TIRA will stay open (even with zero dollars in it) until the next year when you make another TIRA contribution to later be converted. You can then convert into the same Roth IRA account you have already made.
      2) you can do a trustee to trustee transfer from another company to your vanguard Roth IRA. If they offer the same exact fund you probably won’t even have to change anything after you transfer. If it is different you’ll have to sell that fund and buy what you want at vanguard.

      On point number 2, Vanguard has some pretty good information here on the process:https://investor.vanguard.com/account-transfer/transfer-ira

  3. Just sent up a non-deductible IRA and did the subsequent Roth conversion. Your post was so helpful! I’ve looked at step-by-step instructions from other sites but yours was the most clear for a newbie like me. Thank you!

  4. I followed your lead. Great advise. I only had $0.05 gain after one day.

    Question: The Broker sent me a 1099-R for as part of my rollover from the regular IRA into the Roth. It shows $5500.05 as taxable in box 2. I believe this is incorrect as the $5500 is nontaxable and I am only responsible for tax(none) on the $0.05. Box 7 was coded with code “2” which is an “early distribution.” I believe this is inaccurate as well. Which code should be used for a IRA to Roth IRA rollover?

    I am sure I need them to refile. Any advise on which codes we should expect to see from our broker in an accurate 1099-R filing?

    • Caveat: Not a tax expert. The following is what I understand, though:

      Is box 2B checked (“taxable amount not determined”)? If this is checked, then it sounds like it should be fine.

      Putting code 2 in Box 7 seems appropriate given that it was a Roth IRA conversion. This is the specific language provided by the IRS on this:

      “Roth IRA conversions. You must report a traditional,
      SEP, or SIMPLE IRA distribution that you know is
      converted this year to a Roth IRA in boxes 1 and 2a
      (checking box 2b “Taxable amount not determined”
      unless otherwise directed elsewhere in these
      instructions), even if the conversion is a trustee-to-trustee
      transfer or is with the same trustee. Enter Code 2 or 7 in
      box 7 depending on the participant’s age.”

  5. This past year was the first time I did a backdoor Roth conversion. I had a bunch of retirement vehicles that had to be rolled over into my 401k so I didn’t get hit with unanticipated taxes (I could have done the backdoor way before this but it was the step of rolling over to 401k that had me procrastinate a long time).

    Finally did it and after years of nondeductible contributing I think I had close to $60k of basis I was able to move. Going forward will be much easier.

    • Yeah, me too. I might skip it this year and just pay off my loans a few months early. I really want these things gone and delaying it a few more months doesn’t seem worth it to me.

      But I’ll be backdooring it every year after this one.

  6. My wife and I are attempting to back door her IRA from her intern year over to her Betterment Roth IRA before the end of the year. She finishes her residency next year and will likely push our income to a higher marginal rate. This guide would be useful if we opt to roll those funds into our Vanguard Roth IRA account. Thanks for putting this together!

  7. I know this is a few days late but I opened up the Traditional Roth IRA and the money posted into the account on 12/26/18. If I read correctly in your great post, I would have to wait 7 days after the $5500 posts to the account to convert to the Roth?

    If so and I can’t convert to the Roth until 01/03/19, how does that affect 2018 taxes?

    • The same thing happened to me. I actually wrote a post about, which you can find here:

      https://thephysicianphilosopher.com/2018/01/29/dont-miss-backdoor-roth/

      The take home is that you report your contribution for the tax year in which you made it (2018 in this case) on line 1 of 8606 and line 4 in your situation. The conversion will be reported in the following years taxes (2019 taxes, because it was converted in 2019) on line 8 of 8606. Failing to backdoor Roth before January complicates the paperwork, but it is just as legal.

      There is a limit on contributions and not conversions. It’s just the way it works.

      All of this is done on form 8606.

  8. Hi, Very Good Article. I really appreciate it. Well researched article. Now you got one regular visitor to your website for new topics. Keep up the Good Work Thanks for always sharing. Nicole Graham

  9. Great walk through! Any way to avoid the dividend in the Vanguard traditional IRA settlement account? I read elsewhere someone was able to do their roth conversion the day after moving the money by having it in some other type of money market fund within the traditional IRA or at least in a fund that doesn’t earn dividends. Perhaps that is no longer possible. I got $2 and change after the initial 7 day hold and somehow got 2 more dollars even after my traditional IRA was 0!

  10. Hi, can you explain step 9? Are you suggesting that once the fund is available on ROTH IRA account then to exchange it to Total Stock Market Index? Or is this just for the gain in case there was already gain available on the traditional IRA account? Thank you.

    • Hey Hen Li,

      I think that you need to exchange it from the settlement fund into something that works for your overall portfolio allocation. I recommend index funds for a variety of reasons, but you should choose whichever one works for you.

      The total stock market index fund buys a piece of every American company that exists. It is low cost and diversified. And it fits in with my overall portfolio in terms of stocks to bonds ratios and the asset classes I am looking for. That’s why I chose it for me.

  11. Hi, great blog. I have a question about the “pro-rata rule.”

    I already have a traditional IRA and Roth IRA with Vanguard. The traditional IRA was created about 5 years ago when I rolled over a previous employers 401K into the traditional IRA. I haven’t made any other contributions to it. This year I expect to exceed the Roth IRA contribution income limit and want to start my first backdoor Roth. However, I’ve heard about the “pro-rata rule” for existing traditional IRA accounts. Can you explain what I would need to do in this situation? What about tax implications?

    • Hey A Dub,

      Great question. Here’s the nuts and bolts.

      In order to do backdoor Roth IRA conversion without getting hit by pro rata, you need to have no other IRA money as of 12/31 in the year you do it.

      There is no limit on the amount you can convert (only on the amount you contribute to an IRA each year). So you could just convert the traditional IRA money to a Roth IRA and pay the taxes on it now if it isn’t a large sum of money. Alternatively, you could also earn some side income and open an independent 401k somewhere that takes IRA rollovers (e.g. fidelity) and keep the pre-tax status.

      What you do is up to you, but those are the two most common options employed.

  12. So I followed your instructions step by step but my money got stuck in the traditional IRA settlement fund for 7 days. I was not able to convert until a full 7 days later and even called them. As soon as I was able to I hit the convert to roth button but sadly now I made $2.14 in dividends! Is this a huge problem? Or just extra paperwork?

    • In the end, it isnt a big deal. The money can take up to 7 days to clear at Vanguard.

      Something similar happened to me, and I ended up owing like $1 in taxes because of it. It does complicate the 8606, but it is a relatively straight forward form to fill out. Just know you might end up owing a very small amount of taxes.

      Jimmy / TPP

  13. Ok that makes me feel better. Thank you so much for your reply and for your effort to educate all of us on this!!
    🙂
    Sabrina

  14. Can you add how you filled out the 8606 since you had the small amount of interest? That added complication to filling out the 8606 would help a lot of people. Thanks!

  15. Any recommendations on time of year to make the contribution? Same time each year? Doesn’t matter as long as it is in a different tax/calendar year?

    Newly out of residency and would be able to contribute in late 2019 and then again in early 2020.

    Appreciate the content.

    Jonathan

    • Hey Jonathan,

      So long as your emergency fund stays in tact (i.e. you have 3 to 6 months worth of monthly expenses) I’d contribute as soon as you could. That gives your money more time to compound in the market. Given that no one can time the market, I just put it in when I can each year, usually with a bonus.

      At some point, I hope to be doing this during the first week of January each year. But my family isn’t there quite yet because we have prioritized paying off debt each year so far out of training.

      Jimmy/TPP

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