This article describes the steps to perform the ROTH Backdoor. This allows you to contribute money to your ROTH, or your spouse ROTH ($6,000 for each in 2021), no matter your current income.
It bypasses the usual ROTH IRA income limitation that prevents you from contributing to a ROTH IRA.
More details describing the Backdoor ROTH are available here: https://www.investopedia.com/terms/b/backdoor-roth-ira.asp
The steps to perform a Backdoor ROTH are simple:
- Contribute money to a Traditional IRA.
- Transfer (Convert) the Traditional IRA to a ROTH IRA.
I will be showing you the steps to perform Backdoor ROTH on Vanguard and Fidelity.
Note: If you don’t have a Traditional IRA Account, you will need to open one before performing these steps.
Step 1 – Contribute money to a Traditional IRA (External Account)
(Do this step if the money is coming from an external account OUT of Vanguard)
From My Accounts, Choose Buy and Sell
Choose Buy Funds
You can invest directly into the Federal Money Market, or you can invest into whatever ETFs or Mutual Funds you want. I will add $6,000 into VTSAX:
Step 1 – Contribute money to a Traditional IRA (Internal Transfer)
If you already have the money in another account at Vanguard, you can simply transfer it. This is what I do sinceI had already money available in the Vanguard Settlement fund, so I was able to use this money to contribute towards the Traditional IRA.
From Buy And Sell, choose ‘Exchange Funds’:
Choose the source of money and where it is going:
Notice the ‘You’ve contributed’ is $0.00 for 2021 with a maximum of $6,000.00. So we are going to transfer $6,000.
Confirm everything is good and click submit:
You can confirm everything is as expected by going to My Accounts / Transactions History.
You need to wait for the money to ‘settle in’ into the IRA account before you can perform the ROTH backdoor.
Usually this takes one business day. I did this on a Saturday and the money started being settled on Sunday. Vanguard is recognizing that I have $6,000 in the Traditional IRA account, but hasn’t yet processed the VTSAX buy order since the market is closed.
Step 2 – Transfer (Convert) the Traditional IRA to a ROTH IRA.
Go to https://personal.vanguard.com/us/myaccounts/balancesholdings you will see a menu option for Convert to Roth IRA.
As you can see in my example, my IRA has already grown by more than $100, this growth will be taxable.
Upon clicking Convert to Roth IRA, choose to ‘Convert all of the account’.
Vanguard will give you one last screen where you can confirm everything is correct:
Upon clicking submit, Vanguard will give you a confirmation number with a summary of your transaction
Congrats, you are done!
The steps are the same as for Vanguard
- Transfer the Money to Fidelity
- Step 1 – Contribute to a Traditional IRA
- Step 2- Transfer the money from the Traditional IRA to a ROTH IRA
Get the money inside Fidelity
An overview of the different methods to get money to Fidelity is described here.
Step 1 – Contribute to a Traditional IRA
In my case, I had already pre-seeded the Fidelity Checking account so I would have the money directly available to contribute to the IRA at the beginning of the year.
Then I choose to fund the IRA by clicking on Contribute to this IRA
Choose the accounts to transfer From and transfer To
You will get a confirmation screen:
Review the screen and click Submit.
At this point I had to wait for a single business day, otherwise the next step didn’t succeed.
Step 2 – Transfer the money from the Traditional IRA to a ROTH IRA.
Click on Transfer
I like to keep the account open so I can re-use it the next year:
You will get one final screen with the conversion details.
Confirm and get your confirmation number:
You can see your transfer pending in All Accounts, Activity & Order, Pending Transfers and Bill Payments:
You can also see the individual conversion in the ROTH account directly:
And similarly, in the Traditional IRA account:
While the transaction is pending, you can still perform trades, so if you had it invested in cash like me above, you can buy your favorite mutual funds or ETFs immediately.
Congrats, you are done!
What if the value goes up or down in the IRA?
Some people prefer to put the money into the money market in the Traditional IRA before converting into the ROTH IRA. The reasoning is the value will not change and it will simplify taxes. This logic is actually wrong. Assume the following 3 different scenarios:
- Market is stable (0% change).
- Market goes up by 10%
- Market goes down by 10%
Market is stable (0% change)
In this scenario, there is no difference between directly contributing to a money market fund in the Traditional IRA vs your preferred market investment. Both choices will yield same value before and after the conversion.
Market goes down by 10%
In this scenario, you invest $6,000 into the IRA, it goes down to $5,400. You then proceed to convert to the ROTH and you get $5,400 in the ROTH.
This is exactly the same as if you had invested $6,000 in a brokerage account or if you had invested $6,000 directly in the ROTH. In all these cases, you end up with $5,400.
Obviously, if you had invested in the money market before conversion, you have $600 more, but this is simply due to market timing.
Market goes up by 10%
In this scenario, you invest $6,000 into the IRA, it goes up to $6,600. You then proceed to convert the IRA to the ROTH. You will get $6,000 in the ROTH and $600 taxable income. This is exactly the same as if you had invested $6,000 in a brokerage account and had a gain of 10%. You will eventually pay taxes on $600 gains, but that’s what happens when you make money.
Furthermore, if you had invested in the money market before conversion, you’d have missed on the $600 gains, due to market timing.