Vanguard Backdoor Roth IRA

This post could’ve been much bigger with more grammatical mistakes if I decided to write about what IRA is, and all the differences between Traditional and the Roth version of it. This post is not about that. There are a lot of awesome helpful resources where you can read about it:

Traditional IRA
Roth IRA
Backdoor Roth IRA

This post is a simple “how to” Backdoor Roth IRA for those who use Vanguard.

Before you start

If you have money in your traditional, tax-deferred IRA account you can’t use this method. First, you have to do something with this money:

  • Rollover to an employer’s 401(k) account – not all the plans allow rollovers, but if you plan does and has good investment options you can move money and avoid paying taxes yet.
  • Have a solo 401(k) account and move all the money there. – if you have a side gig you can open a solo 401(k) account for your earnings and put all your money there. You can also open a SOLO-IRA account, but in this case, you will not be able to use the back door if you have any money in your SOLO account.
  • Convert into Roth IRA and pay taxes. – you don’t have much money in your Traditional IRA, and you have money to pay taxes on the conversion, you can convert all the money into Roth and forget about taxes on that money for the rest of your life.

How To Backdoor Roth IRA

1. Open Traditional IRA

Backdoor RothIf you don’t have a Traditional IRA account open, you need to do it. Go to Vanguard website and open an account. It should be pretty easy, you just need to specify what kind of account you want to open.

I opened my account a year ago, and Vanguard keeps the account even with zero balance in it; you don’t need to open another one.

2. Make contribution

You need to contribute $5,500 to the account you’ve created.

You can choose several options.

What I usually do, I send all $5,500 to a money market fund. In this case, if for some reason, you can’t convert money into Roth right away, you will not have any gain or lose.

Put money into a Money Market Fund

3. Convert money to Roth

After you made the contribution you can convert your money to Roth

Some people say you can convert right after you made your yearly contribution but I in my case I have to wait for 1-2 business days. I don’t know the reason behind that, but it is what it is.  And this is another reason why I choose a Money Market Fund for my initial contribution. In this case, I don’t have any gain nor lose while I’m waiting for the Roth contribution being done.

Convert all of the account to Roth.

If you don’t have a Roth IRA account you can open a new one or use an existing.

4. Tax Withholding

Next step is about our favorite taxes. Vanguard will ask you whether you need to withhold money for taxes or not.

We are lucky and don’t need to withhold any money for taxes because we made our initial contribution using the aftertax money, the money we already paid the taxes on.

5. Roth, baby, Roth

If everything went well you will see this picture

You will see money in your newly opened Roth IRA account.

Now it’s time to buy some mutual funds using money sitting in the Money Market Account.

Vanguard has a huge variety of good funds and you can choose whatever strategy you want.

6. IRS

It’s not that easy to get rid of KGB IRS. We have to inform IRS about our Roth conversion. When you file your taxes you need to include form 8606 in your tax filing. [IRS source]

IRS form 8086

IRS form 8086

Your CPA should do it without any problems. If you use TurboTax here’s a step by step guide that will help you to file this form without any pain: How To Report Backdoor Roth In TurboTax

How to report backdoor Roth in H&R Block Software

How to report Backdoor Roth in TaxACT

7. Repeat

If your income stays high, praise the Lord, what you need to do is to repeat steps 2-5 every year.

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