Performing a “Backdoor Roth IRA Conversion” can sound intimidating. In actuality, it’s an incredibly simple thing that takes less than 5 minutes (really) at Vanguard. In this walkthrough, we’ll go through the entire process to do a Backdoor Roth IRA conversion. The broad steps for this are relatively simple:
- Open Vanguard IRA and Roth IRA Accounts
- Contribute $5,500 to your IRA Account
- Convert that $5,500 to your Roth IRA
The screenshots I’ll be using for this will be on Vanguard, but the process should be similar for Fidelity, Charles Schwab or whoever you use for your brokerage. Before jumping into these steps, let’s really quickly look at why you should do this.
Why Perform a Backdoor Roth IRA Conversion?
Last week I posted The 2018 Guide to Roth IRA vs IRA – Which Should You Use? which should help figure out which type of account you should be using. That post details the tax benefits for choosing a Roth IRA or an IRA. For a deeper understanding of this topic, you can check out that guide. Here’re the bullet points on why should perform a backdoor Roth:
- You make at above the phase-out limit for contributing to a Roth IRA directly ($120,000, or above $189,000 filing jointly in 2018).
- You do not have a lot of funds in an existing IRA – even one not at Vanguard. If you do this will be a taxable event.
- You want to contribute to a Roth IRA
If you meet these conditions then a Backdoor Roth IRA Contribution is a good fit for you! If you already have funds in an IRA, even if it’s not at Vanguard, then it’s important to be aware that by performing this conversion, you’ll be taxed based on the total amount of pre-tax funds in your IRA.
1. Open a Vanguard IRA and Roth IRA Account
In order to do a Backdoor Roth Conversion, you’ll need both a Traditional IRA account and a Roth IRA account. Having both these accounts at the same firm (Vanguard in my case) makes this easy. If your accounts are at different places, then this won’t be fun – you’ll probably have to do paperwork and wait long periods of time for it. It’s easier just to open another IRA at the same place as your Roth IRA.
Even if you already have an IRA somewhere else, it’s OK to open another one at Vanguard. You’ll be responsible for not exceeding the max each year across all of your accounts.
Within Vanguard, you can find the “Open an Account” button and walk through the guide to open up an IRA. Once that’s done, you can walk through the process again for a Roth IRA.
If this is your first time opening the account, you could also fund it during that “open an account” flow by setting up your bank. The screenshots below will be for the scenario where you choose to just open the account now, then fund it later.
Either works though, as long as you’re making your IRA contribution for 2017 (up until April 15, 2018) or 2018 (up until April 15, 2019).
2. Contribute $5,500 to Your IRA Account
After you have your IRA setup, the next step is to add some funds to it!
Once you select where your funds are coming from (by connecting a bank account), you’ll be able to fund your IRA! It’ll take a few days for the funds to be transferred in. If this is your first time using Vanguard, you’ll also need to go through the bank account verification step where they deposit a few cents in your account and you verify the transactions.
When choosing what fund to use in your IRA, it’s important to keep it all in money or cash. This is because any interest that accrues on the holdings will be taxed. It also slows down the process later. I tend to stick to only using cash for the conversion, then choosing investments once funds arrive in my Roth IRA account.
Contribution Holding Period
Once you contribute from your bank to your IRA account, there will be a holding period while Vanguard waits for your funds to arrive. After they arrive, Vanguard will hold onto them for a little while before they let you take funds out of that account as well (just in case the transfer in was in error I assume). This waiting period takes about a week. There is a way to bypass this though, but it takes some planning ahead.
It requires also opening up a Brokerage Account at Vanguard and funding it with $5,500 – but just leaving the money in a money market/cash fund. Like the IRA, it’ll have a holding period too. If you do this in early December, by January 1st, you’ll be able to immediately fund your IRA, and then jump to step 3 below — completing the entire conversion in minutes! Although it may be too late for that if you’re starting now, it could come in handy next time.
3. Convert to a Roth IRA
Vanguard makes converting an IRA to a Roth IRA comically simple. On your Account Overview page, click on “Convert to Roth IRA”. This will kick off the conversion process. This is the same process whether you’re converting from an IRA to a Roth IRA or performing a Backdoor Roth IRA Conversion.
The conversion from your IRA to your Roth IRA will be instant – if you’re transferring from a money market/cash fund in your IRA to the same fund in your Roth IRA. If you’re just transferring funds into your settlement fund it’ll happen immediately.
You’re done… at least until next year! Mrs. Minafi and I start saving for our Roth IRA for 2019 on January 1st, 2018. We use Simple for our bank and love their Goals feature. This allows you to set an amount and a date, and Simple will slowly move those funds into your goal over time.
What I really like about Simple’s Goals is that the money isn’t in a separate account. The total amount in your account will still be shown and available, but you can see the total in your account minus the goals. Simple calls this total your “Safe-to-Spend” amount. You can spend over this and chip into your goals if needed and Simple won’t charge you an insufficient funds fee, as it’s all still in the same account.
If you’re curious to try Simple, you can use my affiliate link and get $20 free for signing up ($20 for both of us!). They’ll deposit that as soon as you use the visa debit card they provide (which is actually one of the most pretty cards I have).
At the end of the year when you make your Vanguard contribution you can use that money to fund your Roth IRA!
Do you have any concerns or issues with using a Backdoor Roth IRA?