This post was written based on the limits for 2023. The maximum contribution, MAGI, etc. may change year-to-year.
At the time of updating this post for 2023, a Roth individual retirement account (IRA) is a special retirement account that one can contribute up to $6,500 (or $7,500 if > 50 years old) per year. These funds are “post-tax” (money you have already paid taxes on) and can be invested in many financial assets (e.g., large capital index funds). After age 59 1/2 years of age, one can make withdrawals from their Roth IRA without paying tax on the capital gains.
There are limits on Roth IRA contributions based on one’s modified adjusted gross income (MAGI). In 2023, if you are single with a MAGI > $153,000, you cannot contribute anything to a Roth IRA in the traditional way. Enter the backdoor contribution.
Within Fidelity, I have two accounts: a traditional IRA and a Roth IRA. Each January, I transfer $6,500 to my traditional IRA from my checking account. It takes 1-3 business days for the funds to settle. I contribute to the same year as the calendar year to make the tax forms easier.
After confirming the funds have indeed settled, I’ll click on “Transfer” at the top of the Fidelity page and begin rolling over the Traditional IRA funds into my existing Roth IRA as a Roth conversion.
I roll the entire traditional IRA into the Roth IRA such that the remaining balance is $0 each year to avoid accruing interest. In other words, my traditional IRA has $0 for the entire year except for the 1-2 business days it’s holding funds for the Roth conversion. Keep in mind this is a 2023 contribution (contribute and convert the same calendar year as the taxes) for the 2023 tax filing I’ll do by April 15, 2024.
Once the funds have settled in the Roth IRA, I’ll typically invest them in a low expense ratio total market index fund.
To formalize the backdoor Roth contribution for tax purposes, I complete form 8606 for nondeductible IRAs. Here’s an example of my 2021 tax form when the Roth limit was $6,000.
I could theoretically do my Roth contribution anywhere from January 1 till April 15 of the following year when tax returns are typically due. However, it’s easier to do the contribution and conversion in the same calendar year as the taxes. In other words, if I try to contribute to my 2022 taxes by going through the aforementioned process in January 2023, my 8606 tax form becomes a little more complicated. Instead, I complete the contribution AND conversion process in January as part of my yearly tasks – membership/subscription renewals, looking for competitive rates on utilities, rebalancing my portfolio, etc.
Drop me a comment below with your questions and experiences regarding Roth IRAs!