How to fund a Backdoor Roth IRA

It’s that time of year where we prepare for our routine investment account maintenance. For me, one task is reminding myself how to fund a Backdoor Roth IRA. I do this at the beginning of every year in January, so that I can put my funds into the market as soon as possible.

Here are the basic criteria and rationale to fund a Backdoor Roth IRA:

  1. If your gross income exceeds $117,000 if filing single or $184,000 if filing married jointly, then you should proceed with a Backdoor Roth IRA. Otherwise, you can just contribute to a Roth IRA directly.
  2. The Roth IRA offers another “bucket” to invest. You contribute post-tax dollars into this bucket, but there is no tax on any growth in the bucket whenever you take the money out.
  3. This money can go to your heirs tax-free.
  4. It’s not a huge amount ($5500 for 2016), but the amounts do add up throughout your working career, and the potential growth over time is valuable.
  5. This works best if you don’t have any Traditional IRA funds already. The Roth IRA conversions will take into account what you have tax-deferred. If you have Traditional IRA funds, then you will be taxed on any earnings that you convert.

 

 

I have my Roth IRA account in E-Trade. It just happened to be there when I used to buy individual stocks. It has a decent web interface with decent market analysis posts under the “Research” headings.  If you already have a Vanguard or TD Ameritrade accounts, those also work fine as well. My rule of thumb is to minimize the number of accounts you have across the board for simplicity. After a certain age, you start to forget things! 😃

Step 1. Open a Traditional Non-Deductible IRA.

On E-Trade, I select ‘Open a New Account’. From there I select a Traditional IRA. I also keep a savings account on E-Trade, and when the time comes to fund a Roth IRA, I usually transfer funds from my outside bank accounts to my E-Trade Savings Account.

For 2017, the maximum amount that you can fund is $5500 if you are under age 50. Don’t forget to fund your spouse’s account the same way!

 

Step 2.

Let the funds clear and do nothing. I tried to jump to Step 3, and E-Trade gave me an error message. I remember sitting on this for about 1-2 weeks on E-Trade.

Step 3. Apply for a Roth IRA conversion.  

On E-Trade, I usually go to the landing page for conversion: https://us.etrade.com/landing/Roth_Conversion I log in, and click through. Fidelity also has a similar mechanism. Since the funds that you have placed in your account have not been invested yet, you should still have $5500 (or $6500) that you funded previously.  If you already have an existing Roth IRA with the custodian, you can select that account at this time and combine the funds together.

Afterward, you can either close your Traditional IRA or leave it empty for next year. E-Trade allows me to keep the account open. You can then decide how to invest the funds in your Roth IRA!

What other tips do you have for Backdoor Roth IRA’s? 

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