Backdoor Roth IRAs provide an enticing, long term benefit for high income earners that phase out of being able to contribute to an IRA or Roth IRA directly. While the concept itself is not overly complicated, the pre-work, documentation, and tax forms for the process can be confusing. It is important to understand the steps involved to make it easily repeatable year after year for you and/or your CPA.
Step 1 - Prep-Work
Consolidate all pre-tax IRA assets. If you have any existing IRAs, SIMPLE IRAs, or SEP IRAs, these should be rolled into an existing 401(k), 403(b) or equivalent company retirement plan. If balances of pre-tax account assets are relatively low, you may consider skipping this step and converting the balance into a Roth IRA. Talk with your CPA and/or advisor to discuss how this will affect your taxes.
Step 2 - Show Me the Money
Make a non-deductible contribution to your Traditional IRA. Any income level can make a non-deductible contribution to an IRA. You must report your contribution at tax time on IRS form 8606, Nondeductible IRAs.
Step 3 - Flip Mode
Your custodian’s conversion form allows the balance in the Traditional IRA to convert to the Roth IRA. Ideally, convert immediately following your contribution and prior to investing the cash. Form 8606 is used to track your cost basis and calculate any taxable amount from the conversion, if you had any earnings in the Traditional IRA. If you are converting any pre-tax account assets, these amounts would be added back to your adjusted gross income in the year which the conversion occurred.
Step 4 - Tell Your CPA and Uncle Sam
You should receive two other tax forms from your account custodian. The Traditional IRA contribution and distribution/conversion should be shown on Form 5498 and Form 1099-R, respectively. You should also receive a Form 5498 showing the Roth conversion contribution you made from the Traditional IRA.
Bonus Points - Prior Year Funding
If you have the capability to fund for the previous year (prior to April 15 tax deadline), it is unlikely you will receive a 1099-R or 5498 as it occurs in the following tax year after custodial tax forms have been issued. It is still important to utilize Form 8606 to show your contribution as a non-deductible contribution. The conversion for the previous year should be reflected on the 1099-R and 5498 in the calendar year the contribution and conversion was made. It is important to make sure your advisor, custodian, and CPA know the contribution was made for the prior tax year.
The following is an example of a completed Form 8606 for tax year 2019 when the individual had no prior pretax assets. The supporting documentation from Forms 5498 & 1099-R show the contribution, distribution, and conversion.
Example of Filled Out Form 8606 with No Prior Traditional IRA Assets
Traditional IRA - Form 5498 and 1099-R
Roth IRA - Form 5498 and 1099-R
Internal Revenue Service. (June 24, 2020). About Form 5498, IRA Contribution Information (Info Copy Only). Retrieved from https://www.irs.gov/forms-pubs/about-form-5498
Internal Revenue Service. (April 15, 2020). About Form 8606, Nondeductible IRAs. Retrieved from https://www.irs.gov/forms-pubs/about-form-8606
Internal Revenue Service. (April 9, 2020). About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Retrieved from https://www.irs.gov/forms-pubs/about-form1099-r