Funding a Fidelity Backdoor Roth IRA

There have been a lot of tutorials on backdoor Roth IRAs through Fidelity.

While I have used Vanguard in the past for my backdoor Roth’s, this year, I transferred my account to Fidelity to streamline my accounts.

What is Roth IRA?

This is another way to place money in a tax-advantaged account. What do I mean by tax-advantaged? Money that goes into a Roth is taxed when you put the money into the account and earnings grow tax-free. So when you withdraw money in 10 to 20 years, you will not pay additional taxes.

This is different than a traditional account (both IRA or 401k’s), which grows tax-free until you withdraw the money. Then taxes are due on earnings.

A Roth IRA  (and a traditional IRA) are both funded with after-tax dollars. This is different than a traditional 401K, which provides a reduction in your adjusted gross income. So using an IRA is only for the benefits of having your money/investment grow tax-free and not for any immediate tax benefit.

Why Do a Backdoor Roth IRA?

The reason to do a backdoor Roth IRA (as opposed to just funding it through the front door) is because there are income limitations for contributing.

For 2018, you have to make less than $189,000 if you are married filing jointly to contribute the full $5,500. From $189,000 to $198,999, the amount begins to be phased out. Above $199,000, you have to use a backdoor conversion.

If you are single, the income limit is $120,000 to be able to contribute the full amount, and it is phased out up to $134,999. Above $135,000, you have to do a backdoor conversion.

If you are making less than $120,000 (single) or $189,000 (married filing jointly), then you can contribute to a Roth IRA with no use of the backdoor. If you make more, as most physicians do, then keep reading.

How to Contribute to a Backdoor Roth IRA through Fidelity

First things first

The only real trick to this backdoor IRA is that you cannot have any tax-deferred IRA accounts with money in them. The balances have to be $0.00. That includes traditional IRA, SEP IRA, and Simple IRA. You can have your traditional 401(k), and 403(b) accounts still.

If you do have money in your tax-deferred IRAs, then you need to find somewhere to move them. You will get hit with taxes on moving or converting these monies, but it may be worth it to you. For those with no money in traditional IRAs, it becomes less of an issue. White Coat Investor writes a good summary of how you can move funds out of prior IRAs here (check out step 1).

Now for the contributions

I opened up a traditional IRA first through Fidelity and funded it with $5,500 from my bank account. I placed that money into a money market account as a placeholder that does not earn much interest. That way, when I converted it to a Roth, I would not owe taxes on the interest earned.

I learned this lesson in my first year of doing this, where I placed the money in an index fund and earned some profits before converting it. I was left paying the small amount of taxes on the conversion, but it was still annoying.

Step by Step

First, open up a traditional IRA

1) To fund with cash from your bank account. $5,500 if you want to maximize the contribution. Once the money is available in Fidelity, use it to fund a Money Market.

2) Next, open up a Roth IRA. Leave this unfunded.

3) Now you get to wait a day or two. There is some concern for the Step Transaction Doctrine. There has been a lot written about this, though most people would argue waiting a few days is sufficient.

Another caveat is that with Fidelity, it seems that you have to wait five business days. At least that is what I had to do. This is not the case with Vanguard, where they will let you purchase shares right away.

Ready to fund the Roth IRA

4) Go to the upper left side of your screen and click on Accounts & Trade. Under that, go to the “Transfer funds” tab (see below).

Transfer funds from the traditional to Roth IRA

5) Now you should see a screen like the one below. It is a small screen in the upper left corner of the screen. You will want to transfer from your Traditional IRA to the Roth IRA.

7) After you agree to transfer funds, Fidelity will tell you this is a taxable event. You will be allowed to withhold federal taxes now. However, since you will have $0 in gains, there is no need to hold taxes. You will have $0 taxes on this. Instead, elect not to have federal taxes withheld.

6) The next screen asks you to verify the transfer. Easy peasy. Just click on the button at the bottom.

7) Once you have verified the conversion, you will need to agree to transfer the entire account. I would also opt to leave the account open (the traditional IRA account) so that you can fund it in the future.

8) Finally, you have to agree to the conversion. After this, you will receive a confirmation screen and email. You are done. The backdoor IRA is converted.

Tax time- Form 8606

9) At tax time, you will need to fill out Form 8606 for the IRS. Here are the IRS instructions for filling it out.

There you have it—a step by step on how to fund a Fidelity Backdoor Roth IRA.