One of the most common questions we get from clients involves Roth IRA accounts. Everyone seems to have a general idea that Roth IRAs are good, but there’s definitely some confusion on WHY and if Doctors are allowed to use them. We also get several questions from clients about Roth IRA conversions, commonly known as a backdoor Roth IRA for doctors.
Roth IRAs vs Traditional IRAs
Let’s start with the first one: What’s good about Roth IRAs? To understand this it’s helpful to compare Roth IRAs with Traditional IRAs. Both accounts are limited to an annual contribution of $6,0001. You may have heard about the increase this year, the annual contribution limit for 2015, 2016, 2017 and 2018 was $5,500, or $6,500 if you’re age 50 or older.
You see, money that is contributed to a traditional IRA may be tax deductible, and there’s no taxes due while the money stays in the account. But when you take money OUT of a traditional IRA, all the growth will be subject to income tax – and possibly the principal too – at whatever tax rate you happen to be in at the time.
With Roth IRAs, the contributions are never tax deductible. However, all of the withdrawals you take in retirement are income tax free! So if you have a long time for the money to grow, this can be really beneficial. Sometimes I use this farming analogy to describe the difference: with a deductible IRA you get a tax deduction on the seed but the harvest is all subject to tax but with the Roth, there’s no tax savings on the seed but the entire harvest is tax free.
Income Limits for Direct Contribution
Now, the issue most physicians have is that once they’re in practice, they’re not eligible to contribute directly to Roth IRAs because they earn too much. The IRS rules prohibit anyone earning over approximately $117k if you’re single or $184,000 if you’re married from contributing to a Roth. BUT, those same income limit rules do not apply to IRA contributions, which opens up a neat strategy sometimes called a “back door Roth”.
Roth IRA Conversion
Here’s how a back door Roth works. First, you contribute money to a regular IRA – again doesn’t matter how much you make, everyone’s allowed to save $6,000 to an IRA each year. And odds are, because of your income and other rules, this won’t be tax deductible to you – which is fine. Then, after this deposit is made, you fill out a form to CONVERT the balance to a Roth IRA. Yes, the devils’ in the details here. Converting is allowed for everyone, contributing is only allowed if your income is below certain limits. So, once you convert your non-deductible IRA contribution to a Roth, you can now invest however you want and your money has the opportunity to grow and can be withdrawn tax free when you’re retired.
Now obviously there are some key details and caveats that go into this whole topic, so make sure to consult with your CPA or tax preparer first. Hopefully, now you have a little better idea of the difference between IRA and Roths and how even high income physicians can start building tax free money.
(1) The annual contribution limit for 2019 is $6,000, or $7,000 if you’re age 50 or older.
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ABOUT THE AUTHOR:
Shane Tenny is a registered representative of and offers securities, investment advisory services and financial planning through MML Investors Services, LLC. Member SIPC. 4350 Congress Street, Suite 300, Charlotte NC 28209. 704-557-9600. Spaugh Dameron Tenny, LLC is not a subsidiary or affiliate of MML Investors Services, LLC.