By Dr. James M. Dahle, WCI Founder
I receive numerous emails every year, probably at least once a month, from new attending physicians asking for help with a mistake they have made. It occurs so frequently that I have written a post about how to fix it so I could quit typing the instructions into emails. Apparently, I'm not the only one who sees this problem frequently. Check out this email from one of our recommended advisors:
“Thanks in large part to you, a lot of my clients are new attending physicians. As I am meeting with them and creating their financial plans, I am finding that almost all of these new attendings have already made their ‘frontdoor' Roth IRA contribution for the year. They usually do it in January out of habit (again, thanks to you) but fail to realize that even with a few months of attending income for jobs they start in August-October, that they will not be eligible to make Roth IRA contributions unless they use the Backdoor. Almost every new attending I meet with has to recharacterize their Roth IRA contribution for the year. It’s not a big deal, but for those who are not meeting with a financial planner right out of residency or fellowship, I’m imagining there are lot of people in this situation who aren’t realizing they have made this mistake.”
When Do You Need to Do a Backdoor Roth IRA?
For 2023, direct Roth IRA contributions are allowed if you have a Modified Adjusted Gross Income (MAGI) of less than $138,000 if you file your taxes as a single, $0 if you file your taxes Married Filing Separately, and $218,000 if you file your taxes as Married Filing Jointly (MFJ). So, who gets caught in this Backdoor Roth IRA problem? Three types of people.
- People who don't know those facts. Unfortunately, that's a lot of docs.
- People who end up filing Married Filing Separately to try to maximize PSLF or IDR forgiveness. It's pretty hard to stay under a $0 threshold.
- People who end up making more money than they thought they would.
That third category of people might be due to making a lot of money moonlighting; getting a big signing bonus; having a spouse take a job; or, most commonly, just getting a good, high-paying job as an attending physician when you're finished with residency.
Let's say you are a resident or fellow making $70,000 per year. In the first half of the year, you make $35,000. Then, in the second half of the year, you get a job and earn $300,000 per year, so you make $150,000 for the final six months. Total income for the year is $185,000, well more than the single threshold of $138,000. You probably don't have enough retirement account contributions or above-the-line deductions to get your MAGI much lower than your total income, which is well above the $138,000 threshold. What about if you're married to a non-earner? Well, if you got a big signing bonus or did some moonlighting as a resident or if you have a really good income, you can still get above that $218,000 MFJ threshold.
More information here:
The Solution
The solution to this dilemma is to simply do your Roth IRA contribution indirectly via the Backdoor Roth IRA process during that last year of training. Even if your income ends up being below the threshold, you can still do a Backdoor Roth IRA. No problem. In fact, I think my first Backdoor Roth IRA in 2010 wasn't necessary.
If you have a 401(k) or 403(b) from residency or fellowship (and especially if you have an outstanding traditional IRA for some reason), this is also a great time to do a Roth conversion on those. Avoid running afoul of the Backdoor Roth IRA pro-rata rule by ensuring you have no money in a traditional, rollover, SIMPLE, or SEP-IRA on December 31 of the year you do a Roth conversion (including the second step of the Backdoor Roth IRA process.)
More information here:
17 Backdoor Roth IRA Mistakes to Avoid
Fixing the Mistake
As the emailer mentioned, it isn't the end of the world if you make this mistake. You can always do a recharacterization of your Roth IRA contribution to a traditional IRA contribution and then reconvert that money to a Roth IRA. However, this is a pain because it requires you to make some phone calls, fill out some paperwork, and deal with some hassle. Plus, any gains that money made between the time of the initial contribution and the eventual Roth conversion will be taxed at your ordinary income tax rates.
Since the market usually goes up, there is usually a cost. The longer you take to realize the mistake or wait to fix it, the higher that cost will be. For example, if you are in the 24% federal bracket and a 6% state bracket and a $6,500 Roth IRA contribution grows to $8,000, you'll owe 30% * ($8,000-$6,500) = $450.
It gets even uglier if you wait too long. The deadline to do a recharacterization is October 15 of the next year (i.e. if it was a 2023 IRA contribution, you only have until October 15th, 2024, even if you made the contribution in April 2024). If you go past that date, you will need to take your entire Roth IRA contribution back out, including any gains, and pay a 6% per year excess contribution penalty on it (6% of $6,500 = $390 per year).
It might not be a financial catastrophe, but this is an easily avoided costly mistake. Just do your Roth IRA via the Backdoor Roth IRA process the year you finish training, and you'll avoid all this hassle.
If you need extra help with planning for retirement or have
questions about the best way to save your money in tax-protected accounts, hire a WCI-vetted professional to help you figure it out.
What do you think? Did you make this Roth IRA mistake when you became an attending? Did you have to do a recharacterization? Why or why not? Comment below!
Good morning,
I believe that we have a nomenclature issue in regard to the “Backdoor Roth IRA” , as the terminology is confusing to the basically financially literate.
If we would begin discussing 2 different concepts, this may resolve the vast majority of continued perpetual confusion.
I propose we begin discussing yearly traditional IRA contributions. “Did you make your yearly Traditional IRA contribution doctor?” Very straightforward. Very clear.
Then we end by discussing yearly Roth IRA Conversions. “Did you make your yearly Roth IRA Conversion doctor?” This will segway nicely and apply to many people later in life as well.
In conclusion, if we would extinguish the archaic and poorly worded “Backdoor Roth IRA” from our vocabulary, I believe 90% of this confusion would resolve spontaneously.
Sincerely,
J
Well but that confuses docs-in-training who don’t need to be making traditional IRA contributions, but rather direct (“frontdoor”) Roth contributions.
Maybe direct vs indirect Roth IRA?
Or conjugated vs unconjugated…
Exactly JPD. You’re simply making a Roth IRA Contribution. No confusion there either.
If you can’t legally make a Roth IRA Contribution, then you probably shouldn’t.
J
I agree with you and have started calling it the Backdoor Roth IRA process the last couple of years and am careful to use precise wording about contributions and conversions.
This article is so well timed for me. I am anticipating a salary increase later this year that might push me over this limit, especially given the cash yield I am getting on my savings for a home. This article gives me the confidence to go through with the backdoor process this January and not worry about that limit. Thanks Dr. Dahle!
Great topic and just in time.
Another really important tip for the soon-to-be attending is to make sure to update not only your own W-2 withholdings but also your SPOUSE’s withholdings if married filing jointly (alternatively, run the numbers and save up cash to make your next year’s payment, assuming you’ll reach safe harbor on estimated tax payments). There will be a big jump from their what their employer was traditionally withholding to your actually liability when your reach that new 32%+ tax bracket. That difference in tax brackets can easily mean a 10-20k shortfall on your bill come tax time.
Another really important tip for the soon-to-be attending is to make sure to update not only your own W-2 withholdings but also your SPOUSE’s withholdings if married filing jointly (alternatively, run the numbers and save up cash to make your next year’s payment, assuming you’ll reach safe harbor on estimated tax payments). There will be a big jump from their what their employer was traditionally withholding to your actually liability when your reach that new 32%+ tax bracket. Your spouse’s employer will certainly not be withholding 32% of their paycheck, but that’s your new marginal tax rate. That difference in tax brackets can easily mean a 10-20k shortfall on your bill come tax time.
Great topic, thanks for the post.
One other way this can come up is when someone who is under the income threshold for direct Roth IRA contributions and who expects no change in their income for the year, gets married to a high earner.
For example, a 2nd year resident makes a direct Roth IRA contribution in January out of habit but knowing they are getting married to their attending orthopedic surgeon fiancé in August. The new couple then files their taxes MFJ and now the resident’s contribution is ineligible.
So even if marriage plans aren’t finalized, if marriage is possible during the coming year and/or if the combined incomes may exceed the limits, it makes sense to use the backdoor process for that early-in-the-year Roth IRA contribution.
Great point.
Another one is when people choose to file MFS in order to get more benefits via PAYE/PSLF.
The solution to this dilemma is to make indirect contributions to my Roth IRA through the backdoor Roth IRA process during that last year of training. My income ended up being below the threshold, but I was able to do a backdoor Roth IRA. A backdoor Roth IRA is required.
Yes, that’s the solution. But I’m not sure why you’re saying a BD Roth IRA is required.
Hello – I am a resident, and I got married last year. In order to maximize PSLF we are going to file “married filing separately.” As I went to do my taxes I realized I over contributed by maxing out my Roth for 2022 (and what I’ve contributed so far for 2023). I didn’t know about the limit of MAGI $10,000.
So is a simple recharacterization all I have to do? Or is it time to just start putting money into a brokerage?
Any help is appreciated!
Yes, recharacterize and do Backdoor Roth IRAs going forward.