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 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:
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!