By Dr. James M. Dahle, WCI Founder
A Roth IRA has a lot of advantages with regards to investing, tax reduction, asset protection, and estate planning. Even high-earners should be grateful to Senator William Roth, who was the sponsor of the legislation that established them back in the 1990s.
Roth IRA Basics
Roth IRA Contribution Limits
Anyone with earned income can open a Roth IRA and contribute up to $6,000 per year for the 2022 tax year. If income is sufficient, one can also open a Spousal Roth IRA and contribute another $6,000. If you're over 50, those limits are raised to $7,000 per year.
Roth IRA Income Limits and Utilizing the Backdoor Roth IRA
There is a contribution income limit, meaning if you have an adjusted gross income of more than $144,000 (single) or $214,000 (married) in 2022, you can't contribute. However, there is no income limit to Roth IRA conversions, so that leaves the option for a Backdoor Roth IRA wide open for most physicians.
After-Tax Contributions into Roth IRA Account
You contribute to a Roth IRA with after-tax money, but it is never taxed again. You don't pay taxes on capital gains and dividends as the money grows, and it comes out tax-free in retirement. You generally can't access the money before age 59 1/2 (see the exceptions here), but, unlike a 401(k) or traditional IRA, there are no required minimum distributions beginning at age 72.
Roth IRA Benefits and Investing Advantages
Tax-Protection
Roth IRAs are tax-protected. This allows you to invest in tax-inefficient investments, like REITs, TIPS, taxable bonds, and peer to peer lending. You can also buy and sell investments to rebalance, or simply change your portfolio without tax consequences.
More Investment Options and Less in Fees
Unlike a 401(k), you are essentially unlimited in the investments you can choose for a Roth IRA. So you can choose the best investments. If you go to a low-cost provider such as Vanguard, you'll almost always pay much less in fees than with your 401(k). In investing, you get (to keep) what you don't pay for.
I love canyoneering while my Roth IRA is hard at work for me.
Tax Advantages
I already mentioned that you get to save a lot of taxes since, after the initial contributions, it is never taxed again. The fact that both pre-tax (like traditional IRAs and 401(k)s) and post-tax investment accounts are available allows you to diversify your taxes, minimizing the taxes you pay over your lifetime.
For instance, a resident ought to preferentially use an after-tax investment and an attending ought to preferentially use a pre-tax investment. Roth conversions can be done during years of low income, and then in retirement, tax diversification allows you to minimize the taxman's bite.
In addition, practicing physicians ought to continue to make Roth IRA contributions via the Backdoor Roth IRA, as long as they can max out their tax-deferred options like 401(k)s first.
Asset Protection
Roth IRAs are generally protected from your creditors in most states. Many states offer unlimited protection of a Roth IRA.
Many of the steps you do to facilitate estate planning, reduce taxes, or protect your assets have nasty side effects. For instance, some asset protection techniques increase your tax bill or hurt your estate planning efforts. Tax reduction techniques can often hurt your investment return. But with a Roth IRA, you get all these benefits without side effects.
Utilizing the Roth IRA for Estate Planning
Thanks to maxing out my Roth IRAs in residency and during military service, some Roth conversions, and continuing to use backdoor Roths, some of my retirement portfolio will never be taxed again. If you want a great start for your nest egg, I can think of no better vehicle.
How are you using the Roth IRA to diversify and minimize taxes? Comment below!
What happens if the clowns in congress decide to tax withdrawals of Roth IRAs at some point? It’s not like they haven’t changed the rules regarding taxation before [Social Security income used to be tax free]. I’d rather take my tax break now with a defined contribution plan. At least I know what tax break I am really getting.
actually you dont know what tax break you will be getting. I wouldnt be surprised that in the future that taxes for all classes are higher and thus you could accidentally defer into the exact same tax rate or possibly even a higher rate. Now personally im betting that wont happen but i think its possible.
Great post. I had looked into this topic a couple of years ago when the income limitation for conversion was lifted. For estate planning purposes, transferring a Roth IRA to your beneficiaries on your death can be a very valuable decision. The beneficiary receives an asset which will grow at a compounded rate tax-free for his lifetime, and any withdrawals made will be completely tax-free. One point of clarification should be made though… the transfer of the Roth to your heirs is not tax-free. Unfortunately, the Roth IRA is still subject to Inheritance Tax (here in PA) and Federal Estate Tax at the owner’s death. Even with the double-taxation, this is still far better than a traditional IRA or 401(k) transfer to heirs.
Mark and Rex- Remember that with a tax-deferred account you save on taxes at your marginal rate, then pay taxes at your effective rate in retirement. So tax rates need to go up quite a bit (or you need A LOT of retirement income) to be hosed with a pre-tax investment. For an attending, deferring tax now is probably the right move. But when you’re choosing between a taxable account and a backdoor Roth, you probably ought to go with the Roth every time. But yes, there is a risk that Congress can change the rules.
RheumDoc- You’re right that a stretch Roth IRA can be subject to estate/inheritance taxes. But unless you have more than $5 Million (single, $10 million married) it won’t be subject to federal inheritance taxes. State inheritance taxes vary, and some states have only a $1 Million exemption which would catch many docs, so it is quite possible that the estate will owe taxes on a stretch IRA left behind. If it is smart, it’ll pay those taxes out of another pot of money and preserve the Roth benefits as much as possible.
In the article, you should mention the backdoor roth for the individuals making the physician salary. I believe taxes will be higher in the future due to government debt.
I’m a resident getting ready to make the transition into attendinghood, and I was curious about the backdoor IRA conversion. If you set up a SEP IRA and then a post-tax backdoor IRA conversion, do you have to pay tax pro rata as if you had a “traditional” IRA? Is an SEP IRA counted as the same as a traditional IRA in this case?
Yes, a SEP-IRA counts as a traditional IRA for roth conversion purposes. You need to get rid of it by either converting the whole SEP to a Roth, or rolling it into a 401K or perhaps even your own solo 401K.
I’ve added a link in the post to my page on Backdoor Roth IRAs.
Hello WCI, I’m in the process of converting from traditional ira (currently in the money market) to Roth but when I try to convert it keeps says I don’t have sufficient funds though my balance says $5500. I’m not sure what’s going on. Any pointers? This is on vanguard
Hi White Coat Investor,
Thanks for the info, Roth IRAs are my favorite savings tool because they are so flexible and they have so many tax benefits. One of the benefits of a Roth IRA is that you can take out up to $10,000 without paying any tax or penalty. However, there are some rules to follow in order to get the tax-free, penalty-free treatment, so make sure you do your homework before you take a withdrawal.
All the Best
Hi WCI,
I have pre-tax IRAs (from prior rollovers) + a current 403b but my wife has only a 403b and no rollover IRAs… I can’t use the backdoor Roth without dealing with the “pro-rata” conversion because of my pre-tax IRA (without converting back to a 403b). My question is, could we use the backdoor Roth for just her or would the whole “pro-rata” thing still affect us since I have rollover pretax IRAs and file jointly? Thanks!
That’s a great question Matt. You should be able to do it for just her. But I’m trying to think of how you’d do your taxes. You might have to do married filing separately to do it. Which, of course, might make it so it isn’t worth it to you.
Let me do some research and get back to you.
Is there a reason you don’t want to roll yours into your 403B? That’s what I’d probably do. Or just convert the whole thing if it isn’t that much money.
My new 403b has higher ERs and fees so I’d rather not go that route if not needed. I just finished training last June and began practice (hence the rollover to a Vanguard IRA for me) so was able to contribute directly for 2011 into Roths for both of us.
I’ve suggested to the benefits office to look into Vanguard for the retirement plans; they said it’s up for rebidding this year so they will.
You probably should have just converted your entire rollover IRA to a Roth in 2011 at your then lower tax bracket. I’ll see if I can figure out how to do a one spouse backdoor IRA.
Okay Matt. I think this is the answer you’re looking for. If you look at the top of Form 8606 (the IRS form that you fill out when you do Roth conversions) it says this:
Name. If married, file a separate form for each spouse required to file Form 8606. See instructions.
So basically, you do an 8606 for each spouse. Turbotax should do this automatically as well. So the pro-rata calculation is done for each spouse separately.
http://www.irs.gov/pub/irs-pdf/f8606.pdf
http://www.irs.gov/pub/irs-pdf/i8606.pdf
Hope that helps.
Thank you for finding & linking to that… much appreciated!
Need some help with Roth IRA backdoor conversion with Vanguard setting up in 2013. I like the idea of monthly contributions and dollar cost averaging over the year, rather than making one lump deposit—$5500 for 2013. Better to average over year than do it on one day, that could be a high or low buy.
Since I can’t directly contribute to the Roth dut to income limits, is there a way with Vanguard to contribute monthly ($458.33/month for 2013) to a Traditional IRA and then convert the next day to Roth? I’ve noticed Vanguard’s account minimums are $3000…even for the money market account. So far I haven’t been able to figure out how to set this up.
Thoughts?
Good question Jon. Let me talk you out of what you want to do.
You actually could do what you want. You’d invest $458.33/month into a fund within a non-deductible Roth IRA. Then once a year, you could do a Roth conversion with that money. If the fund increased in value over that year, you’d have to pay a little in taxes, but you’d get even more into the Roth. Since Vanguard fund minimums start at $1000, you’d have to do that much at least with your first payment unless you wanted to open a brokerage account and do ETFs. Neither of which is very hard, but too complex for my taste. Doing a Roth conversion every month is WAAAAYYYY too complex. You (or your accountant) will hate yourself come tax time.
So, let me talk you out of it. You make too much to do a Roth conversion. That means $5500 is a tiny piece of your annual earnings, your portfolio, and your eventual retirement nest egg. Save yourself the hassle and just lump sum it every January. Some years you’ll buy a little high, and some years you’ll buy a little low, but over 20 or 30 years, it’ll average out just fine. If you’re really worried about buying high, why not buy $15.07 a day? It’s obvious. It’s too much of a hassle. So is spreading out a $5500 contribution over 12 months. I generally do Roth IRAs in January, the 401K from February to August or September, the 529s in October, the HSA in November, and the defined benefit plan in December. But I lump sum them all. I’m buying stocks throughout the year, just in different accounts. Does that make sense?
Hi WCI and fellow EM Physician,
Fantastic website… I’ve learned more than I thought I would ever need… Little did I know…
Anyways, quick question about the Backdoor Roth conversion. I just opened a new traditional IRA account with the goal of conversion to a Roth. How long should I wait after the account is funded before converting it? I’m finding conflicting answers ranging from the next day to 6 months!
Thanks!
Sam
I have seen some advisors recommend as long as 3 months. I do mine the next day. The Finance Buff has discussed some of his concerns about doing it immediately here:
http://thefinancebuff.com/recharacterize-backdoor-roth.html
I see no reason to wait 6 months.
As a ’13 resident graduate who will become an independent contractor this summer, can I contribute $10,000 (via backdoor Roth for myself and my wife) and still nearly max out the solo Roth 401k (estimated about 170,000 from aug-dec later this year as an IC)?
First, it’s $11K for you and your wife. Second, the backdoor Roth IRA has nothing to do with whether or not you can max out a Solo Roth 401K. You’ll certainly be able to get your $17.5K Roth 401K contribution in there. Will you be able to get the $33.5K traditional “matching contribution?” I’d have to run the math, but you should be awfully close. $33.5K/0.185 or so = $181K so $170K should be enough. If you really wanted to, you might even be able to roll the money out of the 401K and convert it all to a Roth, but you probably could use the tax break, it might not be worth the hassle, and I’m not sure you can even do it. I’d look at it very closely if it was me though.
I never thought of being this involved in my financial planning because i thought it would be too hard. So thank you for your posts. I have a question. I am a dental resident currently . I have a rollover IRA due to 401k contributions that totals about $800. And I currently contribute to my employment 403 .b. my income is about to change dramatically so I want to convert my IRA to the Roth that you taught me about. Should I contribute maximum allowed for me $5000 first to the traditional IRA because I’m about to file taxes then roll everything over to a Roth . Are there benefits based on my low income to file the traditional IRA on my taxes and convert to the Roth a week or so later before the April deadline for 2012.
In addition to my previous question. I was wondering if based on what I understand from comments you made I can roll my IRA into my 403b? And is that a better idea than coverting to a Roth IRA? I like the knowledge of knowing that I can access the funds if really needed for an emergency. But if you can tell me what the best format is based on my situation that would be great.
Thanks
You can roll your traditional IRA into your 403B, but if I were you, I’d try to convert your IRA to a Roth IRA, convert your 403B to a Roth IRA as soon as you leave residency, and do a backdoor Roth IRA for this year. It’ll be a long time before you can do so at this tax rate again (if ever.)
Thoughts on these “Lazy Portfolios”? 26 year old PGY1 starting my first Roth, pretty limited in my financial knowledge/time to manage the account (but working on it). Just want to get something going that I don’t have to worry about too much at the moment.
http://www.bogleheads.org/wiki/Lazy_Portfolios
They’re all fine. You could just buy a Vanguard Life Strategy Fund or Target Retirement Fund or Balanced Index Fund as well for a single fund purchase that lets you get back to being an intern. You can then worry more about asset allocation in a few months or a few years and know you’re not doing anything stupid.
https://www.whitecoatinvestor.com/simple-investing-solutions-including-betterment/
WCI:
I enjoy your site and recommend it to my colleagues. My wife and I have IRA’s. Back in the 2008 market swoon her IRA account value had dropped so that the capital gain was small and she converted to a Roth IRA and paid little tax in 2010 and 2011. Since then she has contributed to an IRA and converted to her ROTH as you suggest.
I was fortunate to have a large gain in my Roth, and did not convert as taxes would have been high. I inquired my 401(k) plan whether I could transfer my IRA deductible portion, thereby isolating the nondeductible portion. However, they said they accept only “conduit” IRA’s from previous rollovers (401k to IRA, as from previous employment). You mentioned something about setting up a solo 401k, could you elucidate further?
A Solo 401K/individual 401K is a retirement account that self-employed people use. I think you could roll your IRA into it. I don’t know for sure, but I think you could write the plan document so it doesn’t accept non-deductible IRA money. If you don’t have non-deductible IRA money, then this is a no-brainer, assuming you’re eligible for a Solo 401K, which you might not be since you say you’ve got a 401K at work. Do you have some moonlighting income?
No I don’t have moonlighting income and I max out my 401k at work. I was thinking more along the lines of a solo 401k from a non-medical source of income, such as medical legal consulting.
That would work fine.
Hello White coat investor,
I am an incoming M1 this year and have a considerable amount in savings ~30,000( that is for a medical student). A majority of this is earned income. I have been contemplating opening a roth IRA for some time now, how should I go about opening an roth IRA. Should I simply go with vanguard?
Yes, you can simply go with Vanguard. It’s very easy to open an account online. I would NOT, however, fund a Roth IRA and then take out student loans at 6.8% or 7.9%. If I had $30K as an MS1, I’d use it to pay for med school.