Doctors, dentists and other high income earners are constantly looking for ways to lower their tax burden, especially when retirement rolls around. One of the best methods to achieve this is via the Backdoor Roth IRA. There have been numerous articles written about backdoor Roth IRA steps you can take to convert your traditional IRAs into Roth IRAs. I’m all about being in control, especially when it comes to money. If you want to take more control of your retirement income without having to worry about tax consequences, the Backdoor Roth just maybe your ticket.
What’s a Roth IRA?
Roth IRAs are a unique and powerful way to save for retirement. Why? Taxes are paid up front but then all growth and withdrawals are tax-free. Got your attention yet?
Let me repeat that.
These accounts offer:
- tax-free growth
- tax-free withdrawals in retirement
Here’s another cool feature especially for those of us that want to retire early: Money can be withdrawn when you want and no federal taxes will be owed as long as:
- you’ve owned your account for 5 years
- you’re age 59½ or older
Roth IRA Advantages
No Age Limit
Once you reach 70½, traditional IRA contributions can’t be made. This is NOT the case with the Roth. You can continue to fund your account for as many years as you want, as long as you have earned income that qualifies.
Earlier and Easier Money Access
There are more and more people having to access their traditional IRAs and 401K plans due to financial hardships. This can put a damper on future earnings in retirement.
The Roth IRA is equipped with better early withdrawal terms than the traditional IRA.
Remember: Money for non-qualified withdrawals from a traditional IRA before age 59 ½ will require you to pay a 10% penalty + income tax.
You can dodge both the penalty and tax as long as the Roth withdrawals come from your contributions and not earnings.
No Required Minimum Distributions (RMDs)
Starting at age 70½, RMDs are required if you own retirement plans such as:
- traditional IRA
- other employer-sponsored retirement plan accounts
If you withdraw less than the RMD amount, you may owe a 50% penalty tax on the difference.
Not to worry if your money is in a Roth as these accounts are RMD-free during the owner’s lifetime.
No Taxes for Your Beneficiaries
After you die, money that is passed down to your heirs left in a traditional IRA or other retirement accounts, such as a 401(k), are taxed on the withdrawals. Distributions from an inherited Roth IRA are tax-free.
Also, non-spouse beneficiaries of a Roth IRA are subject to annual minimum withdrawal requirements, whereas a spouse that inherits one does not have a minimum withdrawal requirement.
Roth IRA Problem
As a high income earner, we have problems. Hopefully not 99 problems (as Jay-Z would say). The main one regarding a Roth IRA has to do with income limits. People who earn over a certain amount aren’t allowed to open Roth IRAs.
Income Limits For Roth IRAs
According to the Vanguard website, the Roth IRA contribution limits are:
If you’re married filing jointly and your modified adjusted gross income (MAGI) is $199,000/year or single $135,000/year, you can’t directly contribute to a Roth IRA.
According to RothIRA.com:
Roth IRA Contribution Limits for Individuals Under 50
Individuals who are under 50 years old may contribute $6,000 to an IRA (2019). This amount is the maximum you may deposit per year across all IRAs you may have with multiple providers, including both Traditional or Roth IRAs.
For example, you could contribute $3,000 to a Roth IRA with one provider and $3,000 with a second provider. You cannot contribute $6,000 to the first Roth IRA and $6,000 to the second provider. Your total contribution limit is $6,000 for all accounts for the tax year.
Roth IRA Contribution Limits for Individuals 50 or Older
For those age 50 or older, the same $6,000 contribution limit across all Roth IRAs is in place. However, the IRS also allows these individuals to also contribute an additional $1,000 as “catch up” contributions. Although this allowance is provided to assist individuals who are behind in retirement savings, it is available to everyone age 50 or over who qualifies for a Roth IRA.
*With a backdoor Roth IRA conversion, these limits do not apply.
If you think tax-free income in retirement would be important to you, but you make too much to open a Roth, you might want to consider the back door.
What is a Backdoor Roth IRA?
— Saverocity (@Saverocity) June 6, 2014
A backdoor Roth is simply a conversion of money in a traditional IRA to a Roth IRA. Currently, anyone can convert money that they have put into a Traditional IRA to a Roth IRA, no matter how much income they earn.
All of this works because, in 2010, the federal government removed the income limits for IRA conversions, creating a Roth IRA loophole. Of course, you’ll need to get the mechanics right. Consult your accountant and/or tax attorney if you have any questions before doing so.
Backdoor Roth IRA Steps
- Contribute to your traditional IRA. If you don’t already have an account, go to Vanguard or other investment company to open and fund it. Remember that you can contribute $6,000/year or $7000/year if you’re over 50. If you’re opening an account specifically to do a backdoor IRA, you can fund your account with post-tax dollars and not have to worry about paying taxes on that money, and what it earns in retirement.
- Convert the account to a Roth IRA. Your IRA administrator (such as Vanguard) will provide you with the necessary paperwork and instructions. If you already have a Roth IRA with the IRA administrator, your “converted” balance will probably go right into your existing Roth IRA. If you don’t already have a Roth IRA, you’ll open a new account during the conversion process.
- Pay taxes on the contributions to your traditional IRA. Remember, only post-tax dollars get to go into Roth IRAs. So if you deducted your traditional IRA contributions and then decide to convert your traditional IRA to a backdoor Roth, you’ll need to give that tax deduction back. In other words, you’ll need to pay taxes on the money you contributed, just like everyone else who invests in a Roth IRA.
- Pay taxes on the gains in your traditional IRA. If the money in that traditional IRA has been sitting there awhile and there are investment gains, you’ll need to pay taxes on the gains as well when you convert to a Roth IRA. You will report this on your federal income tax return.
Backdoor Roth IRA Step-by-Step Guides
There are several fantastic guides to walk you step-by-step on this entire process.
Here are a few to take a look at:
White Coat Investor – Backdoor Roth IRA Ultimate Guide and Tutorial
Dads Dollars Debts – Funding a Fidelity Backdoor Roth IRA – a Step by Step Guide
The Physician Philosopher – Step by Step Tutorial for FIRST Backdoor Roth (Vanguard)
Physician on Fire – Vanguard Backdoor Roth 2019: a Step by Step Guide
Will the Backdoor Ever Close?
When you’re dealing with the government, nothing is for certain. All tax policy—including rules set for Roth IRAs—is subject to change. My advice, if you’re afraid the door may shut, use it while you can.