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Welcome to the latest episode of the Physician Cents Podcast, where we explore complex financial topics tailored specifically for physicians. Whether you're a medical student, resident, fellow, or attending physician, you're going to find valuable insights that can help you increase your financial IQ, further your financial journey, and improve your overall well-being. Hosted by Chad Chubb and Tyler Olson, let’s dive in!
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Let’s demystify one of the most talked-about financial strategies in the physician community: the Backdoor Roth IRA. Today’s episode dives into the Backdoor Roth IRA. Despite its intimidating name, it’s a straightforward strategy once you understand the nuances. Let’s walk through the essentials, potential pitfalls, and strategies to maximize this tool.
A Backdoor Roth IRA allows high-income earners, typically like you as a physician, to contribute to a Roth IRA indirectly. This lets your investments grow tax-free, giving you more financial freedom in retirement.
The term “backdoor” arises because it circumvents income limits that prevent high earners from contributing directly to a Roth IRA. Instead, you contribute to a Traditional IRA and then convert it to a Roth IRA. It's perfectly legal and just requires an extra step.
For physicians, earning beyond typical income thresholds, this strategy is key to tax-free growth. It’s a critical move for your financial health and future security.
For 2024 (these #s change most years!), if you’re single and make over $146,000 (Phase out to $161,000), or married filing jointly with a combined income over $230,000 (Phase out to $240,000), you’re ineligible to contribute directly to a Roth IRA directly.
Thankfully, Traditional IRA contributions have no income limits, but don't get too comfortable yet. Not everyone can deduct these contributions, making the backdoor strategy essential.
The first step is straightforward: open a Traditional IRA account. If you don't already have one, your financial institution can set this up quickly.
Contribute up to $6,000 (or $7,000 if you’re 50 or older) into this IRA. Remember, this is non-deductible for tax purposes. (2024 Limits)
Wait for the contribution to settle before proceeding to the next step. This usually takes a few days.
Convert the amount to a Roth IRA. This step is known as the conversion and is what makes this strategy a “backdoor” entry into the Roth IRA.
Form 8606 is needed when you file your taxes. It reports the contributions to your Traditional IRA and conversions to the Roth IRA. Many miss this form, which can lead to IRS troubles.
Before you execute a backdoor Roth, make sure you don’t have existing balances in any Traditional, SEP, or SIMPLE IRAs. Otherwise, you’ll encounter the Pro-Rata Rule.
Doing the conversion too quickly or too late can trigger the Step Doctrine, a potential tax issue. We recommend waiting at least a month to avoid complications.
Form 8606 keeps track of your non-deductible contributions to the Traditional IRA and any conversions to a Roth IRA. This ensures you’re not double-taxed.
Filing it correctly is crucial to avoid penalties and ensure there’s no mix-up about the non-taxability of your contributions.
Make sure you report the total amount contributed and converted during the year. If unsure, consult with a CPA to ensure accuracy.
The Pro-Rata Rule affects how much of your conversion is taxable. If you have other IRA balances, you must convert a proportionate amount of pre-tax and post-tax dollars, potentially increasing your tax bill.
If you have other types of IRAs like Traditional, SEP, or SIMPLE, the Pro-Rata Rule applies. These must be managed to avoid complications.
Imagine you have $10,000 in a Traditional IRA and you contribute an additional $5,000. When converting, the IRS sees it as you converting $3,333 of pre-tax money and $1,667 of post-tax contributions.
To avoid the Pro-Rata Rule, transfer balances from other IRAs into your current 401(k) or 403(b) plan, which are not included in the Pro-Rata calculations.
The main advantage of a Roth IRA is tax-free growth. Once the money is converted and invested, all future gains are tax-free.
When you convert, any earnings on your contribution will be taxed. Keeping the money in cash for a short period can minimize this risk.
If you have small balances due to interest, these can usually be managed without major tax implications. Regular checks and annual sweeps can help keep these balances in check.
The Step Doctrine examines whether the steps taken to achieve a backdoor Roth are viewed as a single transaction. This can potentially impact its legitimacy in the eyes of the IRS.
Some financial experts recommend waiting a day, others say a month. Waiting longer can help avoid scrutiny based on the Step Doctrine.
We recommend waiting at least a month before converting to avoid the appearance of circumventing tax rules intentionally.
A resident starts with minimal income but expects to increase in the coming years. They can begin with smaller contributions through the backdoor Roth method.
As a new attending physician, your income jumps significantly, making the backdoor Roth essential to continue tax-free growth contributions.
For physicians who have SEP IRA contributions, ensuring these are transferred to a 401(k) plan is crucial to avoid the Pro-Rata Rule complications.
One of the strongest benefits is the long-term tax-free growth, offering significant savings over time.
It provides flexibility in retirement planning, allowing you to withdraw contributions anytime without penalty, making it a versatile tool.
Roth IRAs can be beneficial for estate planning as they do not require minimum distributions during the account holder's lifetime, allowing wealth to grow undisturbed.
Once converted, it’s vital to invest the funds. Leaving them in cash negates the benefits of the Roth IRA.
Consider diversified investments like index funds. Consult with a financial advisor to align investments with your risk tolerance and retirement goals.
Avoid common mistakes like not diversifying. Stay informed and review your investment portfolio regularly.
Given the complexity, consulting with a professional can ensure you’re optimizing your strategy and avoiding pitfalls.
Always inform your accountant about your backdoor Roth activities. This helps them file the necessary forms and avoid mistakes.
While DIY is possible, outsourcing offers peace of mind and professional insights that can be invaluable.
If you have existing IRAs, you’ll need to manage them by moving funds into a 401(k) to avoid the Pro-Rata Rule complications.
If the rule applies, your conversion will be proportionate. Make sure to calculate the taxable amount accurately.
Small balances due to interest are manageable. Aim to sweep these balances regularly.
The IRS has acknowledged the backdoor Roth as legitimate. However, waiting a bit can avoid any scrutiny.
Understanding and executing the Backdoor Roth IRA can significantly boost your financial health. Consult professionals, keep an eye on crucial forms and rules, and make the most of this strategy. Regular reviews and staying informed will set you on a confident path to a secure financial future.
The best of the best list is a paid sponsorship, but these are professionals/companies that Tyler and Chad collaborate with within their own practices or have been vetted to earn a spot this list. By supporting our sponsors, it allows Chad & Tyler to dedicate more time to you and the Physician Cents community. If you ever have a question (or not a great experience, which we don’t expect!) about a sponsor, please let us know. We call it the “best of the best” for a reason, and we will maintain that standard for our listeners & viewers.
This information is for general purposes only. This information is not intended to be a substitute for specific professional financial, tax, or legal advice, as individual circumstances vary. Please see a financial professional, CPA, and/or an attorney in regards to your own individual situation.
Wealthkeel’s Advisory Services and Financial Planning offered through Vicus Capital, Inc., a Federally Registered Investment Advisor. WealthKeel LLC, 615 Channelside Drive, Suite 207, Tampa, FL 33602 -- 267.590.9533.
Olson Consulting LLC, Offering Advisory Services and Financial Planning, is a State-Registered Investment Advisor.
A podcast designed specifically for physicians, offering a breakdown of complex financial topics to help you develop your financial IQ, further your financial journey, and improve your well-being. Whether you're a medical student, resident, fellow, or attending physician, you're sure to learn something new that will benefit your journey.
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