A direct relationship frequently exists between income and investment opportunity. However, according to financial services company Charles Schwab, one exception to this rule is the Roth Individual Retirement Account (IRA), whose inflexible income caps render it a non-option for higher-income earners like physicians.
To circumvent these caps, financial advisors and investors have identified the backdoor IRA as a solution. To open a backdoor IRA account, the investor often initially opens a traditional IRA account, contributes to it, and then subsequently converts it to a Roth IRA.
While both traditional and Roth IRA accounts provide retirement savings options for investors, the IRS suggests certain key differences. Although any individual with taxable income can contribute to an IRA account, married couples filing jointly and widowers seeking to contribute to a Roth IRA account must earn less than $204,000 a year. Single, non-widowed investors must earn an annual salary of less than $129,000.
Minimum Distributions Are Required in Traditional IRA Accounts at Age 72
Another difference between the two IRA options is minimum distributions, which are a requirement in traditional IRA accounts after the investor turns 72. There are no minimum distribution requirements for Roth IRA account holders. Furthermore, Roth IRA distributions are not taxable, but traditional IRA distributions are subject to taxation.
According to Charles Schwab, the maximum allowed contribution for both a traditional IRA and a Roth IRA is $6,000 for those aged 49 and younger and $7,000 for those older than 49. To make the traditional-to-Roth IRA conversion, the main strategy would be for physicians to first open a non-deductible traditional IRA and provide post-tax contributions, making sure to annually file IRS Form 8606. The next step would be transferring assets from the traditional IRA to the Roth IRA.
Backdoor IRAs Have Grown in Popularity Among Physicians
Medical writer Naveed Saleh, MD, MS urges physicians to bear in mind that they must pay taxes on the converted funds and any associated earnings or appreciation. While physicians can make the traditional-to-Roth conversion at any point thereafter, some financial advisors suggest delaying it a few months. Other options for creating a backdoor IRA include converting an entire IRA to a Roth IRA or rolling over one’s 401 (k) account into a Roth IRA, although the latter is only an option for physicians whose 401 (k)’s allow conversions.
Due to its lack of required minimum distributions, along with its tax-free distribution policy, the backdoor Roth IRA has grown in popularity among physicians, who tend to be high-income earners. As long as physicians consult with investment professionals and remain diligent regarding any potential tax implications that may arise upon creating a backdoor IRA account, a backdoor IRA may serve as an excellent financial booster.
