At some point you may have thought "Should I use a Roth account for my investments? If so, how do I do that?" In this first of 2 stories on the topic, Setu Mazumdar, MD, CFP, discusses possible Roth investing strategies.
At some point you may have thought “Should I use a Roth account for my investments? If so, how do I do that?” Generally it’s to your advantage to choose a Roth account over a traditional account if you think that you’ll pay higher taxes when you withdraw the money than you do now. When you contribute to a Roth account, you do not get an up-front tax deduction now in exchange for not paying taxes on the contribution or any gains when you withdraw the money in the future. If you’ve made the decision to Roth your investments, here are 7 ways you can get there:
Path #1: Contribute to a Roth IRA directly
You might think that physicians cannot contribute directly to a Roth IRA account, but that’s not necessarily true. It depends on your income—specifically what the IRS calls your modiï¬ed adjusted gross income (MAGI). For 2015, if you are married and your MAGI is less than $183,000 then you can contribute the maximum $5,500 to a Roth IRA. To ï¬nd an estimate of your MAGI, go to line 37 on the ï¬rst page of Form 1040 of your 2014 federal income tax return. That shows your adjusted gross income (AGI). There are a few adjustments to the AGI to derive your MAGI, but the AGI is a pretty good estimate for most people. What types of physicians does this apply to? First are current residents who are not graduating this year. If you’re in this category you’ve got an opportunity to directly contribute to a Roth IRA and that opportunity will likely go away when you make more income. The second are current residents who are graduating this year. If you are in this group you’ve got to be careful because your income bump later in the year might disqualify you from contributing to a Roth IRA. The third are physicians who work part time and who will make less income than the average EP. This group includes older physicians who are winding down their careers. In that case you can contribute $6,500 to a Roth IRA.
Path #2: Contribute to a Roth 401k or Roth 403b in an employer sponsored retirement plan
If you are an employee and your hospital or group has a 401k or 403b plan, check to see if your plan allows you to designate your contributions to the plan (known as employee elective deferrals) as Roth 401k. Under age 50 you can contribute a max of $18,000 out of your paycheck to the Roth 401k or Roth 403b. Above age 50, you can contribute $24,000 this year. What’s nice about the Roth 401k/403b -- unlike the Roth IRA—is that there are no income restrictions on who can contribute. You could make $1 million of income (I know that’s wishful thinking for a physician) and still contribute to the Roth 401k. Of course you’ll pay thousands of dollars more in taxes this year—over $7,000 if you’re in a combined federal and state income tax bracket of 39%. You do run into a complication later on—which is that just like a traditional 401k, you’ll be required to take distributions form the Roth 401k account at age 70.5 even though you don’t pay taxes on the Roth 401k/403b withdrawals. You can avoid this by rolling over your Roth 401k to a Roth IRA when you retire.
Path #3: Contribute to a Roth 401k in an individual 401k plan
This is similar to Path #2 except that it applies to independent contractors who’ve set up an individual 401k plan. Most custodians now have the Roth 401k option for individual 401k plans. Under age 50, the maximum contribution to an individual 401k plan is $53,000 in 2015. Over age 50, it’s $59,000. That’s assuming you make sufï¬cient income to support that contribution. Realize that in this setup, you can designate a portion of that total as an employee contribution and the rest as an employer proï¬t sharing contribution. It’s only the employee contribution of $18,000 (or $24,000 if above age 50) as Roth 401k. You cannot designate the employer contribution to the Roth 401k. Instead the employer portion must go to the pretax traditional proï¬t sharing account. Next time I’ll discuss 4 more ways to Roth your investments.
Setu Mazumdar, MD, CFP® is board certiï¬ed in EM and he is the president of Physician Wealth Solutions. http://www.physicianwealthsolutions.com