Roth IRAs for physicians: 13 questions and answers

April 6, 2021

There are tools physicians can unlock to gain the financial benefits of a Roth IRA.

Higher earners like physicians may feel locked out of some tax-free withdrawal options as their high income disqualifies them from opening Roth IRA accounts. They may be unaware of some tools that could be at their disposal to get those same benefits, such as the backdoor Roth IRA and Roth IRA conversions.

Here are some common questions and answers about Roth IRAs.

A Roth IRA is an individual retirement account (IRA) where the investor pays taxes on the money funding the account upfront, unlike a Traditional IRA, where the money is taxed when it is withdrawn.
While funds are in the account, the assets grow tax free, and future withdrawals are tax-free as well.
They tend not to be vehicles for high earners; if an investor makes too much money, they cannot use a Roth IRA.

The limit for single individuals in 2021 is $140,000, and for married couples, the current limit is $208,000.

Contributions to a Roth IRA must be in cash, rather than in the form of assets.
The annual limit amount is sometimes adjusted by the Internal Revenue Service; for 2020, the limit is $6000 for the year.
There is an exception for those over the age of 50; those individuals can contribute up to $7000 annually.
There is no tax deduction available for Roth IRA contributions.

Money contributed to the account can be withdrawn at any time, whether for buying a house or living expenses.
Investment returns taken as distributions may be taxed as income or changed an early distribution tax, so it makes sense to leave that money in the account longer.
There is also no RMD requirement in Roth IRAs, as there is in a Traditional IRA, and no tax during any distributions after age 59 ½, again unlike Traditional IRA accounts, which makes them very attractive for tax-free growth and income.

There are several ways high earners like physicians can contribute to a ROTH IRA, including the 401(k) Roth IRA, a backdoor Roth IRA, and a Roth IRA conversion.

This plan allows both employers and employees to continue post-tax earnings to their accounts.
The Roth 401(k) lacks any income cap, so high earners can make use of it to gain those Roth IRA benefits that would otherwise be closed to them.
The contribution limits in this type of account are age-based, with a current limit of $19,500. Individuals over the age of 50 may contribute a catch up of an additional $6500.
Upon retirement or leaving employment, an investor may convert the Roth 401(k) to a Roth IRA and thereby avoid the RMD that would be required from a Rollover IRA.

It’s not actually a type of Roth IRA, but a strategy, and one that is one of the most underused by physicians.
It entails contributing money to a Traditional IRA then doing a Roth IRA conversion and paying those owed upfront taxes at that time.
There is no income limit on a conversion of this type, so the funds are now properly established to gain the benefits of a Roth IRA.
For a larger funding amount, a married investor can make contributions for 2020 and 2021 together and then do the Roth IRA conversion, meaning $14,000 for the investor and then $14,000 for their spouse.

By doing a Roth IRA conversion, there is no tax on the principal. The money in the account grows tax-free and future withdrawals are tax free, just as if the account had been a Roth IRA account all along.
As Traditional IRAs have no income or conversion limits, if an individual already has money sitting in an existing IRA, that can all be converted as well.

A married couple each contributed $7,000 to Roth IRAs to start in 2021, and then an additional combined $14,000 annually for the next 20 years.
Considering a 7% rate of return, at the end of the 20-year period, they will have over $668,000 from just those two Roth IRAs.
When the couple takes withdrawals, all of the income from those distributions will be tax-free.

One issue to keep in mind to use the backdoor Roth IRA, is the pro-rata rule if you have an existing IRA account open.
In the case of converting an already existing Traditional IRA account, the IRS considers the combined balance of all of the investor’s Traditional IRA accounts when determining how much tax is owed on the converting funds.
For example, the investor has 70% pre-tax money and 30% after-tax money, that is the ratio that will determine what percentage of converted money will be taxable.
No matter how much is converted or from which IRA account, 70% of the converted amount will be taxable

One option could be to move Traditional IRA funds to a 401(k) or other qualified employer plans, as 401(k) amounts do not count toward the balance used to determine the percentage of taxed money for the Roth IRA conversion.
After this, a new Traditional IRA can be opened, then that can be converted to a Roth IRA as planned.
These are complicated strategies, however, and it’s best to speak to a financial advisor who will look at your full tax situation before including solutions like these in a retirement plan.

There is no income restriction on Roth IRA conversion. If an individual already has money sitting in an existing IRA account, that can all be converted to a Roth IRA as well.
However, taxes are a consideration when deciding if a Roth IRA conversion is a good fit for an investor. As the taxes will have to be paid up front when the Traditional IRA is converted, it makes sense to analyze what the tax bill will look like at that time.
Particularly for older clients, it is important to see if the amount of taxes paid will outweigh the benefits of the potential Roth IRA. An ideal situation for a Roth IRA conversion is when the market is down with an expected recovery.

A Roth IRA is the ultimate solution for every retirement plan.
Because careful planning is required to get a backdoor Roth IRA set up or to get a Roth conversion moving and to make sure it’s the best fit for your situation, it’s a wise move to consult with an experienced financial advisor.

About the author

Syed Nishat, BFA, is a partner at Wall Street Alliance Group. He holds a bachelor’s degree in business administration from University of Nevada Reno. Syed holds the FINRA Series 7, FINRA Series 63 and FINRA Series 66 licenses, along with licenses for life, disability and long-term care insurance. He also has been awarded the Behavioral Financial Advisor (BFA) designation.

Securities offered through Securities America, Inc., member FINRA/SIPC. Advisory services offered through Securities America Advisors, Inc. Wall Street Alliance Group and Securities America are separate companies. Securities America and its representatives do not provide tax or legal advice; therefore, it is important to coordinate with your tax or legal advisor regarding your specific situation.