Introduction
Roth IRAs are powerful investment vehicles, as they allow you to contribute post-tax earnings that then grow completely tax free for life. If contributed to when in a lower tax bracket (such as in training or from a childhood or college job) than you anticipate being in during retirement, getting continued tax free returns for decades is pretty hard to beat. Additionally, unlike traditional IRAs, Roth IRAs do not have required minimum distributions (RMDs) as the government has already taken its cut for taxes.
Once you pass a certain income level, you are no longer eligible to contribute to a Roth IRA in the traditional way. This means many attending physicians working full time do not qualify.
Thankfully, there are completely legitimate tax loopholes which allow high-income earners such as physicians to get money into Roth accounts for that tax free growth.
The most ubiquitous of these is the ‘backdoor Roth,’ which is a completely legal strategy where contributions can be made to a Roth IRA via contribution to a traditional IRA and then converted to a Roth IRA.
There is also a second strategy called the “mega backdoor Roth” where some 401k plans allow you to make after tax contributions that are then automatically converted to Roth. Not every 401k plan has this, but if yours does, it’s worth looking into and seeing if it’s right for you.
Although these strategies are well known and accepted by the IRS, there are rules and processes that must be followed carefully. This article covers some of the major things to be aware of and walks you through the process.
As always, note that we are not accountants and you should consult appropriate expertise before taking action based on these ideas, which are not individualized to your personal situation. You should make sure this is accurate and up to date. This page contains affiliate links from our advertisers, which support the group at no cost to you. To learn more, visit our disclaimers and disclosures.
Quick Links
Is a Backdoor Roth IRA Right for Me?
Resources
Visit our financial advisor database if you need help assessing your specific tax strategy and potential tax implications of a Backdoor Roth IRA
Visit the IRS.gov website for FAQs on Roth conversions
Visit the IRS.gov website for instructions on completing the Form 8606
For investing strategies within your Backdoor Roth IRA, see our three-fund portfolio page
Visit our personal finance page for more guidance on Roth vs traditional IRAs
Basics of Roth IRAs
Roth IRA Income Limits
For Roth IRA contributions, the government has a phase out limit on income where the amount you can invest in the year decreases. Once you hit the top end of the phase out range, you are no longer eligible for a regular Roth IRA. These limits are not based on your actual income, but rather your modified AGI income amount.
In 2023, to make a full contribution, this means your modified adjusted gross income should be below $138,000 if filing single and $218,000 if filing jointly.
For additional guidance and more specifics, visit the IRS website.
Please note there are additional restrictions if you file your taxes as “married filing separately” but you lived with your spouse at any time during the year.
If you know your income will exceed the maximum income limit, you can proceed to considering a Backdoor Roth IRA.
FAQ: What Happens in a Year Where I Make Variable Amounts of Income?
This question comes up from time to time on our communities, particularly when somebody is graduating from training and starting their first job as an attending physician, or if somebody takes a few months off as a break between jobs or for a parental or sick leave.
One key warning: you can not put contributions directly into a Roth IRA and then try to pass them as a Backdoor Roth if it turns out you made more than the limit for Roth contributions. If you do, you’ll have to reverse it. Overfunding a Roth IRA can be a headache to unwind, especially if the amount invested has already grown since your contribution.
Rather, if you know your modified AGI will be close to the phase out range, it is a good idea to hold off on investing in a regular Roth IRA until the end of the year or the beginning of the next year when you have your final income amount.
How Much Can I Contribute (for both Roth IRA and Backdoor Roth)?
As of 2023, the total contributions guidelines for each year were:
$6,500 standard contribution limit
$7,500 allowed for individuals 50 and up under a catch-up rule
Total is added across all IRAs an individual owns (both traditional and Roth)
You have until tax day (or until you file your tax return, whichever is sooner) to make IRA contributions for the previous year
Extensions are excluded
Account must be opened before the end of the year to fund for that calendar year
Is a Backdoor Roth Right for me?
Whether you should do a Backdoor Roth IRA can depend on your situation and retirement goals. Generally, we love the concept for our physician community members, but here are some considerations to factor in. If after reading this you aren’t sure whether you want to do a Backdoor Roth IRA or if you need additional assistance beyond our step-by-step guide below, reach out to one of the financial advisors on our database.
When You Should NOT Do a Backdoor Roth
If you make below the income limitations to contribute to a regular Roth IRA contribution, keep it simple and do that.
If you have any non-Roth IRA (Sep IRA, SIMPLE IRA, Traditional IRA), pause and read below.
You’re not willing to do the paperwork for a backdoor Roth - there are tax forms you need to file for doing this. It’s not complicated, but does need to be done correctly and you may need to get your accountant involved if you are not comfortable. More about this here.
You are close to retirement and you are planning on withdrawing money within 5 years. Withdrawals from a Roth IRA are only tax free if you are>59.5 years old and have met a requirement for a 5 year holding period. Otherwise they may be subject to ordinary income tax or a 10% federal penalty tax, or both. The 5 years period applies for each conversion separately, and begins on the first day of the year in which the conversion contribution is made.
Estate Planning Considerations
If you plan on withdrawing from your IRA during retirement and think you will be in a lower tax bracket during retirement, it may be more beneficial to do a traditional IRA, defer taxes now, and pay taxes at a lower marginal tax rate in retirement.
However, the longer they are in a Roth, the more advantageous it can be to pay taxes as a high marginal tax bracket for tax-free growth, so factor in how long you plan on leaving your contributions invested.
If you likely won’t need to touch your IRA during retirement, a Roth IRA can be a great tax-advantaged strategy for estate planning and inheritances.
Do You Have Any Pre-Tax IRA Funds?
The IRS has a pro-rata rule for assessing additional tax considerations on a Backdoor Roth IRA. This applies to any pre-tax (tax deferred) funds in an IRA, such as:
SEP IRA
SIMPLE IRA
Traditional IRA
If you have money in these accounts, the pro rata rule will apply to you. Depending on how much you have in non-Roth IRAs, it could negate any tax benefit or actually penalize you for using this.
This rule basically necessitates that all of your IRAs be treated as a single account from a tax perspective. The intent here is to prevent you from getting out of taxes that would normally be involved in a conversion of the funds that you’ve contributed in pre-tax fashion.
Because of that, your Roth conversion will be taxed proportionate to your pre- and post-tax percentages of your total IRA holdings (see an example of this in the pro-rata section below).
Note the pro-rata rule only applies to IRAs, not to 401(k)s or other similar employer-sponsored retirement plans.
Pro-Rata Rule Example
The IRS takes the percentage of post-tax dollars against the total balance of all your IRAs and charges your marginal tax rate on the percentage of taxes on your Backdoor Roth IRA contributions using the following calculation:
(non-deductible amount)/(total of all non-Roth IRA balances) = non-taxable percentage
(amount of Backdoor Roth IRA conversion) x (non-taxable percentage) = taxable amount
For example, if you put $6,000 into a new traditional IRA but have $54,000 in a SEP IRA, the pro-rata rules dictates:
$54,000/($6,000+$54,000) = 0.90, or 90%
So the IRA will assess taxes at your marginal tax rate on the prorated amount of:
$6,000 x 0.90 = $5,400
Tracking the pre-tax versus post-tax amounts can be very complicated for future Backdoor Roth IRAs and when it comes time to assessing taxes for distributions, so we don’t recommend the Backdoor Roth IRA if you have this situation.
Options to Avoid the Pro-rata Rule
If you already have tax-deferred funds in IRA accounts, you may still have an option for a Backdoor Roth IRA that allows you to get around the pro-rata rule, depending on your current work situation.
Not all, but some 401(k)s/457(b)/403(b) plans offer the ability to roll funds into the plan. If you have one of these plans, check with your plan administrator to see your options. Rolling your IRA into an employer plan will remove the balance from counting against you in the pro-rata calculation, as discussed above. Just make sure you assess the different fees and fund options and balance it against the advantages of the Backdoor Roth IRA before rolling your IRA in.
Tax Reporting
In each tax year you do a Backdoor Roth IRA, you are required to file IRS Form 8606 as part of your income tax return to ensure it is accounted for properly. If you already hire an accountant to do your taxes, make sure you mention your contributions and Backdoor Roth IRA, then double check before signing and submitting your taxes that the Form 8606 is included. If you prepare your own taxes, find guidance on the IRS website here.
Summary of Pros and Cons
Doing the Backdoor Roth IRA
If a Backdoor Roth IRA fits well with your situation, we suggest getting one setup and funded sooner rather than later. For one, the government has in recent years proposed to discontinue this tax loophole, but given how widespread its use is, it has been hard to pass. The other reason of course is that the longer it’s invested, the more growth you get tax free.
The first time you do a Backdoor Roth IRA, you might find the process overly complicated, so we’ll walk you through the process below.
Open Your IRAs
If you don’t already have both a Roth IRA and traditional IRA set up, start by creating these accounts with the same institution. Vanguard and Fidelity are two popular choices.
Make a Contribution to Your Traditional IRA
Once the accounts are open, make a contribution to your traditional IRA. Remember, the IRS restricts how much you can contribute for each calendar year across all IRAs, so remember to take those guidelines into consideration when making the contribution.
Typically, when you make your contribution, your institution will ask how you want to invest your contributions. If you set up a new account, it should default to cash, typically a settlement fund. New account or old, leave it in the cash/settlement fund.
IRAs can let you contribute to the previous calendar year or the present. Make sure you pay attention to which year you are funding so you don’t over fund the previous year on accident.
Convert Your Contribution
Once your contribution has transferred successfully into your traditional IRA (this can take a few business days), you are ready to begin your Backdoor Roth IRA conversion.
This process can differ depending on your institution. Vanguard, for example, has a “Convert to Roth IRA” button. With Fidelity, it’s treated as an account transfer, so you’ll use the Transfer function.
While moving your contribution from the traditional IRA to the Roth IRA, you will likely get an alert that this is a taxable event. Under normal circumstances, where you typically have tax-deferred contributions in a traditional IRA, the contribution you made was with after-tax dollars. So long as you’ve accounted for the pro-rate rule above and properly file your Form 8606 with your individual tax return, you won’t be assessed additional taxes on your contribution from the conversion.
Invest the Funds
While you wanted to leave the contribution in the cash account for its short stay in the traditional IRA, don’t repeat this on the Roth side. Make sure once you complete your Backdoor Roth IRA, you invest the funds. If you aren’t sure what to invest them in, we generally recommend a three-fund portfolio strategy. You can also explore our investing page if you are a more hands-on DIY investor.
If you’re a completely hands-off investor, you can usually open IRAs with the financial advisor who manages your portfolio. They will be able to help you complete the process, though they may not assist on the tax side, so make sure your accountant is aware. You can visit our database of financial advisors.
Don’t Forget Your Form 8606
While your conversion is done once you’ve invested your contribution in your Roth IRA, you haven’t completed your Backdoor Roth IRA until tax time comes around. Make sure you or your accountant completes the required Form 8606 and files it with your individual tax return, or the IRS will send you a nastygram.
Mega Backdoor Roth
A Mega Backdoor Roth is different from a Backdoor Roth IRA. This is a strategy that allows for a much larger conversion than the annual contribution limits for Roth IRAs as the transaction occurs with an employer-sponsored plan - such as a 401(k) - instead of a traditional IRA.
Not all 401(k) plans offer the ability to do a Mega Backdoor Roth, so you would need to check with your plan administrator to see if this feature is available.
Mega Backdoor Roths are taxable events, unlike the Backdoor Roth IRA, regardless of the pro-rata rule, so it requires additional cash on hand at the time of the conversion.
Disclaimer: Please remember that while we attempt to keep this information current, all of this is subject to change and you should do your own research and consult with any relevant licensed expertise before making decisions on the basis of this tutorial. We are not licensed financial advisors and this is not individualized advice. This is purely for informational purposes only and should be verified with licensed expertise as you feel appropriate. We specifically disclaim any errors or omissions.