Income Too High for Roth IRA? Don't Forget the Backdoor!

In my previous post ROTH IRA - the Cadillac of Retirement Vehicles I talked about why the Roth IRA is the best overall tax-advantaged retirement vehicle.  I briefly discussed the income limit required to qualify for Roth IRA contributions.  While most medical trainees are unlikely to make a high enough income to be disqualified from direct Roth IRA contributions, those residents/fellows with a lot of moonlighting income or transitioning to their first attending jobs are a different story.  Here is how you can continue contributing to a Roth IRA even after you exceed the income limit.  Hint: It's called a Backdoor Roth IRA.

Why do You Need It?

As a quick review, here is the income limit on Roth IRA contributions:

If you make more than the limit, then:

  1. Congratulations!  Making too much money is a great problem to have.
  2. You can no longer contribute to a Roth IRA directly and may be missing out on its unique benefits.

Backdoor Roth IRA to the Rescue!

Long story short, congress made some changes to our federal tax laws in 2010, resulting in the creation of the Backdoor Roth IRA, which allows unlimited rollovers from a Traditional IRA into a Roth, even if you exceed the income limits.  Let me illustrate:

How does it work?

  1.  Start a Traditional IRA if you don't have one, make your contributions.
  2.  Start a Roth IRA and transfer your contributions from your existing Traditional IRA to the newly created Roth IRA.  You will be required to pay taxes on the amount transferred since the original contributions to a Traditional IRA were tax-deductible.  You will also be required to pay any capital gains taxes if you made a gain from the time you started the Traditional IRA to the time you transfer to the Roth IRA.
  3. Voila!  You now have a Roth IRA, with all its unique benefits.  Repeat the same process every year your income is too high to contribute directly to a Roth IRA.

Caveats

Some savers may not benefit from a Roth IRA.  For example, if your tax bracket in retirement will be significantly lower than the tax bracket you are in currently (most people), then converting to a Roth IRA may end up costing you more money because of taxes on the converted contributions.  Another example is if you are retiring in the near future, then it may be difficult for you to gain back in investments what you lost in taxes.

Bottom Line

As usual, whether a Backdoor Roth IRA will benefit you depends on your specific situation.  It warrants careful consideration before you decide one way or the other.  Be sure to talk to a certified financial planner/advisor if you have further questions.


Sponsor HIghlights

Chad Chubb, CFP founded WealthKeel LLC to help physicians navigate the complexities of financial planning. Today, WealthKeel utilizes true financial planning and custom-craft plans for residents and young doctors in the Philadelphia area and across the United States. From investments to insurance and student loans to goal planning, they tailor a plan to address your specific needs and circumstances.  Schedule your free introduction calland see if they are a good fit for you.


Future Proof, MD

Dr. Bo Liu is an aspiring radiologist-in-training and the founder and editor of the White Coat Money Blog.  He has an interest in interventional radiology and helping his medical colleagues get ahead in this mad world of medicine and money.  When he's not crushing the list at the PACS station or typing up your next favorite blog post, you can usually find him at the local badminton club, movie theater or the most recently opened restaurant.