Earning too much to contribute directly to a Roth IRA doesn’t necessarily mean a Roth IRA is off the table.
In this brief video, Ben Martinek of Bona Fide Finance explains how a backdoor Roth IRA works and why attending physicians and other high-income earners may want to consider it. Watch now to learn more about Roth IRA income limits, nondeductible IRA contributions, Roth conversions, and important tax considerations when using this strategy.
Transcript:
What Is a Backdoor Roth IRA?
Chances are you’ve heard about a Roth IRA, and maybe you even heard that you make too much money now as an attending physician to contribute to a Roth IRA.
Hi, I’m Ben Martinek with Bona Fide Finance, and I want to tell you about my friend, a backdoor Roth IRA. It’s basically able to contribute to an IRA, a Roth IRA, via the backdoor.
Roth IRA Income Limits for High-Income Earners
Now why would we even need such a thing?
The truth is, there are income limitations for being able to contribute to a Roth IRA. I’m not sure why these income limitations are there. Doesn’t make a lot of sense, but it’s part of our Internal Revenue Code.
And so as your household income gets so high, and this depends on your filing status, whether you’re single or joint or head of household or filing separately, that’s an important one. You may not be able to make those contributions to the Roth IRA directly because it’s disallowed. You’re deemed ineligible for it.
How Backdoor Roth IRA Contributions Work
But there’s this notion that’s available within our tax code in which you can make what are called backdoor Roth contributions.
Now, that’s not a technical term, and you won’t see any IRS publication speaking about a backdoor. But there is basically the ability to make contributions to an IRA, known as non-deductible contributions, and then take that contribution and convert it to a Roth IRA.
Now, these are two separate transactions, but because you have what’s known as basis and that non-deductible IRA contribution, when you go to make this conversion, which is normally a taxable event, due to the basis that you have, that’s just basically a fancy word that says money that you’ve made to the account.
Because you have basis, when you do the conversion, the conversion is deemed non-taxable. And so the money basically makes its way into the Roth IRA through a non-deductible IRA contribution.
IRA Contribution and Income Requirements
Happily, there are no income limitations for you being able to make contributions to an IRA.
Now, in case you’re not aware, an IRA stands for “individual retirement account.” It’s comparable to like an employer retirement account that you would have with your employer, like a 401(k), 403(b), 457(b), but this instead is something that you individually manage and own on your own.
It’s not directly attached to your employer.
Now, in order for you to be able to make non-deductible IRA contributions, you still have to have earnings, which means you have to basically have income subject to FICA, Social Security, or Medicare taxes. And you have to at least be able to have $6,000 to $7,000 of those because those are the income or the contribution limits for those accounts.
Spousal IRA Contributions and Married Filing Separately
And now, if you have a non-working spouse, maybe it’s a single-income household, you’re married, one of you works, the other one doesn’t, then you can make what are known as spousal IRA contributions.
You can only make those spousal IRA contributions if you are married finally jointly.
For a lot of our clients who have student loan debt and they file separately intentionally for the purposes of those student loan debt, that whole filing separate does cause issues, especially if you have a single-income household.
Now, that spousal IRA is disallowed, but more so even if you have income below the Roth IRA contribution limit for joint tax return, it may not be allowed for you to make direct contributions to that Roth because you’re filing separately.
It’s actually the income limit is considerably lower if you file separately for Roth contributions.
Benefits of a Roth IRA Before and During Retirement
There’s so much to like about them.
You can use the money potentially for distributions for education purposes, first-time homebuyer purchases, you have a retrieval of basis, like there’s all these ways in which you can access this money before retirement.
So even though it’s known as an IRA (an individual retirement account), you don’t have to wait until retirement to use the money.
And so if you’re setting money aside in a taxable brokerage account and you’re paying taxes on that money through dividends and interest and capital appreciation or capital gain distributions, the better solution for that is to put the money into the Roth IRA because it’s going to grow tax-free for the rest of your life.
And under current law, it’s going to grow tax-free for the next 10 years of anyone that you pass it on to, by and large, who’s within your family through an inherited IRA.
So you get a long lifetime of tax-free growth on that money. That money could double many times over with compounding.
So it makes sense to have Roth accounts. They’re great resources for tapping if needed before retirement. So I always think of them, too, as like a bit of an emergency fund.
Backdoor Roth IRAs for Attending Physicians and High Earners
And so as much as you make a bunch of income now, fear not, fret not, you are not eliminated from being able to make contributions to Roth IRAs. You just have to do it through the backdoor.
Now, this manner is complicated.
Reporting a Backdoor Roth IRA on Your Tax Return
It has to get reported correctly on the tax return. We see this get messed up all the time. We do a lot of taxes.
So if you’re not working with somebody to make sure that it just gets reported correctly and you don’t unnecessarily pay taxes on the money that is supposed to be tax-free, but it’s got to get reported that way to make sure it stays tax-free, then you ought to consider working with us to be able to walk you through the strategy.
We would love to take a call to chat with you. We’re Bona Fide Finance.
You can reach out to us at hello at bonafidefinance.com. Please schedule a call so we can chat about how this can make sense as part of your overall financial plan.
Frequently Asked Questions
What is a backdoor Roth IRA, and why do physicians use one?
A backdoor Roth IRA is a legal strategy that allows high-income earners who exceed the Roth IRA income limits to fund a Roth account indirectly. It typically involves making a nondeductible contribution to a traditional IRA and then converting those funds to a Roth IRA. Many physicians use this approach because their income often prevents them from making direct Roth IRA contributions, while still allowing them to benefit from tax-free growth and qualified tax-free withdrawals in retirement.
Can I make a backdoor Roth IRA contribution if I already have a traditional IRA?
Yes, but you need to be aware of the IRS pro-rata rule. If you have pre-tax money in a traditional IRA, part of your Roth conversion may be taxable. In some cases, rolling those pre-tax IRA assets into an employer-sponsored 401(k) or 403(b) before completing a backdoor Roth IRA may help avoid unnecessary taxes. Bona Fide Finance helps physicians evaluate whether a backdoor Roth IRA fits into their overall tax strategy and navigate the process correctly.
Should I work with a financial advisor before doing a backdoor Roth IRA conversion?
While the steps involved in a backdoor Roth IRA may seem straightforward, mistakes involving timing, existing IRA balances, or tax reporting can create unexpected tax consequences. Working with an advisor can help coordinate the strategy with your broader retirement and tax plan. The Bona Fide Finance team helps physicians determine whether a backdoor Roth IRA is appropriate for their situation and execute the strategy with confidence.