By Charles Cooke, CFP®
High-wage earners, such as dentists, often face a conundrum: they need to save more to enjoy a quality of life in retirement that is comparable to the one they enjoy now; however, some retirement accounts, such as Roth IRAs, have earnings limits that exclude these professionals from participating.
If that is you, take heart: you may be able to take advantage of a Roth’s retirement and tax benefits by using the “backdoor” solution.
Why a Roth IRA?
With Roth options, you contribute post-tax dollars to your account. Although you don’t receive a current tax deduction, your contributions will grow tax-free. Your withdrawals after age 59 1/2 will also be tax-free, making the Roth a valuable tool in retirement planning.
Furthermore, Roth accounts do not have the required minimum distributions (RMDs) that 401(k)s and traditional IRAs do. You will not be required to take money out of your Roth accounts, no matter how old you are.
Unfortunately, Roth IRAs do face income limits, and if your income exceeds those limits, you cannot contribute directly to a Roth IRA.
For 2019, those limits are:
- Single: You cannot contribute if your modified adjusted gross income (MAGI) is $137,000 or above.
- Married filing jointly or qualifying widow(er): You cannot contribute once your MAGI is $203,000.
- Married filing separately: Your MAGI cannot be more than $10,000 to contribute.
The Roth IRA Work-Around
Although you may not be able to contribute directly to a Roth IRA, you can contribute indirectly by converting a traditional IRA to a Roth IRA. This conversion is also called a “backdoor” Roth and is a perfectly legal method to access the power of Roth plans.
Roth conversions offer an additional benefit. Normally, the amount you can contribute to a Roth IRA is limited. For example, in 2019, you may contribute only $6,000 to a Roth IRA (or $7,000 if you are 50-plus years old).
Roth conversions lack those limits, and your backdoor Roth can be for a much higher amount.
The Backdoor Roth Process
The process for converting a traditional IRA to a Roth IRA is straightforward:
- Make a nondeductible contribution to a traditional IRA.
- Convert the desired funds from the traditional IRA to a Roth IRA.
- Pay income tax on the funds converted in that year. (You will use IRS Form 8606 to report nondeductible contributions and Roth conversions.)
Note: The deadline to complete a conversion for any given tax year is December 31.
Before You Decide: Some Considerations
Roth conversions can be an important tool in your retirement planning; however, you should be aware of the following considerations before you decide whether they’re the right tool for you:
- You must have earned income to make a nondeductible IRA contribution.
- You will probably retire in a lower tax bracket, so the tax advantages of a Roth IRA may not be as crucial to you.
- Backdoor Roth IRAs depend on current tax policy and may not always be permissible.
If you have a 401(k) plan, you should see if it allows for Roth contributions, as 401(k)s do not have the high-income limits of Roth IRAs. Be aware, however, that the contribution limit for a 401(k) in 2019 is $19,000 ($25,000 if you are over 50). A conversion would allow for a much higher Roth amount.
Finally, before you decide, consider talking with your financial advisor. They can review your current situation and your retirement goals and give you advice on whether a backdoor Roth makes sense for you.
Charles Cooke, CFP®, is the founder of Cooke Capital, a wealth planning and investment management firm specializing in dental practices.Financial advisory services offered through Acorn Financial Services, Inc. (AFAS), a Registered Investment Adviser. Securities offered through The Strategic Financial Alliance, Inc. (SFA), a registered Broker/Dealer. Charles Cooke is a Registered Representative of SFA and an Investment Advisor Representative with AFAS. Cooke Capital is otherwise unaffiliated with AFAS and SFA. Supervising office (703) 293-3100.