Written by Katherine Vessenes, JD, CFP®, Founder, MD Financial
Getting money into a doctor’s tax-free bucket is not an easy task. The IRS rules are complex and ever-changing. Currently on Congress’ radar: making changes to the backdoor Roth conversion strategy we use with hundreds of our doctors across the country.
We continue to stress to our doctors the importance of funding as much as possible into their tax-free accounts. Not only is this “tax insurance”, meaning you will not have to pay taxes on these accounts in the future, but it can also have a huge impact on how much money you will have in retirement. The amount of funds you have in tax-free investments can even make a difference on how soon you reach financial independence. The more funds doctors have in a tax-free account could mean retiring sooner, or, unfortunately, it could push out retirement for those doctors who have not planned ahead.
We could be looking at some changes to this strategy in 2022 due to some proposals on Congress’ docket. Here’s an overview of both current and possible changes to the backdoor Roth conversion strategy.
Backdoor Roth Conversion Strategy Overview
A backdoor Roth conversion is a strategy we use for successful doctors to get money into a Roth IRA, even if they earn more than IRS income limits. For example, for tax year 2022, if you are a single filer and your modified adjusted gross income (MAGI) is over $144,000, the IRS does not allow you to make a direct Roth IRA contribution. Joint filers can’t contribute to a Roth IRA if they have a MAGI of above $214,000. The solution, for certain doctors, can be the backdoor Roth conversion strategy. (Please note: we do not recommend this solution if you currently have a large IRA that has not been taxed, because it can result in a double taxation- the exact opposite of what we are trying to accomplish!)
The IRS currently imposes income limits on tax-deductible contributions to a traditional IRA. However, there are no income limits on after-tax contributions, or non-deductible contributions. Thus, high-earning doctors can legally make after-tax contributions to a traditional IRA and then convert that money into a Roth IRA.
We have doctors implement this strategy in different ways. In years where we are not worried about Congress making changes, we might suggest to a doctor who is under 50, to contribute $500 a month to a non-deductible IRA, and then we convert the balance before the end of the year. If the account has grown to more than $6,000 (their contribution) there will be a small tax on the gain, but more funds will be going into the tax-free account.
For other doctors, we make a lump sum contribution ($6,000 for those under 50) and then convert it before the end of year.
However, since Congress came close to passing these changes last year, we are suggesting all our eligible doctors forgo the monthly investing and invest a lump sum instead. The idea is to convert the funds before Congress eliminates this technique in the hope they won’t decide to make any changes retroactive.
The Roth IRA limits ($6,000 per taxpayer or spouse of a working taxpayer if they are under age 50, and $7,000 if they are over 50) have no impact at all on your Roth 401-k or Roth 403-b at work. You can maximize those work plans and add a Roth IRA on top of them. In 2022, that means, if your employer offers it, you could potentially invest $20,500 into your Roth plan at work, in addition to $6,000 your Roth IRA. (If you are over 50, then the numbers would be $27,000 at work plus $7,000 in a Roth IRA.)
Funding your Roth 401-k (or 403-b) in addition to your Roth IRA allows your earnings on those investments to be withdrawn tax-free in retirement. If left in the traditional IRA or 401(k) plan, those earnings would ultimately be taxable at ordinary income rates. For our doctors, these rates are likely to be high in retirement. This is why the backdoor Roth conversion strategy is such a benefit to high-income doctors.
Proposed Changes to a Backdoor Roth Conversion Strategy
As of this article's publishing date, the backdoor Roth conversion strategy is currently viable, but that could change at any time in 2022. Under the provisions of the Build Back Better bill, which almost passed Congress in 2021, high-earning doctors would be prevented from making backdoor Roth conversions. The proposed income limits are $400,000 for single filers and $450,000 for joint filers, which would prevent most of our attending doctors from using this technique.
I know a lot of our primary care doctors are under these limits, but given Congress’ propensity for increasing taxes, I don’t believe even our lower-earning doctors will be exempt until we actually see the final legislation implemented.
So far, this bill has yet to pass Congress, and until it garners full Congressional approval, backdoor Roth conversions are still allowed- good news for now!
Any type of legislation that is under debate is likely to change numerous times before it passes both houses of Congress, if it ever does. Expect more action on this legislation in the future. The provisions of the bill could be amended, watered down, or the idea to eliminate the backdoor Roth conversion strategy might be dropped entirely.
Takeaways: If you are a high-earning doctor, now is the time to take advantage of this strategy. Let’s take a look at your situation to see if it makes sense for you and we will let you know if Congress makes any changes. In the meantime, feel free to reach out to us at: info@MDfinancialadvisors.com.
Katherine Vessenes, JD, CFP®, is the founder and CEO of MD Financial Advisors who serve 500 doctors from Hawaii to Cape Cod. An award-winning Financial Advisor, Attorney, Certified Financial Planner®, author and speaker, she is devoted to bringing ethical advice to physicians and dentists. She can be reached at Katherine@mdfinancialadvisors.com.