QUESTION. My partner recently told me that I should be doing a “backdoor Roth IRA.” I nodded my head, but truthfully, I had no idea what he was talking about. What is a backdoor Roth IRA, and should I really be using one?
ANSWER. There are two main types of retirement accounts. The first is a pre-tax, or tax-deferred, retirement account such as a 401(k) or a traditional individual retirement arrangement (IRA). Money contributed to these accounts is deducted from your income for that year, reducing your tax burden for the current year. If your marginal tax rate (tax bracket) is 33 percent, then every dollar contributed to a tax-deferred retirement account saves you 33 cents on your tax bill. The money in that account then continues to grow without taxation until you pull out the money. If you are like most physicians, some or all of that money will be pulled out of the account during your retirement at lower effective tax rates. Tax-deferred retirement accounts are a great way to fund retirement income needs.
The second type of retirement account is a tax-free, or Roth, account. These accounts, named after Sen. William V. Roth Jr. of Delaware, also allow tax savings but in a different manner than a tax-deferred account. You contribute after-tax dollars to a tax-free account such as a Roth IRA or a Roth 401(k). The money then grows without taxation and, in retirement, is withdrawn from the account and spent tax-free. While the bulk of an attending physician’s retirement savings during peak earning years should probably be in tax-deferred accounts, it will be extremely handy to arrive at retirement with significant amounts of both tax-deferred and tax-free assets. Aside from contributing to tax-free accounts, it is also possible to convert tax-deferred accounts to tax-free accounts by paying the taxes due in the year of the conversion.
Prior to 2010, there was an income limit both on making contributions to Roth IRAs and on converting traditional IRAs to Roth IRAs. If you made a typical emergency physician income, you could neither contribute to a Roth IRA nor convert one of your traditional IRAs. However, starting in 2010, that income limit was removed from the conversion process, although not the contribution process. Under current law, a typical emergency physician cannot contribute to a Roth IRA but can contribute to a traditional IRA and then convert it to a Roth IRA.