How to contribute more dollars to tax-sheltered Roth accounts
Key takeaways:
- A popular method to circumvent income limits on direct Roth IRA contributions is with the backdoor Roth IRA.
- Roth 401(k) deferral contributions may be a more straightforward path for funding after-tax accounts.
For high-income earners, including physicians, getting funds directly into a Roth IRA or other after-tax accounts can be a complex challenge.
For 2025, the income phase-out range will increase to between $236,000 and $246,000 for married couples filing jointly, up from between $230,000 and $240,000 in 2024. This limitation often leads many investors to consider alternative strategies, such as making nondeductible IRA contributions followed by a “backdoor” Roth conversion to funnel those funds into an after-tax bucket. However, this approach has a significant caveat: If you have any assets in other IRA accounts, you could face pro-rata taxation on the conversion.
This article explores effective strategies for maximizing contributions to tax-sheltered Roth accounts, particularly for doctors and other high earners, while minimizing tax implications.
Diversify tax buckets
Physicians often focus on diversifying their investments across various asset classes to minimize overall portfolio risk. However, it is equally important to diversify future distribution streams through the three tax “buckets” according to how those streams will be taxed when accessed: ordinary income, capital gains and tax free. This diversification gives investors greater flexibility to manage their tax liabilities during retirement.
Many savers tend to over-allocate to the ordinary income bucket, drawn in by the immediate tax savings that come with traditional retirement accounts (the tax deductions created when making contributions). While this approach can yield significant short-term benefits, it can also lead to challenges during the distribution phase. Required minimum distributions (RMDs) mandate that investors begin withdrawing funds from their pre-tax accounts at 73 or 75 years of age, depending on their birth year. This requirement can lead to substantial tax bills if not managed carefully.
The RMD age is 72 years for people born between July 1, 1949, and Dec. 31, 1950. The RMD age increases to 73 years for those born in 1951 through 1959, and to 75 years for those born after Jan. 1, 1960. Everyone’s first withdrawal is due by April 1 of the year after they turn their designated RMD age.
For example, Dr. Dave, who was born in 1951 and turned 73 years old in 2024, must make his first RMD withdrawal by April 1, 2025. Younger doctors born in 1960 or later will not be required to make their first RMD withdrawals until April 1 of the year after they turn 75 years old.
Backdoor Roth IRA
The backdoor Roth IRA has become a popular method for high-income earners to circumvent the income limits imposed on direct Roth IRA contributions. The strategy involves making a nondeductible contribution to a traditional IRA and subsequently converting that amount to a Roth IRA.
While this method can be effective, the pro-rata rule complicates matters. If there are other traditional IRA assets, the IRS will tax the conversion based on the proportion of nondeductible contributions to the total balance of all traditional IRAs. This makes it essential for people to consider their overall IRA balances before pursuing this route.
Roth 401(k) contributions
A more straightforward path for high-income earners to fund their after-tax accounts is through Roth 401(k) deferral contributions. For 2025, the maximum deferral limit is $23,500, with an additional catch-up contribution of $7,500 available for participants older than 50 years. The law also introduced a feature now referred to as the “super catch-up,” allowing participants aged 60 to 63 years the ability to defer an additional $11,250. Once participants turn 64 years of age, they revert to the standard-age 50 years and older catch-up contribution limit.
Recent changes stemming from the SECURE 2.0 Act have further reshaped the landscape of retirement savings. Under the new regulations, catch-up contributions for employees earning more than $145,000 must be designated as after-tax or Roth contributions. This means that these contributions are made with after-tax dollars, allowing for tax-free withdrawals in retirement.
The IRS subsequently issued Notice 2023-62 to provide clarity on these new rules and delay its enforcement, establishing a 2-year administrative transition period for plan sponsors. After Dec. 31, 2025, all catch-up contributions for participants earning more than the $160,000 threshold (or revised Highly Compensated Employee levels) must be made as Roth contributions. This shift not only encourages more high-income earners to utilize Roth 401(k) plans, but also broadens their retirement savings strategies.
In-service withdrawals
Many 401(k) plans also offer the option to make after-tax contributions, which can be beneficial for high earners. If your plan allows it, you may have the opportunity to do in-service withdrawals directly into a Roth IRA. However, it is important to understand the specific the rules of your plan, as in-service withdrawals are typically not permitted until the employee reaches 59.5 years old.
This strategy can be particularly effective for those who want to maximize their contributions to a Roth account while still benefiting from the tax-deferred growth of a 401(k). In addition, because withdrawals from Roth accounts are tax-free in retirement, this approach can help ensure greater financial flexibility during retirement.
Strategic Roth IRA conversions
Even before RMDs begin, it can be advantageous to consider full or partial conversions of traditional IRAs to Roth IRAs. This strategy is predicated on the idea that many people will find themselves in a lower tax bracket during retirement compared with their working years. By executing conversions while in a lower tax bracket, investors can effectively manage their tax liabilities.
This strategy also hinges on filling up tax buckets without pushing these into a higher marginal rate. Market conditions can provide additional opportunities for conversions. If there is a significant market drop, the value of the assets being converted is lower, resulting in lower taxes owed on the conversion. Once these funds are in a Roth IRA, any subsequent growth is tax free, allowing for substantial long-term benefits.
The mathematics behind Roth conversions become even more favorable the longer the funds remain in the Roth IRA. As the market rebounds, the growth accrued in a tax-free account can compound significantly, enhancing the investor’s overall retirement portfolio.
Conclusion
Contributing more dollars to tax-sheltered Roth accounts is a critical strategy for physicians and other high-income earners seeking to maximize their retirement savings and minimize future tax liabilities.
While the income limits for direct Roth IRA contributions can be a hurdle, alternative strategies such as backdoor Roth IRAs, Roth 401(k) contributions and strategic conversions provide valuable avenues to navigate this complex landscape. By understanding the implications of various tax buckets and leveraging available opportunities, physicians can position themselves for a more flexible and tax-efficient retirement.
Reference:
Mandell and OJM Group partners are pleased to announce the publication of our newest book, Wealth Strategies for Today’s Physician: A Multi-Media Playbook. The playbook’s innovative format features more than 90 links to videos and podcast episodes to enhance important financial topics for physicians. To receive a free print copy or ebook download, text HEALIO to 844-418-1212, or visit www.ojmbookstore.com and enter code HEALIO at checkout.
For more information:
Sanjeev Bhatia, MD, is an orthopedic sports medicine surgeon practicing at Northwestern Medicine in Warrenville, Illinois. He can be reached at sanjeevbhatia@gmail.com or @DrBhatiaOrtho.
David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group www.ojmgroup.com, where Adam Braunscheidel is a partner and wealth advisor. They can be reached at 877-656-4362 or mandell@ojmgroup.com.
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