Physicians can benefit from understanding the differences between available types of retirement accounts when it comes to their long-term savings strategies, specifically Traditional vs. Roth. Here are some common questions physicians often ask regarding this conversation.
What are the differences between Traditional and Roth IRAs?
Contributions: Both Roth and Traditional IRAs allow individuals to contribute up to $6,500 (or $7,500 if over age 50) annually as of 2023. However, there are some differences in how contributions are taxed.
Traditional IRA contributions are typically tax-deductible, meaning you can deduct the amount of your contribution from your taxable income for the year in which you make the contribution. However, you will have to pay taxes on the money when you withdraw it in retirement.
Roth IRA contributions are not tax-deductible, meaning you must pay taxes on the money you contribute in the year you contribute it. However, the money you withdraw from a Roth IRA in retirement is tax-free.
Withdrawals: Traditional and Roth IRAs also differ in terms of when you can withdraw your money and how it will be taxed.
Traditional IRA withdrawals are generally subject to income tax at the time of withdrawal and may also be subject to a 10% penalty if withdrawn before age 59 1/2. You are required to begin taking minimum distributions from a traditional IRA once you reach age 73 (or age 75 depending on your current age).
Roth IRA withdrawals are tax-free in retirement as long as the account has been open for at least five years and you are over age 59 1/2. You can withdraw your contributions (but not any earnings on those contributions) at any time without penalty or tax.
Eligibility: There are also differences in who is eligible to contribute to a Roth or Traditional IRA.
Traditional IRA contributions are available to anyone with earned income. However, if your modified adjusted gross income (MAGI) is more than $83,000 (or $136,000 for married couples filing jointly) and are you or your spouse are covered by a retirement plan at work, then you will lose the ability to deduct your contributions from your income.
Roth IRA contributions are subject to income limitations as well. In 2023, individuals with a MAGI of $153,000 or more (or $214,000 or more for married couples filing jointly) are not eligible to contribute to a Roth IRA.
Overall, both Roth and Traditional IRAs can be useful retirement savings tools, depending on an individual's financial situation and goals. Physicians, like all individuals, should consider speaking with a financial advisor to help determine which type of IRA is right for them.
What options do I have if I’m above the income limitations?
As outlined above, high-income earners, including physicians, may find themselves unable to contribute to a Roth IRA directly due to income limitations set by the IRS. This is where the "backdoor Roth" can come into play.
The backdoor Roth is a strategy that allows high-income earners to contribute to a Roth IRA indirectly by making a non-deductible contribution to a Traditional IRA and then converting it to a Roth IRA. This allows high-income earners to take advantage of the benefits of a Roth IRA, such as tax-free growth and tax-free withdrawals in retirement, even if they are unable to contribute directly to a Roth IRA.
Here's how the backdoor Roth works:
First, make a non-deductible contribution to a Traditional IRA. There is no income limitation on making a non-deductible contribution to a Traditional IRA, so this is a viable option for high-income earners who are unable to contribute directly to a Roth IRA.
Wait a few days or weeks, allowing the contribution to settle in the Traditional IRA.
Convert the Traditional IRA to a Roth IRA. This conversion is generally tax-free, as long as the contribution was made with after-tax dollars and there are no other pre-tax funds in the Traditional IRA.
While the backdoor Roth can be a useful strategy for high-income earners, there are some potential pitfalls to be aware of. For example, if you have other pre-tax funds in a Traditional IRA, the conversion may be partially or fully taxable. Additionally, the backdoor Roth may not be a good option if you expect to be in a higher tax bracket in retirement.
As with any financial decision, it's important to consult with a financial advisor to determine whether the backdoor Roth is a good strategy for your situation.
Why I should I use Roth accounts – even as a high-income earning physician?
Although you probably won’t qualify for the tax deduction of a Traditional IRA contribution anyway, many physicians still have Roth options inside their 401(k) or 403(b). There are no income limitations inside these plans, so it is something that you may need to consider if a Roth option is offered inside your employer sponsored plan.
However, many people advise young practicing physicians not to use a Roth option for saving for retirement because their incomes are usually higher than most. The thought is that since their tax bracket is higher than most, they should be using the tax deferment of their contributions to lower their taxable income. While this certainly is a legitimate strategy (and one that I do recommend in some situations), from a planning perspective, I love the flexibility that Roth accounts provide for my clients when they near retirement. Too often, people come to me nearing retirement with nothing saved outside of their Traditional 401(k) or 403(b). Many times, the balance in those accounts can be worth hundreds of thousands or even millions of dollars. And all those dollars have a future tax burden attached to them. This can create a real challenge when trying to lower your tax burden once you reach your mid-80s and your RMDs are forcing you to withdraw significant amounts of your portfolio.
That said, when it comes to taxes and the future, this is certainly one thing inside your plan that you (or anybody else) won’t have any control over. If tax bracket percentages increase in the future (which they are already expected to do in 2026), then you may end up paying more in taxes later – even if you are making less income in retirement. There are several long-term benefits of having Roth accounts as well, even when you take out the unknowns of how tax law will work in the future. Such benefits include:
Tax-free withdrawals: Roth accounts, such as Roth IRAs and Roth 401(k)s, offer tax-free withdrawals in retirement. With a traditional qualified account, you'll pay taxes on your withdrawals, potentially reducing the amount of money you have available to spend.
No Required Minimum Distributions (RMDs): Traditional qualified accounts require you to take RMDs once you reach age 73 (or possibly age 75 depending on your current age). Roth accounts, on the other hand, have no RMDs, which means you can leave your money invested for longer, potentially allowing it to grow more.
Flexibility in retirement: Because Roth accounts don’t have RMDs, you have more flexibility in how you withdraw money in retirement. You can take out as much or as little as you need without worrying about meeting minimum distribution requirements.
Estate planning benefits: Roth accounts can be a useful tool for estate planning. Because the money in a Roth account has already been taxed, it won’t be subject to income tax when it’s passed on to your heirs. This can be especially beneficial if you expect your heirs to be in a higher tax bracket than you are.
Overall, Roth accounts can provide significant long-term benefits, including tax-free withdrawals, no RMDs, greater flexibility in retirement, and estate planning advantages.
Is a Roth option automatically the best way to go then?
No, a Roth option may not be the best way to save for everyone. The choice of the best way to save for retirement depends on individual circumstances, financial goals, and tax situation. Like in many financial scenarios, there are many variables that must be considered when trying to optimize a savings strategy. Additionally, for individuals who may need to access their savings before retirement, a Roth option may not be the best choice as withdrawals of earnings before age 59½ are subject to a 10% penalty, and conversions can only be withdrawn penalty-free after a five-year holding period.
So how do I decide?
If you’ve read any other articles here on Physicians Financial Design, you already know how I’m going to answer that! Yes, you need a financial plan and a financial planner who understands the career track and unique financial situation of a physician. Hopefully this article helped you understand the differences between the Traditional and the Roth, but if there is one major takeaway, let it be this: Planning properly requires an expert understanding of all these nuances described. If you’re looking for help sorting through the minutia, click on the big yellow button below and take advantage of a free financial evaluation from a financial planner who knows physicians.
Thanks for reading! For more articles geared toward young physicians and their money, click here or check out The Money Malpractice Podcast on any of the major platforms.
Until next time…KEEP SAVING LIVES AND KEEP SAVING MONEY!
Disclosures
• RichMark Private Wealth Management. LLC is registered as an investment adviser with the State of Michigan, and only transacts business in states where it is properly registered, or is excluded or exempted from such requirements.
• Content should not be viewed at personalized investment advice. Market events and other factors may affect the reliability of the potential outcomes. Simulated growth is purely hypothetical and does not represent actual performance.
• Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client's portfolio.
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