Speaker 1 00:00:08 What's up everyone. Welcome to the finance for physicians podcast. I'm your host, Daniel Rin. Join me as we dig into what it looks like for physicians to begin using their finances as a tool to live better lives. You can learn more about our
[email protected] let's. Jump into today's episode. Jen and I are back at it again today talking about the back door Roth IRA. Before we get into that, let me give you the quick and dirty skinny on the back door Roth IRA. It's typically a very beneficial tax shelter for physicians, especially those in practice. We're gonna be discussing when you should consider it, the steps required to fund it. And the most common mistakes we see that you're all gonna want to avoid. So if you're not familiar with the back door Roth, or you wanna make sure you're doing it correctly, or maybe you just wanna refresher on it, you're definitely gonna benefit from today's episode, Jen, what's up. Thanks for taking the time to chat today.
Speaker 2 00:01:00 Yeah, glad to be here.
Speaker 1 00:01:02 Awesome. So today we are gonna be talking about backdoor Roth IRA, and you know, how it all works and, and kind of go through that process. I think a good starting point on the backdoor Roth is just to get into like what it is, what exactly is a backdoor Roth area. Jen, can you kind of give us the low down?
Speaker 2 00:01:22 Yeah. So, you know, I'm sure most people have heard of a, a regular Roth a before and might even know that, um, you know, whether or not you're able to contribute to it has to do with your income specifically, your modified AGI. Um, I think it's around, you know, 200,000 for married filing joint people. And if you're, if you're over that limit, you know, you're, you're out of luck. You're just, you're not able to contribute to it
Speaker 1 00:01:46 Directly,
Speaker 2 00:01:47 Directly, yeah. Directly to it. But fortunately there's a work around for the high income earners who would have otherwise not been able to contribute to it and, and enter the back door Roth IRA. So instead of contributing directly to the Roth, you basically just take an extra step. You have a non deductible IRA that you contribute to first. And then from there you do a Roth conversion that moves the money from the non deductible IRA to the Roth ARA. So in the end, it's the same thing. You're still contributing to the Roth ARA. You just kind of have to take an extra step along the way. You're essentially just, you know, you're, backdooring the contribution into the Roth. It's, uh, they should change the name, you know, it's, it sounds shady, but it's fine. It's um, it's a, just a, a back door.
Speaker 1 00:02:32 Yeah. I think they've even, um, released some revenue rulings or something along those lines that kind of like confirms that
Speaker 2 00:02:41 IRS. Yeah. I was actually reading about it. They, one of the IRS, um, guys had made it wasn't a ruling. They were just, he had come out and said, you know, usually the, the step doctrine is, you know, basically you can get in trouble if, if we consider this to be a, if we think what you're doing is trying to bypass our rules, but in the case of the backdoor Roth IRAs, we don't consider that to be a violation. So it's, it's
Speaker 1 00:03:08 Good. Yeah. The step transaction doctrine, that's like the IRS rule that says you can't take multiple steps to circumvent our rules. <laugh>
Speaker 2 00:03:17 Yeah.
Speaker 1 00:03:18 Yeah. And so that's, that's definitely good news. So basically it kind of like legitimizes this whole process, but so like the Roth IRA, why is it so beneficial to physicians?
Speaker 2 00:03:31 Well, and I think just to, you know, physicians and really anyone, you know, it's an additional option for retirement savings after you've maxed out, you know, anything you have through, through work, it's a retirement savings option for an, an unemployed spouse. If that's an option for you, it provides tax diversification for, you know, your retirement assets. Um, there's no RMDs on Roth IRAs tax re draws in retirement asset protection up to certain limits in most states, any benefits I'm missing. I think that's most of,
Speaker 1 00:04:04 Yeah. I mean, it's just basically the high income physician is typically maxing everything out. And so this is just another way to further shelter, money from taxes, which is always good.
Speaker 2 00:04:18 Yeah. Especially when the alternative would likely have been just in like an after tax taxable account.
Speaker 1 00:04:24 Yeah. When the, yeah. The alternative is typically something that gets tax. So let, let's talk about the considerations to think about before you actually go through this process. I think so it's, it sounds simple. Maybe <laugh> I think it sounds simple. It's, it's really just a, an extra step, but it seems like people get hung up. There's a lot of errors that happen along the way, but what are the big considerations to kind of throw out there before you, you know, actually fund it?
Speaker 2 00:04:55 Yeah. So one of the main things you wanna look out for, and, and one of the things we run into a lot with our clients is you really, in order to do it the most efficiently tax wise, you really don't wanna have any traditional IRA dollars in place. So that's, you know, gonna, let's do your traditional IRAs, your step IRAs, your simple IRAs. So if you have any of those in place, ideally we want to make a plan for moving those around. Before we start using the backdoor Roth IRA strategy, otherwise some, um, some complicated, um, tax pro rating, um, comes into play.
Speaker 1 00:05:30 Yeah. That's and that's the pro rat rule, right? Jen. Yeah. Where they ideally, you just don't have to worry about that. And so the way you do that is you just clear out all your IRAs, or maybe you don't even have any in the first place.
Speaker 2 00:05:45 So if you have a most people that we work with, have some sort of way to clean it up. Like if you have a, a 401k or a 4 0 3 B with work, and you have an old traditional IRA that you had rolled over from, you know, an old retirement plan that you had, usually you can just take that IRA and consolidate it into your, your current plan. You can just roll it over in there and that's how we clean it up. Or you can roll it over into your, you know, your solo 401k, if you're self-employed or something like that. So there's usually an option for, for moving it around. So that's kind of the, the ideal setup is that we can, um, just roll it into one of your existing, non IRA pre-tax accounts.
Speaker 1 00:06:25 Yeah. So ideally you kind of clear those out. Um, you gotta always think about the tax consequences. Ideally, if you can transfer it into a place that has really no tax effect, that's the, the, the key there, but, um, once you clean all that up, so let's just kind of talk through the steps there. So just to make sure it's all clear, the first is to verify that that rule we're just talking about the pro rat rule is not an issue. Um, if it is, you can clean out your, you know, existing IRAs and then you gotta open up a new account if you don't have one. So you have to make sure you have both the traditional IRA and a Roth IRA. Yeah. If they don't already exist. And so from there, Jen, what you, you fund the Roth or sorry, fund the traditional IRA.
Speaker 2 00:07:11 Yeah. So you're gonna fund the traditional IRA and then you're going to move money from the traditional IRA to the Roth IRA. And usually what that looks like is filling out a form called a Roth conversion form that you submit to, you know, whatever company you you're using that just says, Hey, I, I would like to move my money from my IRA to my Roth. Um, and that just essentially converts performs the Roth conversion for you, moves it from the traditional IRA over to the Roth IRA.
Speaker 1 00:07:37 Mm-hmm, <affirmative> the other thing, once you do that, you gotta make sure to invest the money we've, we've seen lots of people just kind of forget that ladder step. And then, and then the last step is just to get it reported on your taxes. And so what's the form, Jen?
Speaker 2 00:07:53 Yeah. It's 8, 6 0 6.
Speaker 1 00:07:55 Yeah. So we'll link to what, to the, the form that you complete. But, um, so besides some of the things we've, we've pointed out already, uh, what, what are some of the most common issues that you see as people work through this process?
Speaker 2 00:08:09 Yeah. So I know, I know we already mentioned the, the pro rat rule. If, if you have the, um, any traditional IRA dollars in place, but the reason we want to avoid that is because you just, you end up paying tax that really, we don't want you to have to pay, you know, basically the IRS isn't gonna let you cherry pick only your after tax contributions. If you have a bunch of pre-tax dollars already in place, they're gonna make you take a, a prorated portion of the after tax to pre-tax balances of your total balance. They make you look at everything together and consider that to be one total IRA balance. Um, and you'll have to pay tax based on the, on the pro rating there. So I ideally we avoid that all together, but not everyone realizes that that's a rule kinda going into it. And then we see it get reported incorrectly on taxes all the time. I would say of our, of our clients that are, are using this strategy. Um, what would you say 50% of the tax returns we see are they're wrong? Maybe.
Speaker 1 00:09:07 Yeah, that would, that would be my guess might be more
Speaker 2 00:09:10 So really what you wanna look for, if you're, if you're using this strategy, you wanna look at line four B on your 10 40,
Speaker 1 00:09:17 So 10 40 is the main,
Speaker 2 00:09:19 Yeah. 10 40 is the main form of your tax return. Um, kind of that, that summary page and line four B ideally should be zero, unless you have some of the, unless you, that pro rat rule coming in, into play with you, which, um, ideally is not. But
Speaker 1 00:09:35 No, it might, it might be a, it might be a few hundred dollars. Like I, I think that's okay.
Speaker 2 00:09:40 Yeah. If you've had some gains,
Speaker 1 00:09:42 So if you, if you put it in the traditional IRA and then it goes up a little bit, and then you convert it, there can be some gains there, but
Speaker 2 00:09:51 It shouldn't be $6,000
Speaker 1 00:09:53 Right. Or 12. So yeah. Yeah. That's usually, that's definitely a common error. We'll look at the tax return later on and see it showing up there, but it's showing as $12,000, uh, as income and that's completely incorrect and it, and it, you know, actually costs you it's like a, what you say like $6,000 or, uh, $4,000 mistake, I guess, for sure. Um, on average. And
Speaker 2 00:10:20 So, you know, as you've pointed out before, even more, if you've then used that tax return to, you know, verify income on your student loans or something like that, so it can, oh yeah. It can kind of have a trickle down effect.
Speaker 1 00:10:31 Yeah. And I've seen that usually when I see that happening, it's been ongoing.
Speaker 2 00:10:36 Yeah.
Speaker 1 00:10:37 You know, so when we see it one time, it's the prior returns. So you can amend the good news is, is if you do catch that you can amend up to three years, returns and fix it. But ideally you catch that on the front end. You just wanna, first of all, make sure the form 86 0 6 is complete in the first place. We've seen a lot of them where they just don't complete the form. And then second of all, that it's coming through correctly where it's not showing that, uh, full amount as income. And the reason it happens is they just did that form incorrectly. The, the, the 86 0 6, you know, is kind of a confusing form.
Speaker 2 00:11:12 I think the backdoor Roth IRAs, you know, fortunately I think is becoming a little bit more widely known as a strategy. I think, um, you know, we've had a few battles with CPAs over the years. Um, but I think, I think it's becoming a little bit more widely known, but I think also part of the confusion is, um, when people process the conversions happen and then, you know, like we use TD Ameritrade, for example, when TD Ameritrade sends out those 10 99 RS that says, Hey, this, this client did this conversion. And then the client give that 10 99 R to their accountant. The accountant sees the box that says $6,000 was distributed. And then there's a box that is checked taxable. And then there's another box that's checked. Um, taxable amount amount was not determined. And usually the CPA just assumes that it was all taxable. And if the client's not sure. So that's just kind of how or why this is an issue a lot, if the client's not sure. And the accountant assumes. So just always double check on that line.
Speaker 1 00:12:08 Yeah. One more side note, there's a few tax forms that get spit out from this whole process and they are gonna be coming from the investment company or the custodian that holds the funds. And you always wanna keep those for your records. They're kind of like, you know, your proof of the transactions in case you're to get audited. And so the, the first form is kind of an informational form that says you made the contribution to the traditional IRA and it's a form 54 98. The problem with that form is it doesn't come until may, right? Jen?
Speaker 2 00:12:46 Yeah. Like after you've done your
Speaker 1 00:12:48 Taxes. Yeah. So it's after you've done your taxes, cuz the deadline to funded is the tax deadline. And so they then create the forms after. So if you use an accountant, the accountant's not gonna know that you contributed to the traditional IRA unless you verbally tell them. And so you always have to verbally tell them and you always wanna save that form kind of for future reference for the contribution. And then the second form is the 10 99. And that happens when you convert from traditional to Roth. And so that'll, you know, gets per, it gets spit out, you know, soon after that conversion and you, it's kind of the same thing. You just wanna keep it on, on file. All right, Jen. Well, thanks for chatting with me about this and I appreciate you going through the process.
Speaker 2 00:13:35 Yeah. I was happy to be here. I'm excited to, um, officially be a podcast guest
Speaker 1 00:13:39 As always. Thank you so much for joining us today. If you found this valuable, please give us a review on iTunes and share with a friend. Also check out our
[email protected] for all sorts of additional content. See you next time. Finance for physicians is not an investment tax legal or financial advisor. All content included in this podcast is for informational purposes only and should not be considered financial tax or legal advice. Material presented is believed to be from reliable sources and no representations are made by finance for physicians as to another party's informational accuracy or completeness, all information or ideas provided should be discussed in detail with an advisor accountant or legal counsel priority to implementation. We don't have an advisor or like a second opinion. Feel free to check out our website for recommended advisors.
