Is your investment advisor wrong about a Roth?
There are many misconceptions about Roth IRAs, but if handled properly with the guidance of financial advisors, they are very good investment opportunities for dentists and their spouses.
Andrew Tucker, JD, CFP, CPA
John K. McGill, JD, MBA, CPA
While Roth IRAscan be tremendous tools, the amount of misinformation regarding their applicability and utility creates a lot of confusion among many investors. Here, we address some of the biggest misconceptions regarding Roth IRAs, and how you might be able to use these accounts to your advantage.
One of the biggest misconceptions perpetuated by investment advisors is that you cannot contribute into a Roth IRA. While there are steps to make sure this is done properly, and non-business-owner doctors may need to calculate the cost benefit of an initial taxable conversion, every doctor can fund a Roth IRA either directly or indirectly. Doctors can make contributions directly into a Roth IRA in 2018 if their modified adjusted gross income (MAGI) is below $118,000 (single) or $186,000 (married). Higher-income doctors can make indirect, or “back door” contributions to a Roth IRA.
With this approach, the doctor and spouse make the maximum annual contribution ($5,500 per spouse if under age 50, $6,500 per spouse if age 50 or older) into a nondeductible IRA and thereafter convert those contributions into a Roth IRA. This conversion is tax free if handled correctly. Doctors who follow our recommended strategies for Roth IRA conversions can achieve federal income tax savings of over $500,000. With potential savings of this magnitude, it’s imperative that all doctors take maximum advantage of Roth IRAs.
Maximizing tax-free Roth conversions
Most doctors have one or more IRAs that contain not only after-tax IRA contributions, but also earnings and rollovers from prior retirement plans. Despite the fact that many doctors use Simple IRAs or SEP IRAs in their businesses, both of these accounts are IRAs by definition and will create tax issues if a conversion is attempted without rolling these assets into a 401(k) or another type of retirement plan. We routinely help clients reach tax-free Roth conversions by using the following five-step process.
1. Calculate the cumulative amount of after-tax contributions that have been made to the doctor’s IRA. Tax laws require doctors to keep a running record of their nondeductible IRA contributions and report them to the IRS on Form 8606 attached to their annual federal income tax return. If the doctor lacks these records, he or she may be able to obtain this information from his or her current investment advisor. Otherwise, the doctor must simply estimate his or her prior nondeductible contribution.
2. Once the doctor has confirmed his or her total cumulative nondeductible contributions, he or she rolls over the remaining taxable portion of his or her IRAs into a qualified retirement plan, such as a 401(k) or defined benefit plan. If the doctor is a small business owner, this is relatively simple since the doctor controls the retirement plan. Otherwise, the doctor can confirm with his or her human resources or benefits department on the ability to do this.
Note: The retirement plan document must allow the doctor to make the rollover into the retirement plan. This is an elected option that must be confirmed prior to attempting this strategy. Accordingly, the doctor must contact his or her retirement plan advisor to assure that his or her plan allows this, and if not, is amended to allow it.
3. Convert the regular IRA containing only after-tax nondeductible contributions into a Roth IRA. Since the doctor’s tax basis is equal to the cumulative amount of the contributions, there will be no tax due on this conversion.
4. Thereafter, the doctor and spouse should make the maximum contribution to their nondeductible IRAs each year. So long as no taxable proceeds are rolled into taxable IRAs from retirement plans, the first year is the only complicated year for shifting proceeds between accounts to avoid triggering taxes.
5. Immediately thereafter, the doctor and spouse should convert these amounts tax free into their Roth IRAs each year.
Andrew Tucker, JD, CFP, CPA, and John K. McGill, JD, MBA, CPA, provide tax and business planning for dentists and specialists. Mr. McGill publishes the McGill Advisory newsletter through John K. McGill & Company Inc., a member of the McGill & Hill Group LLC, the one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com.