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Tax law changes will allow virtually all doctors and spouses to have a tax–free Roth IRA this year. Through proper planning, income taxes can be minimized or eliminated when converting regular IRA amounts into Roth IRAs in 2010. Below, tax planning expert Brad Kucharo* outlines how to gain access to the best retirement savings option ever.
Tax benefits of Roth IRAs — Roth IRAs are undoubtedly the best retirement saving option. While contributions to Roth IRAs are nondeductible, earnings grow tax–deferred and can be withdrawn tax–free after the later of five years or age 59½. With income tax rates headed higher, these tax–free earnings will be of even greater value in the future. Moreover, there are no required distributions from Roth IRAs, unlike traditional IRAs.
Gaining access to Roth IRAs— Unfortunately, most high–income doctors can't take advantage of Roth IRAs now, due to their income level. Single doctors whose modified adjusted gross income (MAGI) exceeds $120,000 and married doctors whose MAGI exceeds $177,000 make too much money to contribute directly to a Roth IRA. Likewise, in 2009, doctors could not convert traditional IRAs into Roth IRAs if their household's MAGI exceeded $100,000.
While the income limits for making direct contributions to a Roth IRA remain intact in 2010, the rules for converting to a Roth IRA have changed. A 2006 tax law change eliminates the income limitations for converting a traditional IRA into a Roth IRA, effective Jan. 1, 2010.
With doctors' IRA values still down 20% to 30% from the 2008 stock market crash, and with future income tax rates headed higher, now is a perfect time for doctors to convert their regular IRAs into Roth IRAs.
Eliminating taxes on the conversion — The law requires that when doctors convert regular IRAs into Roth IRAs, they must pay income tax on all pretax contributions and earnings included in the amount converted. The trickiest part of a Roth IRA conversion involves determining the amount of IRA assets subject to tax. Suppose, for example, a doctor has $250,000 in a regular IRA representing pretax (tax–deductible) contributions made in prior years, as well as rollovers from prior retirement plans, earnings on these amounts, as well as $40,000 in nondeductible contributions made over the past several years, and $10,000 in earnings on those nondeductible contributions. Can the doctor convert the $40,000 representing prior nondeductible contributions tax–free to a Roth IRA and leave the remaining IRA assets where they are? Kucharo says no, the IRS will not allow doctors to “cherry pick” which IRA assets are deemed to be converted. Rather, the amount subject to tax is determined under the IRS pro rata rule. Under this rule, the doctor must divide the total nondeductible contributions ($40,000) into the total balance in all of the IRAs ($250,000) to determine the percentage (16% in this example) of any conversion amount that is tax–free. So, if the doctor decides to convert $30,000 of regular IRA assets into a Roth IRA, $4,800 (16%) will be tax–free, while the remaining $25,200 will be fully taxable.
While IRS rules do not permit the doctor to “cherry pick” which portion of his or her IRA is converted, there's another little known tax planning technique that allows doctors to achieve the same result, says Kucharo. Tax Law Section 408(d)(3)(D) allows the doctor to roll over all pretax contributions (from regular IRAs, SEP–IRAs, and SIMPLE–IRAs), rollover amounts, and earnings into his or her qualified retirement plan (401(k), profit sharing, defined benefit, etc.) and leave only the nondeductible contribution amounts in the IRA. Thereafter, the doctor can convert the regular IRA containing only after–tax nondeductible contributions into a Roth IRA. Since the doctor's tax basis in the nondeductible IRA is equal to the cumulative amount of contributions, there will be little if any tax upon the conversion.
Other steps to take now — Kucharo recommends that each doctor and spouse make the maximum possible contribution to a nondeductible IRA for 2009 before the April 15, 2010, deadline. For 2009, make nondeductible contributions of $5,000 per spouse ($6,000 per spouse if age 50 or older) using cash available for personal savings or from the doctor's personal investments to the extent necessary. Doctors should also make their 2010 nondeductible IRA contributions immediately, thereafter converting their regular IRA accounts into Roth IRAs. *For more information on tax–free Roth IRAs and other tax saving strategies, call (704) 424–9780.
John McGill and Brad Kucharo provide tax and business planning exclusively for the dental profession and publish the newsletter “The McGill Advisory” through John K. McGill & Company, Inc., member of the McGill & Hill Group, LLC. The group's members and affiliates serve as a one–stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit www.mcgillhillgroup.com for more information.
