I recently gave a talk on a live webinar event hosted by Advice Residency for recently matched residents and an interesting point was brought up.
Nearly all of the speakers at some point or another mentioned how powerful the Roth IRA can be if doctors start investing in them as residents.
With the rise of physician finance bloggers and an increase in general financial literacy among residents, we have seen an increase in the use of Roth IRA’s among younger attendings as demonstrated in the American College of Physician’s 2021 Report on Physicians’ Financial Preparedness.
But, as the student loan situation has improved in this country, more and more residents are looking toward Public Service Loan Forgiveness (PSLF) or Income Driven Repayment (IDR) forgiveness to manage their loans.
When pursuing forgiveness, mathematically, it makes sense to try to maximize forgiveness by trying to lower the monthly payment as much as possible.
This is largely done by lowering the modified gross adjusted income reported on taxes. Some residents do this by making pre-tax contributions to their retirement account and/or by filing separately than their spouse.
So if a resident is pursuing student loan forgiveness, the traditional advice of recommending a Roth IRA to residents as the preferred account for initial investments may not make sense.
First, let’s go over some background.
What is a Roth IRA?
A Roth IRA is a retirement savings account available to anyone earning an active income. Since not every residency program offers a 401k or 403b, a Roth IRA can be a convenient workaround for residents to get started on saving for retirement, knowing that time in the market is so important for compounding interest. A Roth IRA does not need to be provided by an employer, an individual can open it.
Contributions: Contributions to a Roth IRA are made with after-tax dollars, meaning you contribute money that you've already paid taxes on. There are annual contribution limits set by the IRS, which can change year to year. For 2024, the contribution limits are $7000 for those under the age of 50 and $8000 for those over 50.
Tax-Free Growth: Once the money is in the Roth IRA, it can grow tax-free. This means you won't have to pay taxes on any capital gains, dividends, or interest earned within the account, as long as you follow the rules for qualified distributions.
Qualified Distributions: The main advantage of a Roth IRA is that qualified distributions (or withdrawals of contributions and their growth) are tax-free. In general, to be considered qualified, the distributions must be taken after the account owner reaches age 59 ½ and the account has been open for at least five years.
Early withdrawals before the age of 59 ½ are generally subject to a 10% penalty and income taxes. There are some exceptions for certain circumstances like first-time home purchases or qualified education expenses. Also, contributions (not the growth) can be withdrawn at any time penalty-free.
No Required Minimum Distributions (RMDs): Unlike traditional IRAs and other pre-tax retirement accounts, Roth IRAs do not require the account owner to take minimum distributions at a certain age. This allows for more flexibility in managing your retirement savings.
Estate Planning Benefits: Roth IRAs can also offer estate planning benefits, as they can be passed on to heirs tax-free, provided the distribution rules are followed.
Income Restrictions: There are income limits on who can contribute directly to a Roth IRA. If your income exceeds these limits, you may not be eligible to make direct contributions. These MAGI (Modified Gross Adjusted Income) restrictions change from year to year.
To contribute to a Roth IRA directly in 2024, single filers must have a MAGI (modified gross adjusted income) less than $161,000, and married filing jointly filers or widows (er)s must have a MAGI less than $240,000.
Attendings, who by en large, do not meet these income restrictions have to contribute to Roth IRA’s through the “backdoor method,” by first contributing to an empty traditional IRA and then converting it to Roth. But, residents who usually make less than these limits can contribute to Roth IRAs directly.
However, there is a caveat. If a resident is filing separately from their spouse, the MAGI restrictions are much lower. A resident filling separately from his or her spouse who has lived with their spouse during the year can’t make Roth IRA contributions if their MAGI is more than $10,000 (which it will be if the resident is working the whole year). So, in this situation, the resident would not be able to contribute to a Roth IRA directly.
His or her option would be to contribute to their employer’s 401k or 403b AND/OR do a backdoor Roth IRA. The backdoor Roth IRA would bypass the income limits placed on couples that are married and filing separately, but would not further decrease MAGI or income based student loan payments. Pre-tax contributions to a 401k or 403b would further the goal of decreasing MAGI for a resident pursuing PSLF.
An interesting caveat to the abovementioned rule is that married couples who are filing separately can contribute to a Roth IRA if they did not live together at all at any time during the year.
Spousal IRA
If one spouse has a job and the other doesn’t, married couples can contribute to a Spousal IRA for the nonworking spouse, if the working spouse is making at least enough to contribute to the spousal IRA contributions and his or her IRA contribution. But, the same caveat applies if the couple is filing taxes separately- they cannot contribute to a spousal IRA.
Traditional IRA
You may be asking why we’re not even considering the traditional IRA for contributions. There are two reasons why putting money in traditional IRA’s doesn’t make sense for physicians.
First, most attendings cannot deduct their contributions to this account like the rest of the population due to income restrictions on deductions (see below).
Second, having money in traditional IRA’s excludes physicians from doing backdoor Roth contributions because in order to do a Roth conversion, all the money in the traditional IRA would be subject to taxes due to the pro-rata rule. That would create a surprise tax bill that is undesirable to most physicians.
So, like most advice in personal finance, one size doesn’t fit all, especially in this environment where the student loan environment is changing so rapidly.
Residents pursuing forgiveness should, in my opinion, get a consultation to go over their particular situation with a professional student loan advisor, financial planner, or accountant to strategize how to maximize forgiveness and save for retirement. In general, if someone is absolutely sure they will pursue PSLF and are filing separately from their spouse, pre-tax contributions to 401k’s or 403b’s would make more sense than a backdoor Roth IRA to further reduce their modified gross adjusted incomes for income based repayment calculations. Doctors filing separately from their spouses should absolutely be aware of the income restrictions placed on them for direct Roth IRA contributions if they are living together. If you’re interested in reading the official IRS publication for IRA contributions, it is available here.
Until next week!
Stay frugal, ya’ll.
Disha
Resource:
Tretina, K. (2023, December 7). Can A Roth IRA Be Used To Pay For College? Forbes. https://www.forbes.com/advisor/student-loans/can-roth-ira-be-used-for-college/