Discover a game-changing retirement account strategy: the mega backdoor Roth. Designed for high-income earners with extra cash to invest, this strategy allows you to deposit funds into a Roth individual retirement account (IRA) or Roth 401(k) while enjoying tax-free growth.
Here’s what you need to know about this strategy.
Mastering the Basics of Roth Accounts
To fully understand the mega backdoor Roth, it’s important to familiarize yourself with Roth retirement accounts and backdoor Roth IRA conversions.
The Benefits of Roth Contributions
Roth retirement accounts, such as the Roth 401(k) and Roth IRA, allow you to contribute money on which you’ve already paid income taxes. These contributions grow tax-free, and qualified withdrawals in the future are completely tax-free. While anyone can contribute to a Roth 401(k), eligibility for a Roth IRA is income-dependent.
If you meet the income requirements, you can contribute up to $6,500 in 2023 (or $7,000 if you’re 50 or older). The contribution limits for 2024 are $7,000 (or $8,000 if you’re 50 or older). In 2021 and 2022, the limits were $6,000 ($7,000 if 50 or over) per year.
Understanding Backdoor Roth IRA Conversions
If your income exceeds the eligibility thresholds for a Roth IRA, don’t worry. A backdoor Roth IRA conversion allows high earners to roll funds from a traditional 401(k) or traditional IRA into a Roth IRA.
The process involves depositing money into a traditional IRA through direct contributions or rolling over funds from a traditional 401(k), followed by converting that traditional IRA to a Roth IRA. While you will owe income taxes on the rollover, this strategy enables you to bypass income restrictions.
Introducing the Mega Backdoor Roth
Take your retirement savings to the next level with the mega backdoor Roth strategy. This powerful tactic allows you to roll over up to $43,500 from a traditional 401(k) to a Roth IRA or Roth 401(k) in 2023, completely tax-free. The rollover cap increases to $46,500 in 2024. Please note that employer contributions may affect these caps.
To successfully implement this strategy, you must have maximized your annual 401(k) and IRA contributions and have additional cash to invest in a Roth IRA. Additionally, you must be enrolled in an employer-sponsored traditional 401(k) plan that allows after-tax contributions and in-service withdrawals, or offers i-plan Roth rollovers.
Maximizing After-Tax Contributions and In-Service Withdrawals
After you’ve reached the annual employee 401(k) contribution limit, some plans enable you to make additional after-tax contributions. These contributions consist of money that’s already been taxed. While similar to Roth contributions, earnings on after-tax contributions are subject to taxation upon withdrawal, whereas Roth earnings remain tax-free.
In-service withdrawals, available in most 401(k) plans, play a crucial role in the mega backdoor Roth process. By making after-tax contributions and immediately taking an in-service withdrawal, you can minimize potential taxable returns during the rollover. If your plan doesn’t allow in-service withdrawals, you can still pursue the mega backdoor Roth by rolling over funds after leaving your job, though you may owe taxes on investment earnings.
For self-employed individuals with a solo 401(k) plan, some providers may not initially permit aftertax contributions and in-service withdrawals. However, customization options may be available to allow for these features.
Take Control of Your Retirement with the Mega Backdoor Roth
If you’re ready to supercharge your retirement savings and enjoy tax-free growth, the mega backdoor Roth strategy is a game-changer. By harnessing this powerful tool, you can maximize your contributions, minimize taxes, and unlock a wealth of opportunities for your future. Consult with a financial advisor to determine how the mega backdoor Roth can fit into your retirement strategy.
Erik C. Sussman, CLU®, ChFC®, CFP®, and CEO of The Institute of Financial Wellness founded the company to provide financial education, resources, and services that help people live their best lives.
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