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Mega Back-Door Roth IRA

Often high earners can’t contribute to a Roth IRA. If their modified adjusted gross income (MAGI) is $161,000 in tax year 2024 ($240,000 if married, filing jointly) or more, they can’t contribute to a Roth IRA at all.

The Mega Backdoor Roth IRA is an advanced retirement savings strategy that allows high-income earners to contribute significantly more to their Roth IRA than the standard limits permit.

This strategy leverages the after-tax contribution limits of a 401(k) plan and the conversion rules of Roth IRAs to maximize tax-advantaged retirement savings. Here’s a detailed look at how it works, its benefits, and examples to illustrate its potential.

Understanding the Mega Back-Door IRA - A Mega Backdoor Roth IRA involves making after-tax contributions to a 401(k) plan and then converting those contributions to a Roth IRA. After-tax contributions to retirement plans are those made with income which has already been subjected to income tax, while tax on pre-tax contributions has yet to be paid and will be payable when distributions are made. Here’s a step-by-step breakdown of the process:

  • Maximize Pre-Tax and Roth 401(k) Contributions: First, ensure you have maximized your pre-tax and Roth 401(k) contributions. For 2024, the limit is $23,000, or $30,500 if you are age 50 or older.
  • Make After-Tax Contributions: Many 401(k) plans allow for after-tax contributions beyond the standard pre-tax and Roth limits. The total contribution limit for 401(k) plans, including employer contributions, is $69,000 for 2024, or $76,500 for those 50 and older (IRS, 2023).
  • Convert to Roth IRA: Once after-tax contributions are made, you can convert these funds to a Roth IRA. This can be done either through an in-plan Roth conversion (if your 401(k) plan allows) or by rolling over the after-tax contributions to a Roth IRA.    

Benefits of the Mega Backdoor Roth IRA

  • Tax-Free Growth: Contributions converted to a Roth IRA grow tax-free, and qualified withdrawals in retirement are also tax-free. This can result in significant tax savings over time.
  • Higher Contribution Limits: The Mega Backdoor Roth IRA allows you to contribute well beyond the standard Roth IRA limits, which are $7,000 for 2024, or $8,000 if you are 50 or older.
  • No Income Limits: Unlike direct Roth IRA contributions, which have income limits, the Mega Backdoor Roth IRA strategy is available to high-income earners who might otherwise be ineligible for Roth IRA contributions.
  • Distributions Not Required: As the owner of a Roth IRA, you would not be required to withdraw from the account once you reach the required minimum distribution age (currently 73) that applies to most other types of retirement plans. Thus, the Roth IRA can continue to grow tax-free until your death, at which time the heir(s) to the account will be required to take distributions.    

Example Scenario - Consider Jane, a 45-year-old high-income earner with a 401(k) plan that allows after-tax contributions and in-plan Roth conversions. Here’s how she can leverage the Mega Backdoor Roth IRA:

  • Maximize Standard Contributions: Jane contributes the maximum $23,000 to her 401(k) plan.
  • After-Tax Contributions: Jane’s employer also contributes $10,000 to her 401(k). This leaves her with $36,000 ($69,000 total limit - $23,000 - $10,000) that she can, and does, contribute as after-tax contributions.
  • Roth Conversion: Jane converts the $36,000 in after-tax contributions to her Roth IRA. This amount will grow tax-free, and she can withdraw it tax-free in retirement.    

Considerations and Potential Pitfalls

  • Plan Restrictions: Not all 401(k) plans allow after-tax contributions or in-plan Roth conversions. It’s essential to check with your plan administrator.
  • Tax Implications: While the conversion of after-tax contributions to a Roth IRA is generally tax-free, any earnings on those contributions before conversion may be subject to taxes.
  • Complexity: The Mega Backdoor Roth IRA strategy can be complex and may require careful planning and execution. Consulting with a financial advisor or tax professional is advisable.    

The Mega Backdoor Roth IRA is a powerful tool for high-income earners looking to maximize their retirement savings. By leveraging after-tax 401(k) contributions and Roth conversions, individuals can significantly increase their tax-advantaged retirement funds.

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