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Mega Backdoor IRA

| August 05, 2021
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A Mega Backdoor Roth is a tax strategy used to dramatically increase contributions to a Roth IRA and bypass the usual income limits.

What Is a Mega Backdoor Roth IRA?

There are several different ways to fund a Roth IRA. A Mega Backdoor Roth allows you to contribute significantly more than other strategies.

Roth IRA

With a Roth IRA, growth and distributions are tax-free because the contributions have already been taxed and have no required minimum distributions in retirement. A Roth IRA has an income limit and a contribution limit of $6,000 to $7,000 per year.

Backdoor Roth

A backdoor Roth is a way to bypass the income limit by opening a traditional IRA, and immediately converting it into a Roth IRA and paying the taxes. However, you can still only contribute $6,000 to $7,000 per year.

Mega Backdoor Roth

Some people who have a 401(k) plan at work that allows after-tax contributions and in-service distributions have the option to create a Mega Backdoor Roth. If you meet all the requirements, you can save an additional $38,500 per year by putting after-tax funds in the 401(k) and then rolling it over to the Roth.

How Does a Mega Backdoor Roth Work?

The most you can contribute to a 401(k) pre-tax is $19,500, or $26,000 if 50 or older. However, the overall IRS contribution limit is $58,000 ($64,500 at 50 or older).
After contributing the tax-deductible maximum, you can contribute $38,500 in after-tax contributions. You can then transfer that $38,500 to a Roth IRA. This only works if your 401(k) plan allows these contributions and rollovers.

Keep in mind that if you receive an employer match, that counts against the maximum total contribution, limiting the amount that can be rolled over.

The Benefits

If you make $38,500 in after-tax contributions to your 401(k) and it grows by $30,000 by the time you retire, you will not have to pay taxes on the $38,500 because it was after-tax money. However, you will be taxed on that $30,000 in growth because money does not grow tax-free in a 401(k). But, if you roll that $38,500 over to a Roth IRA in the same year you make the deposit, you won't owe tax on the $30,000 of growth and can take tax-free withdrawals in retirement.
This gets a lot of extra money in that Roth and when you pull the money out, it’s tax-free.

Is a Mega Backdoor Roth Right for You?

To use this strategy, you need to make sure your company allows after-tax contributions to your 401(k) and an in-service rollover while you're still employed at that company. Check with your human resources department, 401(k) plan administrator, or review your summary plan description to determine if your plan has the necessary flexibility.

If you are uncertain about your plan's rules, working with a financial professional may be helpful to ensure that this strategy is possible and makes sense. If you have a good financial foundation, the Mega Backdoor Roth can be very beneficial.


Have questions?

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