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After-Tax Rollovers & The Mega-Backdoor Roth

After-tax contributions to retirement accounts offer a way for high-income earners to save for retirement beyond the contribution limits of traditional retirement accounts. However, these after-tax contributions don’t offer any tax benefits until the funds are rolled over into a Roth IRA. In this article, we’ll explore how after-tax rollovers work and how they can lead to the creation of a Mega-Backdoor Roth IRA.

What are after-tax contributions?

In a traditional 401(k) or other employer-sponsored retirement plan, there are contribution limits that apply to both pre-tax and after-tax contributions. The pre-tax contribution limit for 2021 is $19,500, while the after-tax contribution limit is $58,000. This means that high-income earners who have maxed out their pre-tax contributions can still contribute up to $58,000 in after-tax funds.

How do after-tax rollovers work?

After-tax contributions are taxed as regular income in the year they are made. However, these funds can be rolled over into a Roth IRA, where they can grow tax-free over time. The rollover process involves transferring the after-tax funds to a traditional IRA and then converting those funds to a Roth IRA.

The conversion to a Roth IRA is a taxable event, but the tax liability is based on the difference between the after-tax contributions and the account’s current value at the time of the conversion. If the account has grown in value, the owner will owe taxes on the gain.

What is a Mega-Backdoor Roth IRA?

A Mega-Backdoor Roth IRA is an advanced retirement savings strategy that leverages after-tax contributions, rollovers, and conversions to create a tax-free retirement account. The strategy involves contributing the maximum after-tax amount to a 401(k) or other employer-sponsored retirement plan, converting those funds to a Roth IRA, and then repeating the process the following year.

By doing this, high-income earners can potentially contribute tens of thousands of dollars to their retirement accounts each year, all of which will grow and be withdrawn tax-free in retirement. This can be an especially attractive option for those who have maxed out their other retirement accounts and are looking for additional tax-free growth opportunities.

Conclusion

After-tax rollovers and the Mega-Backdoor Roth IRA strategy can be a powerful tool for high-income earners looking to maximize their retirement savings and minimize their tax liability. However, these strategies can be complex and may require the guidance of a financial advisor or tax professional to ensure that they are executed correctly. As always, it’s important to consult with a qualified professional before making any tax or investment decisions.