Maximizing retirement savings and devising strategies to keep taxes low are the cornerstones of building wealth. But with relatively low limits on 401(k) savings, how should high earners invest excess cash? Welcome to our discussion on Mega Backdoor Roths. If you’re looking for ways to maximize your 401k savings, we’ll explain how and why this strategy helps and if it applies to you.
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. Investment advice offered through Stratos Wealth Partners, Ltd., a Registered Investment Advisor DBA BWM Financial….(read more)

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The Benefits of a Mega Backdoor Roth

retirement planning is essential for securing our financial future. Traditional retirement accounts such as 401(k)s and IRAs have long been a popular choice, but what if there was an additional option that could offer even greater benefits? Enter the Mega Backdoor Roth.

The Mega Backdoor Roth is a lesser-known strategy that can supercharge your retirement savings. It allows you to contribute significantly more money to your Roth IRA than the standard contribution limits. This powerful tool enables individuals to maximize their retirement funds and enjoy tax-free growth in the long run.

So how does it work? First, let’s understand the basics of a Roth IRA. Contributions to a Roth IRA are made with after-tax dollars, meaning you pay taxes on the money before it goes into the account. Once the funds are invested, they grow tax-free, and when you withdraw them during retirement, the withdrawals are entirely tax-free.

In contrast, a traditional IRA or 401(k) allows for pre-tax contributions. Taxes are deferred until retirement, when you withdraw the funds, and then you pay taxes on those withdrawals at your regular income tax rate. While traditional retirement accounts have their merits, the Mega Backdoor Roth offers some significant advantages.

The Mega Backdoor Roth takes advantage of a unique provision in the tax code that allows for after-tax contributions to retirement accounts. In 2021, the contribution limit for a regular Roth IRA is $6,000 ($7,000 for individuals aged 50 or above), while the contribution limit for a 401(k) is $19,500 ($26,000 if aged 50 or above). However, the Mega Backdoor Roth strategy allows you to contribute much more.

With a Mega Backdoor Roth, high-income earners can contribute additional after-tax dollars to their employer-sponsored 401(k) plans beyond the standard limits, taking full advantage of their annual salary. Typically, the maximum combined contributions allowed for employer-sponsored retirement accounts, including employee contributions, employer match, and profit sharing, is $58,000 ($64,500 if aged 50 or above) in 2021.

Here’s where the magic happens. Once you’ve maxed out your after-tax 401(k) contributions, you can transfer those contributions into a Roth IRA. Unlike the traditional IRA rollover, this transfer doesn’t require you to pay taxes since you’ve already paid taxes on these contributions. Your after-tax contributions can continue to grow tax-free, leading to potentially substantial gains in the long term.

One key benefit of the Mega Backdoor Roth is the ability to enjoy tax-free growth regardless of your income level. Unlike traditional Roth IRA contributions that have income limits, the Mega Backdoor Roth allows high-income earners to take advantage of the tax-free growth potential.

Another significant advantage is that there are no required minimum distributions (RMDs) for Roth IRAs. With traditional IRAs and 401(k)s, you’re required to start taking withdrawals at a certain age, even if you don’t need the money. This can lead to unwanted tax consequences if your income tax bracket remains high during retirement. With a Mega Backdoor Roth, however, you can let your investments continue to grow well into your retirement years without mandatory distributions.

It is worth noting that not all employer-sponsored retirement plans allow for Mega Backdoor Roth contributions. Employers must have specific provisions in their plans to enable after-tax contributions and in-service withdrawals to execute this strategy. Consulting with a qualified financial advisor to understand if your employer plan allows for this option is crucial.

In conclusion, the Mega Backdoor Roth offers a powerful way to maximize your retirement savings without worrying about taxes. By taking advantage of after-tax contributions and the ability to transfer them to a Roth IRA, individuals can enjoy tax-free growth potential, regardless of income level. Consider exploring this strategy and seek professional advice to determine if the Mega Backdoor Roth is suitable for your retirement planning goals.