Several Roth strategies can help you manage your taxes. But the names can get confusing. So, what’s the difference between a Roth conversion, a back door Roth, and a mega back door Roth?

This video breaks it down.

A Roth conversion is the foundation of all of these strategies. When you convert, you shift funds from a pre-tax status to after-tax money. In other words, your funds might start in an account that could (or almost certainly will) get taxed when you take withdrawals. But when you convert, you secure the potential for tax-free income in retirement. Of course, that assumes that you follow all IRS rules.

To convert, you typically pay taxes on any untaxed funds. That might make sense if you think that tax rates are relatively low today, or if you have a particularly low income for the year. By getting taxes out of the way, you might benefit from withdrawals with no taxation down the road.

Roth conversions might happen with money that you’ve built up in a pre-tax IRA over years or decades. But you don’t have to convert everything at once. Instead, you can choose to do partial Roth conversions. For example, you might pick an acceptable tax rate and fill up that tax bracket with the appropriate amount each year.

Be mindful of things like 5-year rules, pro-rata rules, and other requirements as you explore Roth strategies.

Backdoor Roth contributions are a strategy that might make sense for those who don’t qualify for Roth IRA contributions (or deductible IRA contributions). With that approach, you might make annual IRA contributions to a traditional IRA. But if you don’t get a deduction, it might be nice to convert those funds to a Roth account in hopes of taking tax-free withdrawals later.

The annual limit for backdoor Roth contributions is the annual IRA limit.

Mega backdoor Roth contributions allow for much bigger amounts. With a mega backdoor strategy, you use an employer plan, such as your job’s 401(k) plan. Those plans need to allow for “voluntary after tax” contributions, and not every plan does so.

Mega backdoor contributions are different from standard Roth 401(k) contributions. You’d typically make voluntary after tax contributions above and beyond the standard salary deferral contribution—possibly up to the employer plan limit. Then, you could convert those after-tax contributions to Roth, possibly with in-plan conversions. However, many plans don’t offer the mega backdoor strategy.

Note that proposed rule changes may eliminate some of these strategies. In particular, lawmakers might do away with backdoor Roth and mega backdoor contributions, so be sure to pay attention to new legislation.

IMPORTANT: To qualify for tax-free withdrawals, you must satisfy specific IRS requirements. This video is not about those requirements, so you need to research that and discuss your situation with a CPA before making decisions.

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Justin Pritchard, CFP® is a fee-only fiduciary advisor who can work with clients in Colorado and most other states.

IMPORTANT:
It’s impossible to cover every detail and topic in a video like this. The only thing that’s certain is that you need more information than this. Always consult with a CPA before making decisions or filing a tax return. This is general information and entertainment, and is not created with any knowledge of your circumstances. As a result, you need to speak with your own tax, legal, and financial professional who is familiar with your details. Please verify with your plan administrator when employer plans are involved. This information may have errors or omissions, may be outdated, or may not be applicable to your situation. Investments are not bank guaranteed and may lose money. Opinions expressed are as of the date of the recording and are subject to change. The Comments section contains opinions that are not the opinions of Approach Financial, Inc., and you should view all comments with skepticism. Approach Financial, Inc. is registered as an investment adviser in the state of Colorado and is licensed to do business in any state where registered or otherwise exempt from registration….(read more)

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