Does your income prohibit you from making regular Roth IRA contributions? Kerstin Wiles, wealth advisor, shares why a mega backdoor Roth IRA may be a tax-friendly solution.

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Mega Backdoor Roth IRA Tip: Explained

Saving for retirement is crucial, but it’s not always easy. Between bills, mortgage payments, and unexpected expenses, setting aside money can be a challenge. Fortunately, there are several options for increasing your retirement savings, including the Mega Backdoor Roth IRA.

The Mega Backdoor Roth IRA is a lesser-known retirement savings strategy that allows individuals to make additional after-tax contributions to their traditional 401(k) or similar employer-sponsored plans. The contributions can then be rolled over into a Roth IRA, which has several benefits.

The primary advantage of a Roth IRA is that it allows your contributions to grow tax-free. You won’t have to pay taxes on any investment earnings or withdrawals in retirement, which can save you a substantial amount of money over time. Roth IRAs also don’t have required minimum distributions (RMDs) like traditional IRAs, which means you can keep your money in the account past age 72.

Here’s how the Mega Backdoor Roth IRA works:

Step 1: Maximize Your 401(k) Contributions

Before you can make after-tax contributions to your 401(k), you’ll need to contribute up to the annual limit, currently $19,500 for those under 50 and $26,000 for those over 50. This limit includes any contributions your employer may make on your behalf.

Step 2: Understand Your Plan’s Contribution Limits

Next, you’ll need to understand your plan’s contribution limits. These limits vary by employer and plan, so you’ll need to check with your HR department or plan administrator to determine how much you can contribute.

Step 3: Make After-Tax Contributions

After you’ve hit the pre-tax contribution limit, you can begin making after-tax contributions. The amount you can contribute will depend on your specific plan, but it could be up to $57,000 for 2020.

Step 4: Roll Over After-Tax Contributions to a Roth IRA

Once you’ve made after-tax contributions, you can roll them over to a Roth IRA, either through an in-plan conversion or by transferring the money to an outside Roth IRA account. If you choose to do an in-plan conversion, you won’t have to pay taxes on the conversion as long as you don’t have any pre-tax money in your account.

Conclusion

The Mega Backdoor Roth IRA can be a game-changer for savers looking to maximize their retirement savings. By making after-tax contributions to your employer-sponsored plan and then rolling them over to a Roth IRA, you can take advantage of tax-free growth and potentially save thousands in taxes over time. Be sure to consult with a financial advisor to determine if this strategy is right for you.