Backdoor Roth IRA & Mega Backdoor Roth: The Secret Strategy to Unlock Tax-Free Wealth

We are going to take a look at the backdoor Roth IRA and the mega backdoor Roth strategies that will help you legally get around the income limits that prevent you from owning a Roth IRA. Some people might use different terms to describe these strategies but your final result will be the same. These backdoors are not any type of special account or anything like that. High earners like to use this strategy because they want to have the tax-free growth of a Roth account.
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00:00 – Why use a backdoor Roth IRA or mega backdoor Roth
00:35 – Future of the backdoor Roth
01:08 – Backdoor Roth IRA strategy
01:50 – Ways to backdoor into a Roth
03:08 – Mega backdoor Roth
03:50 – What are after-tax contributions
05:05 – Mega backdoor requirements
05:30 -Steps to do a mega backdoor
08:10 – Mega backdoor example
10:34 – Leaving your Roth to your heirs

TRANSCRIPT:
A basic backdoor Roth IRA is done by converting a traditional IRA to a Roth IRA. Unlike a Roth IRA, a traditional IRA does not have an income limit, so as a workaround, you can contribute to a traditional IRA first and then convert. When you convert your traditional IRA, you will pay taxes on the entire amount. This would be your contributions, earnings, AND growth. After you convert, your account will be like any other Roth IRA.

There are four ways that you might be able to backdoor your way into a Roth. For a basic backdoor, you can:
1. Contribute funds to your existing traditional IRA and then roll it over
2. Rollover a portion of your current traditional IRA or convert the entire amount
3. Rollover a self-employed plan such as a solo 401k, SEP, or Simple
4. Rollover your 401(k) or 403(b). If you want to rollover funds from your 401(k) while still employed with the same employer, the plan has to allow conversions to your employer’s Roth 401(k) plan or to an outside Roth IRA.

The mega backdoor strategy is a workaround to make larger contributions than the annual elective deferral limits at your job. Some employers have before-tax plans; after-tax plans and Roth plans. A mega backdoor is done by using after-tax contributions. In order to use a mega backdoor, your employer would have to allow you to convert your after-tax contributions to a Roth. Unfortunately, most companies don’t offer conversions. Usually, only large employers like AT&T will offer conversions. If you are self-employed, you have control to set up your own plan. You can establish a plan such as a solo 401k to allow conversions and tailor the plan to meet all of the qualifications needed to do a mega backdoor.

After-tax contributions are somewhat like a mix between before-tax contributions and Roth contributions. Roth contributions and the earnings on the contributions are not taxed when you withdraw the funds during retirement. With before-tax contributions, you pay taxes on the contributions and earnings when you withdraw the funds during retirement. With after-tax contributions, you can withdraw the CONTRIBUTIONS tax-free at any time but when you withdraw the earnings, you will have to pay taxes and there may be a federal tax penalty if you withdraw your earnings before age 59 and 1/2. Whenever you withdraw after-tax contributions, you also have to withdraw the earnings. You can’t just elect to withdraw the contributions. But, if you convert your after-tax contributions to a Roth, you won’t pay any taxes on the earnings received after the conversion. This is the MAJOR benefit of converting your after-tax contributions.

For the mega backdoor strategy to work, you need to have the following:
a. be able to contribute to your employers 401k or 403b plan
b. Your employer has to offer a Roth option
c. the plan must offer after-tax contributions
d. The plan must allow you to convert your prior contributions to a Roth inside the plan or allow you to roll your money to an outside Roth IRA while you are still participating in your employer’s plan

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Backdoor Roth IRA & Mega Backdoor Roth: The Secret Strategy to Unlock Tax-Free Wealth

When it comes to building wealth, there are countless strategies and financial instruments available. However, one strategy that has gained attention and popularity in recent years is the Backdoor Roth IRA and its more advanced cousin, the Mega Backdoor Roth. These strategies have become a secret weapon for individuals looking to maximize their tax advantages and accumulate tax-free wealth over time. So, what exactly are these strategies, and how can you use them to your advantage?

First, let’s start with the basics. A Roth IRA is an individual retirement account that allows you to contribute after-tax dollars that grow tax-free and can be withdrawn tax-free during retirement. However, there are income limits that prevent high earners from directly contributing to a Roth IRA. This is where the Backdoor Roth IRA strategy comes into play.

The Backdoor Roth IRA allows individuals who exceed the income limits to still contribute to a Roth IRA indirectly. Here’s how it works: you make a non-deductible contribution to a Traditional IRA, and then convert those funds into a Roth IRA. Since the original contribution was made with after-tax dollars and the conversion is allowed regardless of income, you effectively bypass the income limits and create a tax-free bucket of money for your retirement.

While the Backdoor Roth IRA strategy is an excellent way to take advantage of the Roth IRA benefits, it does come with a couple of caveats. Firstly, if you already have a significant amount in a Traditional IRA, the conversion process may trigger taxes on the pre-tax amounts in that account. Additionally, if you have multiple Traditional IRA accounts, it’s important to pro-rata the conversion to ensure the tax implications are properly calculated.

Now, let’s move on to the more advanced strategy: the Mega Backdoor Roth IRA. This strategy is designed for high earners who have access to an employer-sponsored retirement plan, such as a 401(k) or 403(b). These plans allow individuals to contribute significantly more than the annual contribution limit imposed on Traditional and Roth IRAs.

The Mega Backdoor Roth IRA takes advantage of an additional provision some employer plans offer, allowing after-tax contributions beyond the annual limit. Once these after-tax contributions are made, individuals can convert them into a Roth IRA, creating another tax-free savings vehicle. The key benefit is that this strategy allows for much higher annual contributions, potentially reaching up to $58,000 in 2021.

While the Mega Backdoor Roth IRA strategy can be highly rewarding, it’s important to note that not all employer plans allow for after-tax contributions or in-service conversions. Consult your plan administrator or HR department to determine if your plan offers these options.

Both the Backdoor Roth IRA and the Mega Backdoor Roth offer individuals an opportunity to accumulate significant tax-free wealth over time. These strategies effectively allow you to bypass income limits and take full advantage of the tax benefits that a Roth IRA provides.

However, it’s essential to consult with a financial advisor or tax professional before implementing these strategies. They can help you navigate the complexities of the tax code and ensure that you’re maximizing your benefits while staying compliant with all regulations.

In conclusion, the Backdoor Roth IRA and the Mega Backdoor Roth are powerful strategies for individuals looking to unlock tax-free wealth accumulation. By bypassing income limits or leveraging employer-sponsored retirement plans, you can create substantial savings in a tax-efficient manner. With careful planning and expert guidance, you can take advantage of these secret strategies to build a more secure financial future.