Breaking the Code: Retirement Strategies with Mega Backdoor Roths
By: Justin Lin, Associate
Regardless of your age as you read this, it’s always a good time to start thinking and planning for retirement. Fortunately, there are many tax-advantaged options that can help you save the amount you need for retirement.
Backdoor Roth IRA Conversion
While taxpayers with higher income levels are not allowed to contribute directly to Roth IRA accounts, they can still take advantage of these accounts by utilizing this option. Taxpayers can make a non-deductible contribution to a traditional IRA and immediately convert it to a Roth IRA. These contributions are limited to $6,000 for 2022 ($7,000 if 50 or older). In order for this to not result in any additional tax liability, the taxpayer should not have any Traditional IRA or SEP IRA balances (though traditional 401(k) balances are OK).
Mega Backdoor Roth IRA Conversion
Since many would like to utilize over the annual contribution limit, this is where the aptly named mega backdoor Roth comes into play. First and foremost, taking advantage of this strategy hinges on your employer-sponsored 401(k) meeting the following criteria:
Allows conversion to Roth / in-service distributions
Allows non-deductible / post-tax contributions
If you’re lucky enough to utilize this strategy, you could contribute up to $40,500 to a Roth IRA or Roth 401(k) in 2022 - all of which would grow tax-free. So how exactly could you contribute almost 7x the normal contribution limit? Here’s an example along with the steps involved to execute the mega backdoor Roth.
Example: You are under 50, with a salary of $150,000. Your employer offers the mega backdoor Roth and matches 3% of your salary. If you maximize your pre-tax contribution, the total pre-tax contribution would be calculated as $20,500 + (3% * $150,000) = $25,000. The maximum post-tax contribution you could then make is the maximum annual limit of $61,000 less $25,000 pre-tax contribution = $36,000 of post-tax contributions. At this point, you have maximized your pre-tax contribution of $25,000 plus your post-tax contribution of $36,000. Then you immediately rollover the $36,000 to a Roth IRA and $25,000 to a traditional IRA. The $36,000 would grow tax-free and the $25,000 bucket would grow tax-deferred.
To execute, please review the following steps:
1) Confirm your employer’s plan offers both post-tax contributions and in-service distributions.
2) Calculate your employee pre-tax contribution. For 2022, the pre-tax contribution is capped at $20,500 ($27,000 if 50 or older).
3) Calculate your employer match on your employee contribution from #2.
4) Add items #2 and #3 - this is your total pre-tax contribution.
5) Take the total annual 401(k) contribution limit for the year of $61,000 ($67,500 if 50 or older and subtract the total pre-tax contribution (item #4). This is your post-tax contribution amount.
6) Take a total distribution of all post-tax and pre-tax amounts in your 401(k), convert the post-tax amounts to a Roth IRA, and convert the pre-tax amounts to a traditional IRA
Feel free to reach out so we can help you determine the best options for your individual situation.
To ensure compliance with the requirements imposed on us by IRS Circular 230, we inform you that any tax advice contained in this communication (including any attachments) is not intended to and cannot be used for the purpose of: (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.