Retirement Planning

Mega Backdoor Roth Conversions

Mega backdoor Roth conversions give high-income earners an opportunity to participate in after-tax savings and tax-free investing. This strategy is available to individuals that participate in a qualified retirement plan, such as a 401(k), that allows after-tax contributions to the plan.

Who Should Consider a Mega Backdoor Roth Conversion

A mega backdoor Roth conversion may benefit individuals who are:

  • High income-earners with sufficient cash flow.
  • Employees who can maximize retirement plan deferrals and still have a desire and ability for further savings.
  • Sole proprietors with solo 401(k) plans.
  • Individuals who expect to be in a high tax bracket in their retirement years and therefore want to accumulate retirement savings in a Roth IRA.

What is a Roth IRA?

A Roth IRA is a tax-free retirement account. Contributions to Roth accounts are made with after-tax dollars, the investments grow tax-deferred, and so long as distributions are qualified, taxes are not due at distribution. Unlike traditional retirement accounts, Roth IRAs do not have required minimum distributions beginning at age 72.1

Benefits of a Mega Backdoor Roth Conversion

A limitation of Roth IRAs is that contribution eligibility is phased out for individual taxpayers with income between $125,000 and $140,000 and is phased out between $198,000 and $208,000 for taxpayers married filing jointly.2 As a workaround, high-income earners may be familiar with making nondeductible IRA contributions then facilitating a backdoor Roth conversion. However, this strategy is subject to the annual IRA contribution limit of $6,000 plus a $1,000 catch-up contribution for those over age 50.3 The mega backdoor Roth, on the other hand, converts after-tax contributions to a qualified plan up to a limit of $58,000 in 2021 or $64,500 for those over age 50.

How Does a Mega Backdoor Roth Conversion Work?

Before taking advantage of the mega backdoor Roth opportunity, an individual must verify that their qualified plan allows for after-tax contributions and whether the plan allows in-service distributions. Here is how the mega backdoor Roth conversion works at a high level:

  1. The plan participant defers up to the annual limit set by Section 402(g) of the Internal Revenue Code ($19,500 in 2021 or $26,000 if over age 50).4
    The deferrals can be either tax-deductible or Roth deferrals.
  2. The participant receives any employer matching and/or non-elective contributions.
  3. Participants then contribute the difference between the total of the employee deferrals plus employer contributions up to the Section 415 limit ($58,000 or $64,500 for those over age 50) as an after-tax contribution to the plan.

The after-tax contribution is converted into a Roth in the same year the taxes are paid. The Roth conversion can occur within the 401(k) plan if the employer offers a Roth 401(k). If the employer offers in-service withdrawals, the after-tax contribution can be rolled out into a Roth IRA.

Before initiating a mega backdoor Roth conversion, we recommend confirming the process with your wealth manager or tax adviser and your plan administrator.

Please contact us if you have any questions about this topic or other wealth management subjects!

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Alyssa Yocom is a Wealth Manager with Schultz Financial Group Inc.

Schultz Financial Group Inc. (SFG) is a wealth management firm located in Reno, NV. Our approach to wealth management is different from many other wealth managers, financial advisors, and financial planners. Our team of fee-only fiduciaries strives to help our clients build their wealth across four capitals: Financial Matters, Physical Well-being, Psychological Space, and Intellectual Engagement. We provide family office and wealth management services to clients located in Nevada, California, and other states. If you’d like more information, please check out our website or reach out to us via our contact page.

 

[1] https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions

[2] https://www.irs.gov/newsroom/income-ranges-for-determining-ira-eligibility-change-for-2021

[3] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

[4] https://www.irs.gov/retirement-plans/401k-plans-deferrals-and-matching-when-compensation-exceeds-the-annual-limit#:~:text=Compensation%20and%20contribution%20limits%20are,g)%20and%20414(v))

  • Schultz Financial Group, Inc. (“SFG”) which is a registered investment adviser, drafted this blog post for its website and for the use of its clients or potential clients. Any other distribution of this blog post is strictly prohibited. Registration as an investment adviser is not an endorsement by securities regulators and does not imply that SFG has attained a certain level of skill, training, or ability. While the content presented is believed to be factual and up to date, it is based on information obtained from a variety of sources. SFG believes this information is reliable, however, it has not necessarily been independently verified. SFG does not guarantee the complete accuracy of all data in this blog post, and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of SFG as of the date of publication and are subject to change. This blog post does not constitute personalized advice from SFG or its affiliated investment professionals, or a solicitation to execute specific securities transactions. SFG is not a law firm and does not intend for any content to be construed as legal advice. Readers should not use any of this content as the sole basis for any investment, financial planning, tax, legal or other decisions. Rather, SFG recommends that readers consult SFG and their other professional advisers (including their lawyers and accountants) and consider independent due diligence before implementing any of the options directly or indirectly referenced in this blog post. Past performance does not guarantee future results. All investment strategies have the potential for profit or loss, and different investments and types of investments involve varying degrees of risk. There can be no assurance that the future performance of any specific investment or investment strategy, including those undertaken or recommended by SFG, will be profitable or equal any historical performance level. Any index performance data directly or indirectly referenced in this blog post is based on data from the respective copyright holders, trademark holders, or publication/distribution right owners of each index. The indexes do not reflect the deduction of transaction fees, custodial charges, or management fees, which would decrease historical performance results. Indexes are unmanaged, and investors cannot invest directly in an index. Additional information about SFG, including its Form ADV Part 2A describing its services, fees, and applicable conflicts of interest and Form CRS is available upon request and at https://adviserinfo.sec.gov/firm/summary/108724.

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