Retirement Planning

Mega Backdoor Roth Conversions

At Schultz Financial Group (SFG), we view wealth differently through our Four Capital approach. Our team works with you to build your wealth across Four Capitals – Financial Matters, Physical Well-being, Intellectual Engagement, and Psychological Space. This post provides an overview of 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 financial advisor or tax adviser and your plan administrator.

Please contact us if you have any questions about this topic or other retirement planning questions!

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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))

  • The information contained within this blog is for informational purposes only and is not intended to provide specific advice or recommendations. If third party products or services are referenced in the above blog post, then Schultz Financial Group is providing that information for informational purposes only and is not recommending or endorsing any third-party products or services. Please remember that past performance does not guarantee future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Schultz Financial Group Incorporated), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Schultz Financial Group Incorporated. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Schultz Financial Group Incorporated is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Schultz Financial Group Incorporated’s current written disclosure statement discussing our advisory services and fees is available for review upon request. Please Note: Schultz Financial Group Incorporated does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Schultz Financial Group Incorporated’s web site or incorporated herein, and takes no responsibility therefore. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

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