Roth IRAs are one of the greatest gifts ever given to retirement savers.
They enable individuals who qualify to enjoy tax-free withdrawals of their money after they retire, or even earlier in some situations. This can help retirees stretch their savings even further.
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But there’s one big catch when it comes to Roth IRAs.
If you earn too much money, you can’t open or contribute to one. You cannot open or contribute to a Roth IRA if your modified adjusted gross income (MAGI) is:
- $139,000 or more in tax year 2020 ($140,000 in tax year 2021) if you’re single
- $206,000 or more in tax year 2020 ($208,000 or more in tax year 2021) if you’re married and file jointly
But there’s good news. You can still reap the benefits of a Roth account even if your income exceeds these limits by using a technique known as a mega backdoor Roth. This strategy may enable you to sock away tens of thousands of dollars more for retirement this year.
Read More: Roth IRA vs. Roth 401k: How Are They Different?
How Does a Mega Backdoor Roth Work?
Here’s how the process works. If you can check the box on each of the following conditions, then you may qualify to for a mega backdoor Roth IRA.
- Determine the maximum after-tax contribution you can to your traditional 401k account. Make that contribution.
- Roll over or convert this amount to a Roth IRA or Roth 401k. Unlike with a normal Roth IRA conversion, the principal will not be taxable. However, the earnings portion of the rollover will be considered pre-tax and subject to taxation at time of the conversion.
Are You Eligible?
You can only perform a mega backdoor Roth under the following conditions.
- You participate in a 401k plan at work that allows after-tax contributions. Regular 401k contributions are made on an elective deferral, or pre-tax, basis. Fewer than half of 401k plans allow after-tax contributions, so check with your benefit plan administrator before moving forward.
- The 401k plan allows in-service distributions to a Roth IRA or transfer of funds out of the after-tax portion of the account into a Roth 401k. If it doesn’t, you’ll have to wait until after you leave the company to perform a mega backdoor Roth.
How Much Can You Contribute?
With a mega backdoor Roth, you may be able to contribute an additional $37,500 toward your retirement this year — on top of the regular plan contribution limits. If you have access to a Roth 401k at work, you can decide whether to roll over the funds into this Roth 401k or a separate Roth IRA. If your employer only offers a traditional 401k, then you’ll roll over the funds into a Roth IRA.
The bottom line: If you are unable to contribute to a Roth IRA because you earn too much money, or if you still have money left over to save for retirement after maxing out your traditional 401k and IRA, then a mega backdoor Roth might be a smart strategy for you.
The details in performing a mega backdoor Roth can be complex, so you should consult with your financial and tax advisors for guidance in your situation.
Suggested Next Steps for You
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- Sign up for Personal Capital’s free financial tools so you can track all of your accounts, including your retirement accounts, in one place. The tools will also help you spot inefficiencies, like where you may be paying too much in fees, or where you may be taking too much risk.
- Download your free guide to managing tax burden as an investor.
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We are not licensed tax professionals. All insight provided represents a courtesy extended to you for educational purpose and you should not rely on this information as the primary basis of your tax planning decisions. You should consult qualified legal or tax professional regarding your specific situation.
