How a Mega Backdoor Roth Can Accelerate Your Retirement Savings, #87
401k and IRA contribution limits can stand in the way of trying to save a lot of money in a short amount of time. If you got a late start on retirement planning and you’re trying to save as much money as possible in a tax-advantaged way, this episode is for you! I’m going to tell you all about the Mega Backdoor Roth IRA: what it is, how it works, who should consider it, and what the alternatives are if you don’t qualify.
You will want to hear this episode if you are interested in...
What is a Mega Backdoor Roth IRA? [1:08]
How a Mega Backdoor Roth IRA works [3:10]
Who should take advantage of a Mega Backdoor Roth IRA? [9:37]
Alternative options if you don’t qualify for the Mega Backdoor Roth IRA [11:47]
Understanding traditional Roth accounts
Before diving into what a Mega Backdoor Roth IRA is and how it accelerates retirement savings, we need to understand how a traditional Roth account works. With both a Roth 401k and Roth IRA, you contribute money that you’ve already paid taxes on, allowing it to grow and be withdrawn tax-free. While Roth 401ks are pretty straightforward, Roth IRA contributions are a bit trickier because they depend on your adjusted gross income (AGI) and your tax filing status. For example, the 2022 AGI for those filing as single needs to be under $129,000 to make the full contribution. Additionally, people who are married and file jointly need an AGI under $204,000 to do the same. You can also convert traditional 401k and IRA money over to a Roth IRA by paying taxes on it at your current rates.
There are also limits to how much you can contribute to both accounts. If you are over 50 years old, you can contribute up to $27,000 to a Roth 401k and $7,000 to a Roth IRA. Those under 50 can contribute up to $20,500 and $6000, respectively. These limits pose a potential problem for those who waited for retirement planning and need to increase their saving power. That’s why a Mega Backdoor Roth account might be your next best option!
Using a Mega Backdoor Roth IRA
To determine if you’re eligible for a Mega Backdoor Roth account, you need to make sure your company allows for after-tax contributions and in-service withdrawals on your traditional 401k. The next thing to look at is the total profit sharing contribution limit. This limit is the combined contributions of what you and your employer make. Pending eligibility, those under 50 can save up to $61,000 while those over tap out at $67,500, depending on your specified limit.
The final step to setting up this account would be converting the money over to a Roth IRA as soon as possible. This is why you need in-service withdrawals! Transferring the money out of your pre-tax 401k account into a Roth IRA means you would benefit from the tax-deferred growth that occurs on top of whatever amount you are contributing. To learn more information about Mega Backdoor Roth IRAs and alternative options for those who don’t qualify, listen to this episode!