If you’re like me, you love the idea of having tax-free income in retirement from a Roth IRA. That can help you stretch your savings much farther after you stop working. However, there’s a catch: if you earn too much, you can’t contribute to a Roth IRA.
But the good news is that you can still get Roth benefits, even as a high earner, using a “mega backdoor Roth.” It can help you save much more for retirement and make entirely tax-free withdrawals! This post will review how it works and who can take advantage of a mega backdoor Roth, plus more Roth strategies, when possible.
What is a Roth IRA?
If you’ve been a Money Girl podcast listener or have read any of my books, you probably know that a Roth IRA is an individual retirement account. It requires you to make nondeductible, after-tax contributions. Its tax benefits come in retirement when you can take withdrawals that are entirely tax-free.
If you follow some simple rules, you could have colossal investment growth in your Roth and skip paying tax on it. Those tax savings could be massive, depending on your account earnings.
Another Roth IRA benefit is that you can withdraw your original after-tax contributions at any time penalty-free because they were previously taxed. Taking earnings from a Roth IRA would be subject to income tax and an additional 10% penalty if you’re younger than 59.5.
However, your contributions and earnings are tax-free if you have owned the account for five years and are over 59.5. That gives you a lot of flexibility with a Roth IRA that isn’t possible with other retirement accounts.
Another benefit is that, unlike traditional retirement accounts, Roth accounts have no required minimum distributions (RMDs) at any age. Therefore, you, not the IRS, control when and how much to take from your retirement account. You can take tax-free money from a Roth as needed or let it grow tax-free indefinitely for you or your heirs.
For 2024, the maximum IRA contribution is $7,000 or $8,000 if you’re over 50. You can make IRA contributions if you have earned income, no matter your age, up to your tax filing deadline for the prior year.
SEE ALSO: 10 IRA Facts Everyone Should Know
Who qualifies for a Roth IRA?
Since a Roth IRA offers many excellent tax benefits, the rules were created to shut out high-earners. So, if you exceed an annual income threshold, you become ineligible for regular “front door” contributions. And by the front door, I mean directly contributing to a Roth IRA using an after-tax source, such as your checking or savings account.
For 2024, the Roth IRA income cutoff for singles happens when you have a modified adjusted gross income (MAGI) of $161,000 or higher. Married couples filing joint taxes can’t contribute to a Roth IRA when their household MAGI is $240,000 or above. But I’ll explain ways to get around the income thresholds and legally boost your Roth funds anyway!
Note that there are no income limits if you have a Roth at work, such as a Roth 401(k) or Roth 403(b). That’s why I encourage you to use it for all or a portion of your retirement contributions when possible. The long-term tax benefits of a Roth are just too good to pass up.
Laura answers a listener’s question about choosing a traditional or Roth retirement account at work. Listen in the player below:
Should you have a traditional or Roth retirement account?
I want to review some considerations if you’re unsure about choosing a traditional or Roth retirement account.
I mentioned RMDs with traditional retirement accounts. Depending on your account balance, they could be hundreds of thousands of dollars per year and will get taxed as ordinary income.
Having extra RMD income could even result in paying taxes on most of your Social Security retirement benefits and increasing your monthly Medicare costs. However, Roth accounts have no RMDs and are tax-free, eliminating these potential tax side effects.
If you believe your income in retirement will be higher than today, using a Roth is wise. You’ll pay a lower tax rate today instead of a higher one in retirement. Even if your income in retirement won’t be higher, you might strongly believe tax rates for all Americans will rise in the future.
Or, you don’t want the hassle of paying income taxes to the federal and state governments (depending on where you live) on your future retirement income. All those situations or beliefs are reasons to favor loading up one or more Roth accounts.
What is a mega backdoor Roth conversion?
If I’ve convinced you that putting more money in a Roth is good for your situation, you may wonder how. If your income is below the thresholds I mentioned, you can make direct Roth IRA contributions up to $7,000 or $8,000 for 2024.
But if your income makes you ineligible, or you want to make higher Roth contributions, the mega backdoor Roth could be a legal workaround. It requires the following steps:
- Make after-tax contributions to a traditional workplace retirement plan.
- Convert your after-tax contributions to a Roth.
For the first step, you must be enrolled in a workplace retirement plan, such as a 401(k) or 403(b). And that plan must allow after-tax contributions, which is not the same as making a Roth 401(k) or 403(b) contribution.
If your plan allows after-tax contributions, that may enable you to save more than the typical annual limit. For 2024, you can contribute up to $23,000 or $30,500 if you’re over 50, in pre-tax or Roth contributions to a workplace retirement plan.
But the rules say you or your employer can contribute up to $69,000 or $76,500 if you’re over 50 in all types of workplace contributions, not exceeding your annual income. That leaves an additional $46,000 in potential after-tax contributions, which could come from you or your employer.
For example, if you’re under 50 and make $100,000, you could contribute an additional $46,000 to your retirement plan at work. The math is $69,000 minus $23,000 in pre-tax or Roth contributions, leaving $46,000 for after-tax contributions.
But if you’re under 50 and make $60,000, you could only put in an additional $37,000 ($60,000 – $23,000 = $37,000) in after-tax contributions. Again, your contributions can’t exceed your income.
That brings us to the second step, converting your after-tax contributions to a Roth account. If you have a Roth option at work, you may be able to convert after-tax amounts from your traditional 401(k) directly to your Roth 401(k), known as an in-plan Roth conversion.
Or, if your workplace plan allows it, you may be able to roll over your after-tax contributions to a Roth IRA, known as an in-service withdrawal.
Whether you convert after-tax workplace contributions to a Roth 401(k) or Roth IRA, there would be no taxes except any earnings on the contributions. But if you do a rollover quickly, there should be minimal account gains for taxation.
To sum up, being eligible for a mega backdoor Roth depends on what your workplace retirement plan allows. You can use this advanced strategy if you can make after-tax contributions and do an in-plan Roth conversion or an in-service rollover.
Some plans may allow an in-plan conversion but not an in-service IRA rollover. If your plan doesn’t allow either, you’ll have to wait until after you leave the company to do a mega backdoor Roth conversion. So, review your plan documents or speak with your benefits administrator about what’s possible.
If you can set up a mega backdoor Roth, you’ll make after-tax contributions to your retirement plan and periodically roll them over to your Roth at work or Roth IRA. Some plans have a feature that automatically converts after-tax funds at regular intervals.
RELATED: Roth IRA vs Roth 401(k)–10 Differences Investors Should Know
Should I do a mega backdoor Roth conversion?
Whether mega backdoor Roth conversions are right for you depends on factors including:
- What financial goals you have.
- What your workplace retirement plan allows you to do.
- How much you’ve already saved in Roth accounts.
- How much you’re currently saving for retirement.
- What your tax rate in retirement could be compared to your current rate.
- How a Roth conversion would affect your taxes.
- Whether you already have both pre-tax and after-tax amounts in the account, making distributions subject to the IRS pro-rata rule,
To sum up, with a mega backdoor Roth, you can contribute up to an additional $46,000 for retirement in 2024. That’s on top of your regular plan limits of $23,000 or $30,500 if you’re over 50.
SEE ALSO: Your Complete Guide to 401(k) Retirement Accounts
How do you make Roth contributions without a workplace retirement plan?
If you earn too much to contribute directly to a Roth IRA but don’t have a workplace Roth, here are three legal ways to boost a Roth IRA.
-
Max out a Roth IRA in any years you qualify.
If your income dips for any reason, such as getting laid off, not receiving a bonus, or having a less profitable business or side gig, you might qualify for a Roth IRA.
-
Make backdoor Roth IRA contributions.
Everyone qualifies to make backdoor Roth IRA contributions using after-tax funds you contribute to a traditional IRA and then roll over to a Roth IRA. Note that the pro-rata rule also applies here.
-
Do Roth IRA conversions.
With a Roth IRA conversion, you move funds from a pre-tax source, such as a traditional IRA, to a Roth IRA and pay income taxes on the full amount. There are no annual income limits or contribution limits on Roth conversions.
In other words, you can convert as much as you like from traditional to Roth accounts each year, and the IRS will happily take your income taxes, no matter how much you earn.
For example, if you want to convert $50,000 from your traditional IRA to your Roth IRA, your annual taxable income increases by $50,000, significantly increasing your tax liability. If you’re in the 22% tax bracket, you’d owe up to $11,000 on the conversion–but it could be more if the extra income pushes you into the next higher tax bracket.
To learn more about these three ways to boost your Roth savings, check out Money Girl episode 768, Too Rich for a Roth IRA? 3 Legal Ways to Have One.
Speaking to a tax pro or financial advisor before making retirement account moves is always best. Get guidance on whether paying taxes now is worthwhile in exchange for future tax-free Roth benefits.