Roth IRAs are a popular type of retirement account because of the favorable tax treatment they provide. Once a post-tax deposit is made, it grows tax free and can be withdrawn tax free after age 59 ½, assuming you have owned the account for at least 5 years. In addition, funds in a Roth IRA are not subject to Required Minimum Distributions (RMDs) beginning at age 73. One issue is that high earners are excluded from contributing to a Roth. Individuals with modified adjusted gross income (MAGI) over $161,000 or married couples filing jointly with MAGI over $240,000 cannot contribute to a Roth IRA.
The Backdoor Roth is a strategy (not a different type of account), that allows those with incomes exceeding the above limits to contribute to a Traditional IRA and then convert the funds to a Roth IRA. The contribution to the Traditional IRA must be non-deductible) and is subject to current limits. For 2024, the combined limit for contributions to any type of IRA is $7000 for those under 50, and $8,000 for those 50 and above. Once the contribution is made, it is immediately rolled into a Roth IRA. It is important to do the rollover before any earnings are created in the Traditional IRA or they will be subject to income tax. If the contributor has multiple Traditional IRAs the contribution will be subject to the pro-rata rule, which could result in a large portion of the contribution being subject to income tax. It is usually advisable to work with a financial planner or CPA when executing a complex strategy with potential tax ramifications.
The Mega Backdoor Roth allows some to leverage their workplace retirement account for even greater conversion opportunities. If your workplace account allows post-tax contributions, your total contribution limit increases from $23,000 pre-tax, to $69,0000 total, allowing a $46,000 post tax contribution. For those over 50, the limits are $30,500 pre-tax and $76,500 post-tax. In addition, this strategy requires the workplace account to offer a Roth 401(k) with the option for in-plan Roth conversions. While it is more complicated, the Mega Backdoor Roth exponentially increases one’s ability to utilize tax free withdrawals during retirement. As stated earlier, it is best to work with a qualified professional when executing complex strategies.
When assisting clients in planning for retirement, I recommend having both tax free and taxable accounts. This allows clients to manage their annual tax bill by choosing the accounts from which they withdraw. In addition, your principal contributions made to a Roth IRA can be withdrawn penalty free prior to age 59 ½ if necessary. While I never recommend early withdrawals from retirement accounts, it could help in an emergency or help to bridge the gap to 59 ½ when retiring early. If you have questions about Backdoor Roth IRAs, or any other financial planning matters, please reach out through this link. I provide financial planning services locally in Bentonville, AR and virtually anywhere in the United States.