Saving money for retirement is something every person in the current workforce should consider. After all, having a retirement fund can be the difference between living comfortably and struggling to get by. An IRA, 401k, and other accounts can help you save money for your golden years.
However, what if your situation is unique? Optimizing retirement funds and catching up on savings are typical desires for people seeking financial security. Let’s look at how a Mega Backdoor Roth IRA can impact your situation.
Explaining a Traditional, Roth, and 401k Account
Before getting too involved with the concept of a Mega Backdoor Roth IRA, it’s necessary to consider the typical accounts people use for retirement.
401K
A 401k is a relatively straightforward account compared to the rest. Put simply, a 401k is an employer-sponsored pension account funded by a worker’s earnings and often matched by the employer. The 401k retirement account can be a traditional or Roth account.
Traditional IRA
Unlike a 401k, an IRA is an individual account not tied to an employer. A person can contribute to the IRA outright. Traditional IRAs are usually tax-deductible, but there is a limit to how much a person can contribute; for 2021, the limit is $6,000 per year unless you’re over 50, then it’s $7,000. You pay income tax on the money when you withdraw the money later.
Roth IRA
Like the traditional IRA, the Roth IRA is an investment vehicle established by an individual, often with the help of a financial specialist. The Roth IRA is unique because it allows you to pay taxes on your investment beforehand, so your withdrawals are free after you’ve retired.
How Does a Mega Backdoor Roth Work?
The Roth IRA vehicle comes with some drawbacks. Your contributions are limited if you have an adjusted gross income (AGI) of over $125,000 as a single person, and you can only add $6,000 or $7,000 per year.
Individuals with an income too high for regular Roth IRA contributions have used a Backdoor Roth. They use it to roll money from a traditional IRA to a Roth, taking advantage of the lack of contribution limits.
The process is complex and results in the user paying taxes on the money converted to a Roth and any investment gains made on the money while it was in the traditional IRA.
The Mega Backdoor Roth takes that process a bit further. Suppose an individual has a 401k plan at work with allowances for after-tax contributions. They also have the option for in-service distributions (moving money while still working for the company) and extra money to invest. In that case, they can attempt to put together a Mega Backdoor Roth IRA that results in an additional $38,500 in yearly contributions.
Who Can’t Use a Mega Backdoor Roth IRA
The rules on a Mega Backdoor Roth are strict, so you must accomplish the following before considering this financial vehicle:
- Max out your IRA and 401k contributions (a total of $19,500 for your 401k and $6,000 for your IRA
- You meet the income limitations
- Your employer must offer after-tax 401k contributions
If you have all the following and want to pump up your savings, you should consider investigating the swap to this plan.
Establishing a Mega Backdoor Roth IRA is even more complicated than its name. You will almost certainly need the help of benefits experts to help you make sense of all the moving pieces in this scenario.
Remember, this tool is not suitable for everyone, but it’s worth considering if you meet all the requirements.
