A big topic of financial writing these days is The Mega Back Door Roth. Sounds like a King Kong type of movie and coincidentally has about as much use in most people’s financial knowledge as a giant ape movie in an Oscar race.
As discussed in the previous blog, a back door Roth IRA contribution is a way for those who earn too much money to just write a check each year into a Roth IRA can get around the income limitation rules. The Mega Back Door Roth conversion is another such tool, but only a very tiny percentage of savers can use it.
Before reading further, ask yourself this: Do I participate in a 401(k) that offers after tax contributions?
AND this question: Does your 401(k) offer in-service distributions to a Roth IRA or in-plan conversions to a Roth IRA? This is an HR question if you don’t know.
If the answer to either of these is “no,” stop reading and pay no attention to future headlines you see talking about this strategy.
If the answer is yes, (or you just are a glutton for financial article punishment), read on. 401(k)s allow for up to $58,000/year in total additions ($64,500 if you are 50 or older). This includes your usual employee deferred or Roth contributions plus any match or profit sharing money your company may add.
If all of that adds up to less than $58,000, you can put the difference into the plan as an after-tax contribution. Normally, the growth of that after-tax contribution would be tax-deferred.
However, if you employer allows for in-plan Roth conversions or in-service distributions to a Roth IRA, you can immediately move that money (before you start accumulating earnings) to a Roth bucket. This will give you the lovely tax-free growth that you are looking for.
In summary, this strategy is a great way for high earners who have extra money to put away for retirement to get around the Roth contribution income rules and build up a nice bucket of tax-free retirement money. As always, check with your tax adviser and financial planner before embarking on a new financial strategy.