What Is A Roth And A Backdoor Roth?
A Roth plan allows you to pay taxes on money then save that money for retirement. The reason it’s a good idea to have one is that when you retire and take the money out all the gains are tax-free.
Let’s look at an example, say you invest the maximum starting at 25 until you retire at age 65. When you’re done you’ll have invested $235,000 but have $1,201,741. And those gains would be tax-free, meaning you can spend them as you would like.
Now, some make too much to contribute to a Roth IRA and so they have to do what’s called a backdoor Roth. This is where you invest in a Traditional IRA (taxed) and convert it over to the Roth IRA.
What Is The Mega Backdoor Roth?
The tax law allows for a backdoor Roth conversion, but now they also allow for what’s called the mega backdoor Roth. Why is it called that? Well instead of being able to contribute $5,500 a year this will allow more, a lot more.
The maximum you can contribute for 2017 to after-tax differed accounts is $53,000. Meaning if you contribute the max to your 401K ($18,000) then you still have $35,000 allowed to be invested. That money can all be done through a Mega Backdoor Roth.
Who Has Access To The Mega Backdoor Roth?
Before you start trying to get this done, you should realize that very few people have access to this. You have to have the “perfect storm” of a financial situation. First, you have to be a high-income earner, so much so that you don’t qualify to invest in a Roth IRA without a backdoor conversion.
Second, your employer has to allow after-tax contributions. Most of the time they won’t understand that you aren’t asking about a Roth and that you want to make after-tax contributions to your traditional IRA so be very clear when speaking with them.
Third, you also have to be contributing the maximum allowed. If you aren’t already contributing the $18,000 a year, then focus on that first and if you have money left then you can start working on other types of investments.
How The Mega Backdoor Roth Works
Once you’ve met the requirements then you need to make your after-tax contribution to the traditional IRA. After that do an in-service transfer to your Roth IRA. That’s it you’re done.
Sounds Simple But Isn’t
The process of the Mega Backdoor Roth sounds very simple, but actually being able to do it is difficult. First saving $53,000 in a year isn’t easy, even if you’re a high-income earner. Second, as mentioned before many employers don’t allow it.
So yes this “perfect storm” can save you a ton of money, but only if you can actually get it.
