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If you’re a high-income earner looking for ways to save more for retirement and reduce your tax bill, you might be interested in a little-known benefit of SOME 401ks: the ability to make mega backdoor Roth contributions.
What are mega backdoor Roth contributions?
First, let’s define some terms. A traditional 401k allows you to contribute up to $23,500 (as of 2024) of your pre-tax income to your retirement account each year. This money grows tax-free until you withdraw it in retirement, at which point you pay taxes on it as ordinary income.
A Roth 401k, on the other hand, allows you to contribute post-tax dollars to your retirement account. This means that you pay taxes on the money now, but you won’t owe any taxes on the money when you withdraw it in retirement.
A backdoor Roth contribution is a way for high-income earners to contribute to a Roth IRA, even if their income exceeds the Roth IRA contribution limits. This involves making a non-deductible contribution to a traditional IRA, then immediately converting it to a Roth IRA. Because the contribution was made with after-tax dollars, there are no tax consequences for the conversion.
A mega backdoor Roth contribution is a variation of this strategy that allows high-income earners to make even larger contributions to their Roth accounts. It involves making after-tax contributions to a traditional 401k, then converting those contributions to a Roth 401k. Because the contributions were made with after-tax dollars, there are no tax consequences for the conversion.
Why are mega backdoor Roth contributions beneficial?
Mega backdoor Roth contributions can be beneficial for several reasons. First, they allow high-income earners to save more for retirement than they would be able to with a traditional 401k or Roth IRA alone. Second, because the money is contributed after-tax, it grows tax-free and can be withdrawn tax-free in retirement. This can be particularly beneficial for individuals who expect to be in a higher tax bracket in retirement than they are now.
How do you make mega backdoor Roth contributions?
Not all 401ks allow for mega backdoor Roth contributions, so you’ll need to check with your employer to see if this option is available to you. If it is, the process typically involves making after-tax contributions to your traditional 401k, then rolling over those contributions to your Roth 401k.
Here’s a step-by-step guide to making mega backdoor Roth contributions:
It’s important to note that the tax implications of mega backdoor Roth contributions can be complex, so it’s a good idea to work with a tax professional to ensure that you’re following the correct procedures and reporting the contributions correctly on your tax return.
In conclusion, if you’re a high-income earner looking to save more for retirement and reduce your tax bill, mega backdoor Roth contributions can be a powerful tool. By making after-tax contributions to your traditional 401k and rolling them over to your Roth 401(K).
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