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September 8, 2021
Today, we’re going to talk about a strategy for people who love Roth IRAs, and how to maximize Roth contributions with something we call the Mega Back Door Roth.
Most of you know what I’m talking about. If you’re self-employed, if you’re a business owner – somebody that gets Schedule C or 1099 income – September 15th and October 15th are your tax filing deadlines.
It’s important to know what you are going to do about those IRAs and 401ks that you’re making contributions to.
Today, we’re going to talk about a strategy for those of you who love Roth IRAs, and how you can maximize Roth contributions and something we call the mega backdoor Roth.
The mega backdoor Roth is not a type of IRA.
It’s a strategy you could use with different Roth vehicles – or different IRAs – to contribute more money than your typical Roth IRA, and end up getting more contributions into a Roth type account.
This could be life-changing to people taking self-directed accounts and investing their Roth IRAs into real estate, promissory notes, oil and gas interests or even cryptocurrency. So, pay attention to how this mega backdoor Roth works, and how it might be beneficial to you.
If you have earned income as an individual, you can make contributions to either a traditional IRA or Roth IRA. The contribution limits are relatively small. These are your personal plans, and the limits for making contributions are:
And all it requires is that you have some sort of earned income.
Now, many people have already been using this trick, which would be called maybe a mini backdoor Roth. But, if you exceed the income limits to make a Roth contribution, what you’ve been forced to do is:
The second step in this process is using a 401k or an employer-sponsored plan. And for self-employed people, you may have a solo 401k where you could contribute up to $19,500 as an employee.
Now, this increases above the age of 50, where you’re allowed to make contributions up to $26,000, and that can be Roth money. All you need is income, at least in that amount.
So, if you’re over the age of 50 and you make at least $26,000, you can make a $26,000 Roth contribution to a 401k.
So, with your personal plan contributions of either a direct Roth contribution, or a contribution to a Roth at $7,000 (if you’re above 50) added to your 401k contribution (as an employee) of $26,000 gets us to total Roth money of $33,000.
You have to make sure that your 401k plan administrator allows for this.
You’d have to ask them – or search your plan documents – to see if your 401k allows for non-deductible employee contributions.
Now, this non-deductible – or after-tax – employee contribution is the difference between what you contribute as an employee, added to that your employer matching contributions.
You can make up the difference all the way up to the contribution limit for the 401k, and make that as an after-tax employee contribution.
If you’re over the age of 50, the maximum you can contribute to a 401k is $64,500.
Let’s assume you max out your employee portion, and that’s directly to the Roth component of the 401k. That’s $26,000 you can make to your Roth portion.
If your employer doesn’t match – and if your plan allows for it – you can make an additional after-tax employee contribution of $38,500. This brings you to a total of 64,500. But, you don’t want that $38,500 to grow tax-deferred since you never got the deduction.
So, a lot of investors convert that additional contribution over to a Roth, thus giving them in their Roth side of their 401k $64,500, plus the additional IRA personal contribution outside of the 401k of the $7,000. This brings us all the way to $71,500 in one year, all in a combination of Roth contributions and/or Roth conversions.
Now some of you might be saying, “Nate, I don’t have it an extra 38,000 or $50,000 to throw”, or “I don’t even have a 401k.”
Don’t worry. There are other strategies for you.
For instance, let’s say you and a spouse both have earned income. Let’s say your earned income is above the income limit to make contributions to a Roth. There’s nothing preventing you from making a contribution to a traditional IRA, and then converting it to a Roth. Then, your spouse can also do the same.
Besides IRAs, there are other accounts that might be advantageous to you. Have you ever thought about a health savings account (HSA)? Health savings accounts are a great option, and they work similar to a Roth, but you actually get a tax deduction.
There are some qualifying criteria to have an HSA. But, if you have one, you know the power in using this account. If you’re covered by a family plan on your insurance, you can contribute up to $7,200 and that’s dollar for dollar tax-deductible.
It can be invested like a Roth IRA, but the distributions can be taken out any time, tax-free and penalty-free to pay for qualified out-of-pocket health expenses.
Beyond that, you can look at other accounts like an Education Savings Account (ESA) for your kids. These are great for minors who have education expenses that you’re looking to pay for.
Contributions are not tax-deductible like the HSA, but the distributions work in a similar fashion where you can invest the ESA set up for your children. And the distributions can be used to pay for qualified out of pocket education expenses all the way from kindergarten through college.
If your kids are a little bit older – and they have earned income – what about setting up Roth IRAs for them? It doesn’t matter how old they are, anybody can contribute to a Roth IRA, as long as they have earned income.
So, think of all the ways and creative strategies you can use to get money into large Roth buckets.
And whether you have different accounts or not, the important thing to know is that you can always partner accounts together to make investments. And when we talk about self-directed IRAs, we always focus on the partnering aspect of it.
Make sure you reach out to one of my IRA specialists at IRA specialists at newviewtrust.com so that they can do a proper consultation with you.
Consultations are always free with us, but they can ask you the right questions to make sure that you get the right account set up for your investment strategy needs.
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