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Mega Backdoor Roth IRAs

Recently, we have had numerous clients ask about a new type of individual retirement account conversion called a “Mega Backdoor Roth IRA”. Although this provision has been around for several years now, more attention has been brought to it since it was specifically targeted for elimination by the “Build Back Better Act”, which passed the House of Representatives last November. This bill is currently stalled in the Senate, so this tax-saving strategy can still be used under certain conditions.

How does a regular Backdoor Roth IRA work?

A regular Backdoor Roth IRA is a way of converting a conventional deferred tax individual retirement account into an after-tax Roth IRA. This allows the retirement funds to grow capital gains tax and income tax-free instead of being taxed when they are eventually withdrawn upon retirement.

What makes a Backdoor Roth IRA a “Mega” Backdoor Roth IRA?

A regular Roth IRA has a contribution limit of only $6,000 per year for 2022 (and up to $7,000 for those age 50 or older). However, a Mega Backdoor Roth IRA conversion allows up to $45,000 from a traditional 401(k) retirement account to be converted into a Roth IRA (sometimes without even paying taxes on the funds). The greater contribution limits of the 401(k) compared to the traditional IRA are what create the larger savings opportunity of the Mega Backdoor Roth IRA.

What are the requirements for the Mega Backdoor Roth IRA Conversion?

This conversion is only possible with active 401(k) plans, which allow for after-tax contributions and in-service distributions of after-tax funds. Unfortunately, not all 401(k) plans allow for in-service distributions. Also, some 401(k) plans do not permit in-plan Roth conversions.

How does a Mega Backdoor Roth IRA conversion work?

Taking advantage of this opportunity is fairly straightforward for people who qualify. Transferring monies from a 401(k) into a Roth IRA can often be done in a single transaction. For example, if an active wage earner was enrolled in an employer sponsored 401(k) plan which permits in-plan Roth conversions and in-service distributions, they could move their savings of $38,000 from their pre-tax 401(k) into a Roth IRA. The tax liability of this conversion would depend on their income situation.

How can I find out if I am eligible for a Mega Backdoor Roth IRA and what the implications would be?

Please feel free to give Steinbrenner Financial Group a call at (414) 266-1900 so our experts can help you figure out if an IRA conversion strategy is right for you.

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