Personal Finance Roth IRA, Backdoor Roth, & Mega-Backdoor Roth

BamaNation

Publisher and Benevolent Dictator
Staff member
Apr 9, 1999
14,946
5,562
423
As always, I offer no credentials nor am I a financial advisor. I do offer to the reader my own research and opinions which should be checked with your accountant or tax advisor and your own investigation before taking any actions based on this post or the links it contains. Caveat emptor!

OVERVIEW
This is a succinct guide pointing to some good resources for you to do more investigation about how IRAs and Roth IRAs can benefit you. It is not meant to be a comprehensive guide! It is meant to whet your appetite for doing more investigation and reading on your own and to point to those resources that I have found helpful. As with anything related to investing and taxes there are caveats and caveats to the caveats. So, if you have a "yeah, but" that's fine but know that the links below probably cover that "yeah, but" in a lot of detail not given here.

Saving in an IRA, particularly a Roth IRA, is one of the most no-brainer things you can do.

However, being able to contribute directly to a Roth IRA is income-limited. For many folks, this isn't really much of an issue since, for singles, contribution limits begin at $124K of taxable compensation per year and you may no longer contribute at income greater than $139K. For Married Filing Jointly, it is $196K, and $206K, respectively. However, with more people having side gigs with decent income, double-time for overtime, higher-paying skilled trades, etc., these limits impact more and more people every year. The Roth IRA contribution limit for 2020 is $6K for folks age 49 and below and $7K for age 50 and above.

TYPES OF IRAs
There are two types of Individual Retirement Accounts (IRA's): Traditional and Roth. Both offer some tax advantages About 10% of the total American's IRA assets are invested in Roth's.

Check out the Bogleheads.org Wiki comparing Roth vs Traditional IRAs.

IRA CONVERSIONS
You can convert your Traditional IRA to a Roth IRA without penalty but you must pay the tax due. This could be particularly advantages if you have IRA savings and find yourself in a low-tax bracket. It is worth investigating because the tax man is going to get his taxes from you. Why not take advantage of being in a lower tax bracket and do a conversion. You do need to check the IRS guidance on this and check out some of the links at the bottom which explain things well.


BACKDOOR ROTH IRA
FOR WHEN INCOME LIMITS (OR PREVENTS) ROTH IRA CONTRIBUTIONS

If you are prevented from Roth contributions because of your income, you are fortunate in two ways - you have a relatively high income ... AND, there is a solution for you called Backdoor Roth IRA.

Per Bogleheads.org: "The Backdoor Roth IRA is a process used to indirectly contribute to a Roth IRA for taxpayers whose Modified Adjusted Gross Income prevents them from contributing to a Roth IRA directly. There are two steps to a Backdoor Roth IRA:
  1. Non-deductible contribution to a Traditional IRA
  2. Conversion (usually, shortly thereafter) of the entire Traditional IRA to a Roth IRA
The net result of these two transactions is the same as a direct contribution to a Roth IRA. Neither of these two steps has any income limitations, and so taxpayers of any income can make Backdoor Roth IRA contributions. Aside from the complexity, there is no real disadvantage to using the Backdoor process.

Note that there isn't a "Backdoor Roth IRA" account type. The Backdoor Roth IRA is a conversion method allowed per the IRS. See the Backdoor Roth IRA article for more details.

There are also a lot of ways to screw up your attempt to do a Backdoor Roth. Try not to do that.


MEGA BACKDOOR ROTH IRA
FOR WHEN YOU HAVE A DECENTLY "HIGH INCOME" AND WANT TO MEGA-BOOST YOUR SAVINGS

Mega Backdoor Roth IRA is an after-tax 401k to Roth IRA conversion. It is a much more complicated process for getting additional funds into a Roth IRA. It involves a number of non-trivial steps, including: having maxed out your other tax-advantaged options, having at least a moderately-high income, having a 401k plan that allows for this type of transfer and a plan provider who understands it, and your willingness (and patience) to follow instructions precisely.

Customer service or the supervisor with your plan provider may not even know what this is (most don't) or how to do it because so few people do this so you have be persistent and follow the guidance these websites provide. Talk to your HR / benefits folks to find if your plan provides for this and if not, advocate for it to do so. Then follow through.

TheFinanceBuff.com says "If your plan cooperates, you can put up to additional $35,000 a year into your Roth IRA! If you are married and both of you have a cooperative plan, you can put up to additional $70,000 a year into two Roth IRAs!" So, very worthwhile if you have the income and the motivation to save a lot more than your neighbors!

The WhiteCoatInvestor.com website is produced by a practicing emergency room physician and is targeted toward highly-compensated doctors (and other high income individuals and business owners). He covers topics and strategies that most of us might not be able to implement because of the high-income of his audience. However, he provides some great insight into the whys and has several useful guides for how to do things. One of these really good guides is on the Mega Backdoor Roth IRA. See how he does it. The process involves making after-tax contributions to your 401k plan. If a Mega Backdoor is an option for you, definitely investigate doing it. But make sure you do it correctly!

If you are a highly compensated employee (the IRS requires a nondescrimination test be performed every year that separates employees into non-highly compensated and highly compensated) this could mean that you get some or all of your after-tax 401k contributions back at the end of the year if the company's 401k doesn't pass the test that year. For companies where executives & senior employees make their 401k contributions but lower level employees don't as much (typical examples: retail and restaurants) this can result in you not being able to do the strategy, but it is still a process worth attempting.

Check out the Mega Backdoor Roth Advantages & Disadvantages (via Bogleheads.org Wiki).


MORE RESOURES
ADDITIONAL RESOURCES ON THE VARIOUS IRA TYPES & METHODS DISCUSSED ABOVE

TideFans Personal Finance
[These links are also now under Personal Finance in the secondary navigation menu near the top.]

 
Last edited:

BamaNation

Publisher and Benevolent Dictator
Staff member
Apr 9, 1999
14,946
5,562
423
Just a note to say that when my wife has been able to do the mega-backdoor, it has been a difficult slog with customer support folks at her plan. Last year she had them document everything and then give it a reference code they could follow in the future. This year she told them to see the reference code. The guy she spoke with had never heard of mega backdoor (AKA after-tax 401k to IRA conversion) but was able to follow the documented procedure from last year. Went from taking hours to get them through it to about 10 minutes.
 
  • Like
Reactions: Bazza

Bazza

TideFans Legend
Oct 1, 2011
27,131
5,015
178
New Smyrna Beach, Florida
Just a note to say that when my wife has been able to do the mega-backdoor, it has been a difficult slog with customer support folks at her plan. Last year she had them document everything and then give it a reference code they could follow in the future. This year she told them to see the reference code. The guy she spoke with had never heard of mega backdoor (AKA after-tax 401k to IRA conversion) but was able to follow the documented procedure from last year. Went from taking hours to get them through it to about 10 minutes.
Nowadays....it pays to do the thinking for others. ;)
 

BamaNation

Publisher and Benevolent Dictator
Staff member
Apr 9, 1999
14,946
5,562
423
Nowadays....it pays to do the thinking for others. ;)
So true but so few people even know about these (probably esoteric) things that plan providers don't train their support folks on how to process them. This was an AHA moment for us about 5 years ago when we came across it.
 
  • Like
Reactions: Bazza

TF Shop : NATIONAL CHAMP GEAR!


TideFans.Shop - Get your Bama Championship gear here!
TideFans.Shop - Get your Bama Championship gear here!
TideFans.Shop - Get your Bama Championship gear here!

Purchases made through our TideFans.shop and Amazon.com links may result in a commission being paid to TideFans.

Latest threads