Getting your money into a Roth: Roth IRA Conversions, Backdoor Roth, and Mega Back Door Roth.

Why do so many people want to get money into a Roth IRA?

The primary appeal of a Roth IRA lies in its provision for tax-free qualified distributions, contrasting with traditional IRAs, where withdrawals are subject to taxation. While traditional IRA contributions may offer initial tax deductions, Roth IRA growth and subsequent withdrawals remain tax-exempt, contingent on adherence to qualified distribution criteria. Non-qualified withdrawals incur penalties.

Contribution and income limitations govern Roth IRA eligibility. For detailed specifics regarding 2024 and 2025 limits, refer to IRS Publication 590-A.

How can you get money into a Roth if you exceed the income limits?

 

Roth IRA Advantages and Contribution Strategies

Some individuals exceeding income thresholds can access Roth IRA benefits through the following strategies:

Employer-Sponsored Plans: If available, utilize Roth contribution options within employer-sponsored plans, such as 401(k)s, in consultation with the plan custodian.

Backdoor Roth IRA: A "backdoor Roth IRA" is a strategy that can allow high-income earners to contribute to a Roth IRA, even if their income exceeds the standard Roth IRA contribution limits. Here's a breakdown of how it works:  

Understanding the Strategy of a Backdoor Roth

Roth IRA Income Limits: Traditional Roth IRAs have income limits that restrict direct contributions for high earners. If your modified adjusted gross income (MAGI) is above these limits, you cannot contribute directly.  

The Backdoor Solution: The backdoor Roth strategy circumvents these income limits by utilizing a traditional IRA and then converting it to a Roth IRA.  

Steps to Execute a Backdoor Roth IRA

Open a Traditional IRA:

• If you don't already have one, open a traditional IRA account at a brokerage firm or financial institution.  

• Crucially, if possible, ensure that you have $0 in all other traditional IRA accounts. This is due to the pro-rata rule, which will be explained later.

Make a Non-Deductible Contribution:

• Contribute to your traditional IRA. This contribution must be non-deductible. This is very important.  

• Keep meticulous records of your non-deductible contributions using IRS Form 8606. This form is essential for tracking your basis (the amount of your non-deductible contributions).  

• The 2023 and 2024 contribution limit for IRAs is $6,500, or $7,500 if you're age 50 or older.

Convert to a Roth IRA:

• Once the contribution has settled in your traditional IRA, initiate a Roth conversion.

• Contact your IRA provider and request a conversion of the funds from your traditional IRA to a Roth IRA.

• There are no income limits for Roth conversions.

File IRS Form 8606:

• When you file your taxes, complete IRS Form 8606. This form reports your non-deductible contributions and the Roth conversion.

• This form documents the non-taxable portion of your conversion. Without this form, the IRS will assume that the entire conversion was made of pre-tax dollars and tax you accordingly.  

Important Considerations

The Pro-Rata Rule: 

• If you have existing pre-tax balances in any traditional, SEP, or SIMPLE IRAs, the pro-rata rule applies.  

• This rule dictates that any Roth conversion will be taxed proportionally based on the ratio of your non-deductible contributions to your total IRA balances.  

•  For example, if you have $90,000 in pre-tax traditional IRAs and make a $10,000 non-deductible contribution, only 10% of your conversion will be tax-free. The other 90% will be taxed as ordinary income.

• This is why many people try to have $0 in traditional IRAs before doing a backdoor Roth.

Timing:

• It's generally recommended to perform the Roth conversion soon after the non-deductible contribution to mitigate any potential gains in the traditional IRA, which would be subject to taxation during the conversion.

• However, some people do conversions at the end of the year.

Record Keeping: 

• Maintain thorough records of all contributions and conversions.

  Tax Implications: 

• While the conversion itself is not subject to the 10% early withdrawal penalty (if you are under 59.5), any earnings converted are taxed as ordinary income.

Consult a Professional: 

• Tax laws and individual financial situations can be complex. It's always advisable to consult with a qualified financial advisor or tax professional before implementing a backdoor Roth IRA strategy.

  
  

  In Summary

• The backdoor Roth IRA can be a valuable strategy for high-income earners seeking the tax advantages of a Roth IRA.

• However, it's essential to understand the rules and potential pitfalls, particularly the pro-rata rule, and to maintain meticulous records.  

The Mega Backdoor Roth IRA: A Strategy for High-Income Retirement Savers

The "mega backdoor Roth IRA" represents an advanced retirement savings strategy designed to potentially increase Roth contributions beyond standard limits. This technique leverages after-tax contributions to employer-sponsored retirement plans, specifically 401(k)s, and subsequent conversions to Roth accounts.  

Mechanism of Operation

1. After-Tax Contributions:

• Participants contribute after-tax funds to their 401(k) plan up to the IRS's annual defined contribution limit (e.g., $70,000 for 2025, encompassing employer contributions, pre-tax contributions, and after-tax contributions).[i]

• This strategy necessitates a 401(k) plan that permits after-tax contributions and in-service distributions or conversions.

2. In-Service Distribution or Conversion:

The core of the mega backdoor Roth lies in the ability to access these after-tax contributions while still employed.  

• In-service distribution: the after-tax funds are distributed to the participant, who then rolls them into a Roth IRA.

• In-service conversion: the 401(k) plan directly facilitates a conversion of the after-tax funds to a Roth 401(k) or a Roth IRA.  

3. Roth Account Accumulation:

   
   

   The converted funds, now residing in a Roth account, benefit from tax-free potential growth and tax-free withdrawals in retirement, provided qualified distribution requirements are met.  

Some Key Considerations

Plan Availability: The mega backdoor Roth is contingent upon the employer's 401(k) plan provisions. Not all plans offer after-tax contributions or in-service distributions/conversions.  

Contribution Limits: The overall annual defined contribution limit must be adhered to. Careful calculation of pre-tax, employer, and after-tax contributions is essential.

Tax Implications: While the conversion itself is not a taxable event (as the funds were already taxed), any earnings generated on the after-tax contributions prior to the conversion will be subject to income tax.

Record Keeping: Meticulous records of after-tax contributions and conversions are vital for accurate tax reporting.

Financial Consultation: Due to the complexity of this strategy, it is strongly recommended that you consult with a qualified financial advisor.

Advantages

• Significant expansion of Roth retirement savings beyond standard IRA and 401(k) limits.  

• Tax-free potential growth and withdrawals in retirement.

Disadvantages

• Dependence on employer plan provisions.

• Complexity of implementation and record keeping.

Conclusion

The mega backdoor Roth IRA can provide a sophisticated avenue for high-income individuals to augment their Roth retirement savings. However, its successful execution necessitates a thorough understanding of plan provisions, contribution limits, and tax implications, along with careful planning and execution.

Investment advice is offered through Stratos Wealth Advisors, LLC, a registered investment advisor. Stratos Wealth Advisors and Synergy Wealth Management are separate entities.       

The information in this material is not intended as tax or legal advice. Synergy Wealth Management does not advice tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.

Reference:

• IRS Publication 590-A and 590-B.

[i] IRS Notice 2024-80 IRS.gov