What Is A Backdoor Roth IRA?

What Is A Backdoor Roth IRA?

Hi there and thank you for stopping by. My name is Tina Anders and I am the Certified Financial Planner for my firm here in Petaluma, California, Anders wealth management. I appreciate you taking the time to learn a little bit today about Backdoor Roth IRAs, and even better Mega Backdoor Roth IRAs. First, let me just tell you, we’re filming at home because of COVID. So, please bear with me.

Backdoor Roth IRA contributions. Okay, so that’s an IRS sanctioned method for high income taxpayers to fund a Roth IRA even if their income is higher than the maximum IRS allows for regular Roth IRA contributions. Non-deductible traditional IRA contributions can be rolled to your Roth IRA. That’s a backdoor Roth IRA.

If your income exceeds the limits the IRS is placing on you so that you can’t contribute to a Roth IRA. That’s okay. Because you could put in non-deductible traditional IRA contributions in your traditional IRA, and then you can roll that to your Roth. That’s one way to do a backdoor Roth IRA contribution.

But let’s talk about something else called the Mega Backdoor Roth IRA contribution, which is amazing. So, let me ask you a couple questions. Do you know if your 401k plan, this is a plan at work, employer sponsored retirement plan? Do you know if your 401k plan allows you to make after tax 401k contributions? I’m not talking about Roth contributions; I’m talking about after tax non tax deferred traditional 401k contributions. If so, does your employer do separate accounting of the pretax and post-tax contributions? If so, are you allowed to take in service withdrawals during your employment? Okay, so if you answer yes to these questions, you may want to consider a Mega Backdoor Roth. Because really, I like for you to get as much money into a Roth IRA as soon as possible to get as much tax free growth for as long as possible. And the way to do this is to make after tax payroll deferrals into your 401k.

Regarding these after-tax contributions or deferrals to your 401k account, if your after tax contributions accumulate investment earnings, the IRS said it’s okay to split up the money between the contributions and their earnings. So, you can put the contributions, you can roll them straight into a Roth IRA, and the earnings go into a traditional IRA. Okay?

Now let’s remember Roth IRAs are tax free with a few rules, one of which is you have to have held it for at least five years. You can’t take money out penalty free before the age of 59 and a half. There are other rules that go along with these rules, but I’m not going to go into those today, I want to talk about who’s prohibited from doing a Mega Backdoor Roth conversion and that is a highly compensated employee. And that’s a person who either owns more than 5% of the interest in the business at any time during the year or the preceding year, or they receive compensation from the business for more than $125,000 in 2019 or $130,000 in the year 2020. And if the employer so chooses, they can say that the top 20% of employees ranked by compensation are highly compensated employees. So just be careful if you’re highly compensated employee, you don’t want to do a Mega Backdoor Roth IRA.

The other thing I want to mention is, and this is the good news, when you find a traditional or a Roth IRA under normal circumstances, you’re putting in $6,000 a year $7,000 a year, right in there depending on what year it is and what the rules are. But in 2020, the maximum you and your employer combined can put in your 401k is $57,000. If you’re under the age of 50, guess what? If you’re 50 or older, you can put in a total of $63,500 into your employer sponsor 401k accounts, which includes all contributions to include employer contributions. So, don’t go over the limits. Talk to your employer, HR department about this, and see if there are ways for you to do a Mega Backdoor Roth IRA. A fantastic saving tool, a fantastic tax liability relief tool.

Thank you again for stopping by today. Hey, if you would like me to speak about any particular topic on a video or if you have a question or a comment, please go to my website, anderswealth.com. Go to the contact page. Fill out as much or as little as you want. But in the bottom of the contact page, there’s a text box, fill out anything you would like to share with me that you could use my help on. You want to have me speak on a video and I will do what I can to help out. Thanks again. I am in your corner.