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  • Writer's pictureJeran Van Alfen, CFP®

Tax-Free Savings: The Backdoor Roth and the Mega-Backdoor Roth

The Roth IRA is a great retirement savings tool. It allows you to save your money for retirement without paying taxes on the investment earnings in your account each year and then when you make withdrawals in retirement, the entire amount is tax free! This means that you never pay taxes on the interest and gains in your account (as long as your withdrawal is done properly).

I often recommend building up a tax-free bucket of money to create more control over your income and taxes in retirement. With such good future tax-benefits, many savers would like to stuff as much money as they can into their Roth. However, there are some limits to contributing to the Roth. First, while you have earned income, you can only put up to $6,000 into your Roth this year ($7,000 if you are over 50) and if you put any money into a traditional IRA, this offsets the amount you can put into a Roth. Second, if you are single and make over $144,000 or married and make over $214,000, you can’t contribute to a Roth IRA.

If you are under the income limits above, then it may be a good idea to try to prioritize your Roth IRA. However, if you are no longer eligible for Roth IRA contributions, here are some other ideas to fund a Roth strategy:

Roth 401(k)

Many employers offer Roth 401(k) contributions. These are different than traditional after-tax contributions in that the money is actually characterized as Roth in your 401(k). Since it is a 401(k) account, there are no income limits to making these contributions and you can take advantage of the full 401(k) contribution limit of $20,500 this year.

Backdoor Roth

The backdoor Roth is a strategy where you make a contribution to a traditional IRA and then convert the money to a Roth. This works because there is no income limit to contributing to a traditional IRA. However, this can create some tricky tax situations, so it is important to seek some guidance and work with a professional before you start converting your pre-tax money.

Mega-backdoor Roth

This is a unique strategy where you utilize after-tax contributions to a 401(k) to fully maximize your retirement savings. It also gets a little tricky. I have linked to a good article below that explains that strategy. Keep in mind that the article was written in 2021 so the numbers have changed. For 2022, the maximum participant contribution to a 401(k) is $20,500 and the maximum defined contribution plan limit is $61,000.

If you have any questions about your retirement strategy or how to optimize your savings for your financial plan, please reach out to us and we are happy to help!

Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.

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