Want to “Mega-Fund” Your Roth IRA?
We’ve discussed in a previous video about the potential benefits of having money inside a Roth IRA: specifically, that qualified distributions from a Roth don’t count against you when calculating the taxability of your Social Security benefits. Whether it’s a Roth IRA or 401(k), the potential tax-free nature of Roth withdrawals can make them an attractive asset to have, especially if your income levels are relatively high.
The problem for some higher-income people, though, is that they lose the ability to contribute directly to a Roth IRA when their income reaches $228,000 for married couples filing jointly (or $153,000 for a single filer). One way to potentially get around those income limits is to do what’s called a Backdoor Roth, or Roth 2-step, where you contribute non-deductible money to a traditional IRA, and then turn around and just convert it to a Roth. Anyone with earned income can contribute to a non-deductible traditional IRA, so that strategy at least allows you to get money into a Roth.
The problem with that is the annual contribution limit to any IRA, Roth or Traditional, is relatively small – $6,500 for those under age 50, and $7,500 if you’re 50 or older in 2023. Complicating things even more, if you have any pre-tax money in an existing IRA, SEP or IRA Rollover from prior 401(k)s and you want to do a Roth conversion, you can’t just slice off the post-tax money and convert it. The pre-tax and after-tax money must be accounted for on a pro-rata basis. That’s where it gets a bit messy.
So is there anything you can do to get more money into a Roth? Maybe.
Some employers allow their 401(k) plan participants to make after-tax contributions to the plan. And for 401(k) plans, the limits are a lot higher than the traditional pre-tax contributions – up to $66,000 of total contributions in 2023 if your income is high enough.
So let’s say you’re around 45 years old, and you’re a highly-compensated employee working for a company that has a 401(k) that offers a 50% match on the first $6,000 in contributions, AND allows post-tax 401(k) deposits up to the maximum. If you really wanted to juice up your retirement savings, you could not only max out your deferral limit of $22,500 into the 401(k) and take the $3,000 company match, but you could also contribute an additional $40,500 of after-tax money into the 401(k) plan as well, taking you up to the $66,000 total contribution limit.
These additional after-tax contributions would have to go into the “traditional” 401(k) and not into a Roth 401(k), but that shouldn’t create a problem.
If you were able to make these contributions for, say, the next 10 years, you would’ve contributed a total of $405,000 in after-tax money to your 401(k). Of course, whatever earnings you may have accumulated in the account over that period of time would be tax deferred and then eventually taxed when you withdraw the money. But once you retire or you sever employment with that particular company, you could then do a direct rollover of the $405,000 of after-tax contributions to a Roth IRA and roll all of the pre-tax contributions and earnings into a traditional IRA. And just like that, to coin a phrase, you’ve “mega-funded” your Roth.
Keep in mind, these are sophisticated Roth strategies that are not suitable for those who don’t have the extra money to put away. But if getting a lot of extra money into a Roth IRA is something you want to do and you have the funds to do it, you may want to consider this strategy.
These are just a few of the many things we do for our clients at Lucia Capital Group. If you’d like some guidance and advice as to whether or not this Roth strategy may work for you, give us a call. As always, we’re here to help!
The information provided should not be considered specific tax, legal, or investment advice and is not specific to any individual’s personal circumstances. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.
No client or prospective client should assume that this information, or any component thereof, serves as the receipt of, or a substitute for, personalized advice from Lucia Capital Group or from any other investment professional.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
IRA withdrawals will be taxed at ordinary income rates. Withdrawals prior to age 59½ may also be subject to a 10% penalty tax.
Roth IRA distributions of principal from a Roth IRA are tax-free; however, any earnings will be taxed at ordinary income rates and a 10% penalty tax will apply if withdrawn prior to age 59½ or within five years of the date the Roth IRA was established, whichever is longer.
Examples cited are hypothetical, are for illustrative purposes only, are not guaranteed and subject to potential federal and state law amendments. There is no guarantee that you will achieve the results discussed or illustrated.
Rick Plum is a registered representative with, and securities and advisory services offered through LPL Financial, a registered investment advisor and member FINRA/SIPC. The investment professionals are affiliated with LPL Financial and are conducting business using the name Lucia Capital Group, a separate entity from LPL Financial.