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Backdoor Roth IRAs Remain Alive — For Now

One of the less-publicized provisions of the Build Back Better Act is the elimination of a popular retirement saving strategy used by some wealthy families. With the legislation now put on the Congressional back burner until at least next year, this strategy remains alive and well, at least for now.

The strategy, commonly referred to as a “backdoor Roth IRA,” lets wealthy individuals and families reap the tax benefits of a Roth account even if their income exceeds the limits for opening and contributing to a Roth IRA.

A Little Background on Roth IRAs

Many retirement savers prefer a Roth IRA over a traditional IRA since Roth IRA earnings and withdrawals are tax-free after age 59½. With traditional IRAs, earnings grow on a tax-deferred basis but retirees pay ordinary income taxes on their savings when withdrawals begin. Also, there are no required minimum distributions (RMDs) at age 72 with Roth IRAs like there are with traditional IRAs.

However, Roth IRAs are subject to income limits. Individuals with modified adjusted gross income (MAGI) above $140,000 and married couples with MAGI above $208,000 in 2021 can’t open or contribute to a Roth IRA. These limits preclude many affluent Americans from enjoying the benefits of Roth IRAs.

Using the backdoor Roth IRA strategy is one potential way to get around the MAGI limits. To execute the strategy, you must participate in a traditional 401(k) plan at work that permits after-tax contributions. You will contribute the maximize amount of money that you can for the current year to this account. Then you will immediately rollover this contribution to a Roth IRA or Roth 401(k) at work if one is offered.

When you do the rollover, the earnings in the account, but not the principal, will be immediately taxable. With a normal Roth IRA conversion, both the principal and earnings are taxable, so this is another benefit of the backdoor Roth IRA.

Go “Mega” with Your Roth IRA

Unlike Roth IRAs, there are no income limits when it comes to participating in a workplace Roth 401(k). This opens the door to what’s referred to as the “mega backdoor Roth IRA.” With this strategy, you will make an after-tax contribution to your traditional 401(k) and then convert this to a Roth 401(k) or Roth IRA.

The annual limits for these after-tax contributions are much higher than the normal 401(k) and IRA limits. For tax year 2021, you can contribute up to $38,500 to a Roth IRA in addition to the normal annual contribution limit of $6,000, or $7,000 if you’re 50 years of age or over. This brings the total amount that you can contribute to a Roth IRA using the mega backdoor strategy up to $44,500 this year, or $45,500 if you’re 50 or over.

Note that only about 20% of 401(k) plans allow these types of contributions, according to the Plan Sponsor Council of America. Talk to your human resources department about whether your plan allows these contributions.

Likely Available at Least Through Next Year

It’s possible that the Build Back Better Act could be resuscitated in 2022 and the backdoor Roth IRA strategy eventually eliminated. However, some experts say it’s unlikely that a mid-year effective date would apply because it would be too complicated. So there’s a good chance that you will have until the end of next year to utilize this strategy if you decide that it’s appropriate.

The details of backdoor Roth IRAs can get complicated. Give us a call if you’d like to discuss the strategy and whether or not it makes sense given your situation.


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