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The Roth IRA Loophole for Absurdly High Contributions (And No Income Limits)

July 18th, 2012 by 
PK

The Mega Roth IRA Backdoor is an extreme strategy to contribute tens of thousands of dollars to a Roth IRA. If it's available to you through your 401(k) you don't have to worry about income limits.

How much can you contribute through the Mega Backdoor Roth?

Depending on your company's match and your own contributions, you can probably contribute $30,000 or more. Once money is Roth protected, it grows without the burden of income or capital gains taxes.

How 401(k) Limits Work

Mega Roth IRA Backdoor flag!
The reason for this flag is obvious, isn't it? The Mega Roth IRA Backdoor!

In 2019, an employee can contribute $19,000 as an elective deferral to a 401(k).  However, 2019 contribution limits are actually capped at $56,000. 

That includes employer matching contributions and any employee after-tax contribution categories.

The key to this method is that last piece of the puzzle, employee after tax contributions

Not all 401(k) plans allow this little twist on the traditional 401(k), but if yours does, it usually works something like this:

  1. Contribute the maximum elective deferral ($19,000)
  2. Receiving matching funds from employer (Say, up to 6% of $100,000 = $6,000)
  3. Contribute the rest of the $56,000 in after-tax contributions ($31,000)
  4. Move onto the next step (obviously, don't proceed if the next rule doesn't apply)

What's the Secret Step to the Mega Roth Backdoor?

The key to the whole strategy is a feature of SOME 401(k) accounts known as "in-service withdrawals".

All but the most liberal of 401(k)s will lock down the money that you contribute on the elective deferral side. However, a fair amount of accounts will allow in-service withdrawals of certain types of money. This is usually rollovers from previous employers and (more importantly) after tax contributions.

If your employer offers both of those features (or, alternatively, some other types of rollovers) you're well on your way. 

Usually, however, in-service withdrawals are limited over a certain time frame. Most commonly, this is once per year.

Anyway - if you have both in service withdrawals or rollovers and after-tax contributions, you're all set for the next step.

If You Have the Ingredients: Profit From the Mega Roth IRA Backdoor

Again, if you have both in-service withdrawals and after-tax contributions you're good to go.

Because of tax changes in 2010, you can roll over withdrawals from a 401(k) directly into a Roth IRA. That withdrawal is the trick to making the scheme work. You either call your provider or go through the online withdrawal form to roll over to a Roth IRA.

Note that you contributed your after tax funds after tax. This sounds obvious, but it means you don't have to pay income taxes on that part of the withdrawal. You do have to pay income taxes on any earnings or fluctuation in the deposited funds though. Of course, if you lost money that also counts as a capital loss.

Here's the math on the backdoor Roth:

     $31,000 in rollovers/withdrawals
+  $6,000  in regular Roth IRA contributions

_________________________________
$37,000 in Roth IRA contributions in 2019

Now, I make no claims that it's worth getting a Roth IRA in your situation, and if you're not sure talk to a financial adviser before you attempt this maneuver. 

You'll also need to pour over your company documents and probably verify with someone in the plan administration this will work. Also check out Fairmark.com's article on the topic.

Big Gains Through the Backdoor Roth IRA

So, there you have it – a way for even very high earners to contribute a large amount of cash to a tax-free account. 

As Judge Learned Hand once famously stated, "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes. "

Go avoid taxes in a completely legal way with the Mega Backdoor Roth IRA, you patriot!

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