Contributing to a Roth IRA is one strategy to save for retirement because it provides one with tax-free income in retirement. However, there is a way for high-income taxpayers to save even more than the $6,000 investment maximum for the 2021 and 2022 fiscal years; or $7,000 if one happens to be over 50. This method is referred to as the mega Roth IRA, a strategy that may increase your yearly Roth IRA contributions to more than $30,000 per year.
What Exactly Is a Mega Roth IRA?
Contributions to Roth IRAs are not allowed for high-income earners. Furthermore, contributions are also prohibited if one files as a single person or as the head of a family with a yearly income of $144,000 or over in 2022, increasing from $140,000 in 2021. The income cap for married couples filing jointly is $214,000, increasing from $208,000 in 2021.
As a result, a mega Roth IRA provides an opportunity: employees can contribute to a traditional IRA that happens to be non-deductible before changing it into a Roth IRA. An identical conversion strategy is used in a giant backdoor Roth IRA, but the tax burden on the conversion could be greatly reduced or eliminated.
To determine whether or not a mega Roth IRA is possible, one must meet the criteria below:
One’s solo 401(k), 403(b), or 457 plan, or their employer's yearly 401(k), 403(b), or 457 plan, are both maxed out (k).
One can also make extra after-tax deposits over and above the yearly 401(k) limit of $20,500 ($27,000 if one is 50 or older).
If one is unmarried or the head of household in 2022, and make more than $144,000, or $214,000 if they're married and filing jointly.
In 2022, the pre-tax contribution limits should increase to $20,500 ($27,000 if one was over 50), increasing from $19,500 or $26,000 if one was 50 or older in 2021.
This is optional, however in 2021 or 2022, one can contribute up to $6,000 in non-deductible conventional IRA deposits ($7,000 if one is over 50).
In-service distributions, a technical term for withdrawals, of these after-tax payments are allowed under one's employer's retirement plan.
Taxes Associated with a Mega Roth IRA
When one transfers money to a Roth IRA through a traditional backdoor Roth IRA, they owe income taxes on the sum they transferred to a Roth IRA to the degree that their conventional IRA investments were initially deductible. Similarly, after-tax contributions to a mega Roth IRA are tax-free. Only portfolio gains on after-tax deposits are taxed at one’s current marginal tax rate at the time of a non-qualified withdrawal for Roth IRA deposits.
However, there is a way to potentially avoid paying such taxes. The earnings should be minimal if you constantly make withdrawals of after-tax money, such as at a monthly or quarterly rate, or keep your deposits in a money market fund. There are also no taxes to pay if one’s holdings don't make any money for some time or if they have a bad run and lose money.
If one is contributing after-tax money and their workplace doesn't allow in-service withdrawals, this can be challenging. When someone quits their job, they can continue contributing after taxes and move the money to a Roth IRA, but any gains on after-tax financial assets could result in a large tax bill. To potentially avoid paying taxes on these contributions, one should consider investing that after-tax money and moving the earnings to a regular IRA.
Should One Use a Mega Roth IRA?
If one’s salary isn't high enough, they could remain with a conventional backdoor Roth IRA conversion. The same is true if you can't contribute the maximum amount to both your 401(k) and conventional IRA each year, or if your company doesn't allow in-service withdrawals.
However, if one fulfills the income and savings criteria, a mega Roth IRA can broaden their retirement income by allowing them to earn both tax-deferred (subject to tax at the time funds are withdrawn) and tax-free income on their pre-tax contributions (should funds be moved to a Roth IRA). A mega Roth IRA can also potentially avoid the capital gains tax that a standard backdoor Roth IRA conversion frequently causes.
The Bottom Line
A mega Roth IRA is one way to save you some extra money. Should one meet the criteria, it is an avenue that they could consider exploring. If you have any further questions regarding this matter, find an experienced Pittsburgh PA financial consultant that can guide you along. They can help address any type of concern related to taxes and finances, even if you simply want to know what is the 5-year rule for Roth IRA or understanding if Pennsylvania is even a retirement-friendly state.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision. This information is not intended to be a substitute for specific individualized tax, legal, or investment related advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
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 the required minimum distribution (RMD) in the year you convert you must do so before converting to a Roth IRA.
This material was prepared for The Kelley Financial Group.
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