Roth accounts play a very important role in creating a tax-diversified retirement savings strategy, providing tax-free income during retirement. Because Roth accounts are funded with after-tax contributions, they grow completely free of income taxes. As a result, we work with many clients to maximize the amount accumulated within Roth accounts under the principle that accumulating as much money in Roth accounts as soon as possible allows for the most tax-free growth.

The most common strategies for Roth accumulation include making annual contributions to Roth IRA and Roth 401(k) accounts and strategically converting funds from Traditional IRA accounts to Roth IRA accounts as opportunities arise from a tax-planning standpoint. A mega backdoor Roth is an additional strategy that is available to some.

A mega backdoor Roth allows you to save up to an additional $38,500 into a Roth account in 2021 through your employer-sponsored 401(k) plan. This amount is in addition to the $19,500 ($26,000 if age 50 or older) that you can contribute to the Roth 401(k) or Traditional 401(k), resulting in a maximum total contribution of $58,000 ($64,500 if age 50 or older). This amount would be in addition to the $6,000 ($7,000 if age 50 or older) you may contribute to a Roth IRA account annually either directly or as a backdoor contribution.

Here is what you need to know to determine if you qualify:

  • Are you making the maximum contribution to your Roth 401(k) or Traditional 401(k) and the maximum contribution to your Roth IRA either directly or as a backdoor contribution and still have the capacity to save more?
  • Does your employer’s 401(k) plan allow for after-tax contributions to be made to the plan?
  • Does your employer’s 401(k) plan allow for in-service distributions from the after-tax account, which would allow you to convert funds from the after-tax account to the Roth 401(k) account?

If you can answer “yes” to all three questions, you are in an ideal position to implement a mega backdoor Roth strategy and maximize the tax-free growth of your income. The next step is to explore the specific details and rules of your employer’s 401(k) plan to determine the appropriate actions steps to put the strategy in place. Please reach out to your CCM advisor, and we will work through these details with you.

NOTE: The information provided in this article is intended for clients of Carlson Capital Management. We recommend that individuals consult with a professional adviser familiar with their particular situation for advice concerning specific investment, accounting, tax, and legal matters before taking any action.