In last blogpost, we discussed Roth IRA conversion disadvantages.
Roth IRA Conversion Strategies
A Roth IRA conversion can be a versatile financial planning tool. Here are a few Roth IRA conversion strategies to consider, depending upon your specific situation.
Convert When Asset Values Are Low
Doing a Roth IRA conversion when asset values in your traditional IRA are low can provide you with “more bang for your conversion buck”.
During the steep stock market declines we saw in March 2020, many financial experts were touting the idea of doing a Roth conversion to take advantage of these lower valuations. A conversion under these circumstances allows you to potentially convert a higher percentage of your traditional IRA, offering the potential for this depressed amount to appreciate tax-free in the Roth account over time.
Backdoor Roth IRA
The backdoor Roth is a popular strategy for those who earn too much to contribute to a Roth IRA. Here’s how it works: You make an after-tax contribution to a traditional IRA and then immediately converts this to a Roth IRA. This method is simple and straightforward if you don’t have any other money in a traditional IRA.
The backdoor Roth gets a bit trickier if you do have other money in a traditional IRA that includes pretax contributions and earnings. In this case, the amount converted will be taxed as a percentage of the after-tax contributions to the pre-tax contributions and earnings. An example might look like this:
Mega Backdoor Roth IRA Conversion
A variation of the backdoor Roth conversion is the mega backdoor Roth conversion. This is a strategy that can allow you to contribute up to $38,500 on an after-tax basis to your employer’s 401(k) and then convert this money to a Roth IRA at some point in the future. This amount is reduced by any matching contributions made by your employer.
Your 401(k) plan must allow after-tax contributions over and above the $19,500 or $26,000 (for those who are 50 or over) contribution limits. The maximum total contributions allowed to a 401(k) for 2021 are $58,000 and $64,500 for those who are 50 or over.
If your employer allows in-service withdrawals, you can roll the after-tax money to a Roth IRA doing the Roth conversion with little or no taxable income. An alternative, if your employer allows this, is to transfer the extra after-tax money to a designated Roth account within the 401(k) plan. The money is still in a Roth account where it can grow tax-free. When you leaves your employer, you can then roll the funds in the Roth 401(k) over to a Roth IRA.
If your employer doesn’t allow in-service withdrawals then you will have to wait until you leave the employer. In some cases your plan might allow participants to move this money once you reach age 59 ½. In either case this can still be an advantageous strategy, but you will have to pay taxes on the portion of the Roth conversion that pertains to earnings on these after-tax contributions over time.
Roth IRA Conversion Strategies
A Roth IRA conversion can be a versatile financial planning tool. Here are a few Roth IRA conversion strategies to consider, depending upon your specific situation.
Convert When Asset Values Are Low
Doing a Roth IRA conversion when asset values in your traditional IRA are low can provide you with “more bang for your conversion buck”.
During the steep stock market declines we saw in March 2020, many financial experts were touting the idea of doing a Roth conversion to take advantage of these lower valuations. A conversion under these circumstances allows you to potentially convert a higher percentage of your traditional IRA, offering the potential for this depressed amount to appreciate tax-free in the Roth account over time.
Backdoor Roth IRA
The backdoor Roth is a popular strategy for those who earn too much to contribute to a Roth IRA. Here’s how it works: You make an after-tax contribution to a traditional IRA and then immediately converts this to a Roth IRA. This method is simple and straightforward if you don’t have any other money in a traditional IRA.
The backdoor Roth gets a bit trickier if you do have other money in a traditional IRA that includes pretax contributions and earnings. In this case, the amount converted will be taxed as a percentage of the after-tax contributions to the pre-tax contributions and earnings. An example might look like this:
- You are at age 52
- After-tax traditional IRA contribution $7,000
- Additional assets in traditional IRAs from pre-tax contributions and earnings $100,000
Mega Backdoor Roth IRA Conversion
A variation of the backdoor Roth conversion is the mega backdoor Roth conversion. This is a strategy that can allow you to contribute up to $38,500 on an after-tax basis to your employer’s 401(k) and then convert this money to a Roth IRA at some point in the future. This amount is reduced by any matching contributions made by your employer.
Your 401(k) plan must allow after-tax contributions over and above the $19,500 or $26,000 (for those who are 50 or over) contribution limits. The maximum total contributions allowed to a 401(k) for 2021 are $58,000 and $64,500 for those who are 50 or over.
If your employer allows in-service withdrawals, you can roll the after-tax money to a Roth IRA doing the Roth conversion with little or no taxable income. An alternative, if your employer allows this, is to transfer the extra after-tax money to a designated Roth account within the 401(k) plan. The money is still in a Roth account where it can grow tax-free. When you leaves your employer, you can then roll the funds in the Roth 401(k) over to a Roth IRA.
If your employer doesn’t allow in-service withdrawals then you will have to wait until you leave the employer. In some cases your plan might allow participants to move this money once you reach age 59 ½. In either case this can still be an advantageous strategy, but you will have to pay taxes on the portion of the Roth conversion that pertains to earnings on these after-tax contributions over time.
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