Clarifies Roth conversion vs. mega backdoor Roth and tax implications.
Sources:
Here's a breakdown of the differences between a Roth conversion and a Mega Backdoor Roth, along with their tax implications, clarified by from the podcast.
Roth Conversion
- Mechanics: A Roth conversion involves transferring funds from a traditional, pre-tax retirement account (like a 401(k) or IRA) to a Roth IRA.
- Tax Implications: This is a taxable event. For example, if you convert $30,000, that amount is added to your taxable income for the year, potentially increasing your tax liability. You’ll need to set aside money to cover this tax cost 1 2.
Mega Backdoor Roth
- Mechanics: This involves making after-tax contributions to your 401(k) and then moving these contributions to a Roth IRA or Roth 401(k). This allows you to potentially contribute up to $35,000 a year over the regular Roth IRA limit.
- Eligibility: Not all employers offer this option; it's essential to check if your company's 401(k) plan supports after-tax contributions and in-service withdrawals 3 4.
- Tax Implications: While you contribute after-tax dollars (which means no immediate tax hit for contributions), if you move these funds into a Roth IRA, the growth on these contributions will be tax-free in the future. There could be a minor tax implication if the withdrawn amount includes growth before age 59.5 2 5.
Summary
- Roth Conversion: Direct transfer from a traditional retirement account to a Roth, taxable during conversion.
- Mega Backdoor Roth: Leverages after-tax contributions to your 401(k), then moves to Roth for tax-free growth, with potential eligibility and procedural hurdles.
Both strategies offer ways to maximize tax-advantaged retirement savings, but it's crucial to understand the specific tax impacts and procedural requirements 1 3 2.
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