Enhancing Your Retirement Savings: Additional Opportunities

Backdoor Roth Contributions, Spousal IRA Contributions, and Mega Backdoor Roth Contributions

Life is good. You have a good job with a 401(k) plan, which you think you are maxing out. You are not overspending, so you find your bank account grows year over year. But as your income has grown, so has your tax bill and you wonder, are there other ways I could be saving more tax efficiently?

The answer is likely yes. But first some questions:

• Do you and your spouse have IRA accounts? Do you have Roth IRA accounts?
• Are you contributing to these accounts?
• Do these accounts have a balance?
• Does your spouse work?
• Does your employer allow “after-tax contributions,” “in service distributions,” or “in service rollovers?”

Depending on your answers to these questions, there may be several ways to enhance your retirement savings. Let’s discuss several underutilized strategies, starting with the most common.

Traditional IRAs

Anyone can make IRA contributions each year, up to the statutory limits which adjust with inflation. In 2024 these limits were $7,000 per person if under 50 ($8,000 if at least 50) or the level of the couple’s earned income, whichever is lower.

For single taxpayers, or couples who are covered by a workplace retirement plan, to be fully tax deductible, your income must be below certain thresholds:

• A couple must earn less than $123,000 per year, with partial deductibility up to $143,000.
• Single taxpayers must earn less than $77,000, with partial deductibility up to $87,000.

Roth IRAs

If you don’t qualify for a traditional IRA deduction, you may be able to contribute to a Roth IRA. You won’t get a tax deduction, but the assets in the Roth will grow tax-free. The income limits for taxpayers making contributions to a Roth IRA are:

• $146,000 for singles and heads of household (with reduced limits up to $161,000)
• $230,000 for married filing jointly (with reduced limits up to and $240,000)

ACTION ITEM #1:  Contribute to a Traditional or Roth IRA, if you qualify.

But the opportunities don’t stop there…

It is a common misconception that a non-working spouse cannot make IRA contributions because they have no income. This is incorrect. See Spousal IRAs below.

And if your income exceeds the Roth limits, there may still be a way to contribute to a Roth. See Backdoor Roth Contributions below.

Spousal IRAs

If one spouse works, and the other does not, the non-working spouse can still make IRA contributions up to the annual limit based on the working spouse’s income.

• For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the income limit in 2024 is $230,000 (with partial deductibility up to $240,000).

ACTION ITEM #2:  If you are married, and one spouse does not work, contribute to an IRA on their behalf.

Backdoor Roth Contributions

If either of you does NOT have a traditional IRA (or has one with a zero balance), but your income exceeds the Roth contribution limits, you can make backdoor Roth contributions through the following process.

1. Make a non-deductible contribution to your traditional IRA up to the limits described above. Do not invest it.
2. Transfer (or “roll”) the balance from your IRA to your Roth. Invest the proceeds now in your Roth IRA.

Because the initial contribution was made with after-tax (non-deductible) dollars, the conversion from the traditional IRA to the Roth IRA is not taxable.  And voila!  You have sheltered another $7,000 (or $8,000) from future taxes.

ACTION ITEM #3: If you have no assets in a traditional IRA, make backdoor Roth contributions.

Finally, you may have the opportunity to make additional contributions to your 401(k) and make…

Mega Backdoor Roth Contributions

Different 401(k) plans have different rules, and many plans do not allow this strategy. But as my mother used to say, you’ll never know if you don’t ask…

Write a quick email to your human resources (HR) benefits person and ask these questions:

• Do we have a Roth option in our 401(k)?
• Does our 401(k) plan allow after-tax contributions?
• If so, does it allow in-service rollovers or in-service distributions?
• If the answer to these questions is yes, then how do I do accomplish these tasks?

If the answer to the first three questions is YES, you are in luck.

Just like the traditional backdoor Roth contributions, you will be making after-tax contributions to a traditional retirement account and then rolling the balance to a Roth account.  The process varies by plan, so we will describe this in a general way, and you will need to work out the details for your specific plan, and of course, reach out to your JMG advisor for help as needed.

1. You will need to make after-tax contributions to your plan in addition to the contributions you are already making. The contributions must be made through your payroll. HR or the plan administrator should be able to tell you how to do this for your plan.
2. Once the funds are in the plan, instruct the plan to transfer (or “roll”) your after-tax balance into your Roth. HR or the plan administrator should be able to tell you how to do this for your plan.

The hardest part of this (and where your JMG financial advisor may be very helpful) is calculating the amount of after-tax contributions to make. Here is the thought process:

• The combined limit for employer plus employee contributions for 2024 is $69,000, plus $7,500 if you are 50 or older.
• The limit for pre-tax (tax deductible) employee contributions is $23,000, plus $7,500 if you are 50 or older.
• This leaves $46,000 available for employer contributions, but most employers don’t max this out.
• If the employer doesn’t make any contributions, you can contribute (and roll to Roth) up to $46,000 in 2024. (That’s why they call it the MEGA backdoor Roth…) If your employer does make contributions, you can use what’s left.
• Divide your total after-tax contribution by your remaining number of paychecks to determine your monthly after-tax contribution amount.
• Tell HR or your plan administrator you want to contribute your monthly after-tax contribution amount per paycheck to your 401(k) on an after-tax basis.

ACTION ITEM #4: If your 401k plan allows it, consider making a Mega backdoor Roth contribution.

While making normal 401(k) contributions, and maxing them out, is a great first step, as you can see, for those with sufficient free cash flow, there may be additional saving opportunities to consider. If you think you may be eligible or have questions about any of these tax-saving strategies, please reach out to your JMG Financial Advisor.

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