1. Roth IRA Conversion
Those who have savings in a tax-deferred account, like a traditional IRA, can convert some or all of that balance to a Roth IRA and pay ordinary income tax on the converted amount. As a result, you might choose to spread out the conversion over multiple years to better manage the associated tax bill. A good place to start may be to see how much room you have left in your current tax bracket, before you 'spill over' into the next highest bracket. The idea is to pay taxes when the rate is low, and then enjoy tax-free growth on any appreciation once inside the Roth IRA.
If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and penalties. Also, if your traditional IRA includes both pre-tax and after-tax contributions, the converted amount will be partially taxable (called the pro rata rule), so you may want to consult with a tax expert in advance. Each conversion will be subject to a separate 5-year holding period rule and once a conversion is done, it can't be undone.
2. Roth 401(k)
If your employer offers this option—which has no income limits—you can set aside up to $23,000 ($30,500 if you’re age 50 or older) in Roth contributions in 2024.
3. Backdoor Roth IRA
If you earn too much to make deductible contributions to a traditional IRA, you can still make after-tax contributions (also called ‘non-deductible’ contributions), up to the annual limit, and then convert them to a Roth IRA.
The contribution limit for 2024 is $7,000 ($8,000 if you’re age 50 or older), as long as you had at least that much in taxable compensation for the year. Also, spousal IRA contributions are typically available even for non-working spouses. As with all Roth IRA conversions, the pro rata rule applies.
4. MEGA-Backdoor Roth IRA
Before you begin, verify with your employer's retirement plan administrator that your plan allows contributions of after-tax dollars above and beyond the annual contribution limit, as well as withdrawals while you're still working (which are required to perform the final step below). If it does:
First, max out your normal 401(k) contributions.
Next, contribute after-tax dollars up to the overall limit of $69,000 ($76,500 if you’re age 50 or older) in 2024, regardless of income.
Important Notes:
The regular 401(k) contribution for 2024 is $23,000 ($30,500 for those 50 and older). You can put an additional $46,000 of after-tax dollars into your 401(k) account, assuming you don't get an employer match. If you do get an employer match, you'll need to deduct your employer contributions from the $46,000.
If you have a Roth 401(k) at work (and the plan allows for the MEGA option), generally you can choose whether the final destination of your MEGA contributions is the Roth 401(k) or a Roth IRA. If your employer offers only a traditional 401(k), then your MEGA contributions would end up in a Roth IRA.
Finally, make an (irrevocable) transfer of the after-tax funds into a Roth 401(k) or IRA—the sooner the better, since any earnings will become pre-tax dollars if left in the regular 401(k).
You risk a hefty tax bill on the transfer if you have pre-tax money — either contributions you’ve deducted or investment earnings — sitting in ANY traditional IRAs (another pro rata rule!). Again, you may want to consult with a tax expert in advance.
At Whitford Financial Planning, we develop customized saving and withdrawal strategies based on your overall financial goals and situation.
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