Take the back door into a Roth IRA

investing2If you’re a high-salary-earner and are looking for ways to put away a sizeable portion of your income for retirement, traditionally your options have been limited. Employer-sponsored retirement accounts like 401(k)s and individual accounts like IRAs have contribution limits that cap how much you can put in each year. For example, Roth IRAs have a limit of $6,500 per year for those age 50 and over. And if you make over a certain limit ($131,000 for singles in 2015) you can’t open a Roth IRA at all.

But under recent IRS rules, you have a potential way around that. Some are calling it the mega-backdoor Roth because it allows you to sock away larger amounts into your Roth IRA, if you qualify.

First your employer must offer an after-tax 401(k), which allows you to contribute with after-tax funds. This type of account is relatively rare (and is not the same as a Roth 401(k)). Many retirement plans that do include this type of account, however, allow employees to contribute a combined $59,000 to all of their 401(k)s if they are 50 or over. So if you’ve contributed $18,000 to your pretax 401(k) and your employer has contributed another $6,000 in matching funds, that leaves up to $34,000 you could contribute to an after-tax 401(k).

When you leave your company (or retire), you can roll over those funds into a Roth IRA. This allows you to put away a larger amount than you could otherwise, and benefit from the tax-free growth that the Roth IRA offers. This is particularly advantageous if you’re relatively early in your career and have many years of earnings ahead. Considering that many people change employers frequently, you could use this technique over and over to effectively contribute tens of thousands of dollars each year to a Roth IRA.

The president’s proposed budget seeks to phase out this loophole. But for many people, it’s an effective backdoor entry to a Roth IRA that they might otherwise not have access to. The rules can be complicated and mistakes costly, so it’s best to work with a qualified financial advisor when implementing this strategy.

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