Supercharge your Roth IRA

Don’t let Roth IRA income limits prevent you from gaining tax-free growth

“It’s the best motivation to save for retirement that we’ve seen in America.
Everybody should be in the Roth game if they can.”

-IRA expert and financial-industry speaker, Ed Slott

The Roth IRA is perhaps the most attractive retirement savings vehicles for investors. Unlike traditional IRAs which provide tax-deferred growth (you pay the tax eventually), Roth IRA assets grow tax-free. Assets with this favorable tax characteristic can provide desirable flexibility in retirement years, where the future state of tax rates is very uncertain. The Roth IRA protects you from paying future income taxes, and this protection also continues for your heirs.

While everyone should get in the Roth game, as Mr. Slott proposes, for high-income earners it hasn’t always been so easy. Roth IRA contributions are not allowed once a married couple has an AGI over $196K (or $133K for an individual). IRA conversions – changing an account from an IRA into a Roth IRA – were not possible for high-income earners until recent changes in the tax law removed income limitations. Here, the “backdoor IRA” strategy was born.

Backdoor IRA: How it Works

The Backdoor Roth IRA strategy allows those who earn more than the Roth limitations contribute to a Roth IRA anyway, with one small workaround. While contributing to a Roth IRA is prohibited for high-income earners, anyone can make contributions to a Traditional IRA. In addition, anyone who has funds in an IRA can “convert” the assets into a Roth IRA. Put together, high-income earners can sidestep the Roth income limitations by contributing to an IRA and then converting it to a Roth. IRA limits are currently $5,500 ($6,500 for those aged 50 and over), and the strategy can be repeated every year.

The main obstacle to making a “backdoor” Roth contribution is the pro-rata rule, which can limit the effectiveness of the strategy. The pro-rata rule forces all IRAs to be counted as one account, so a $5,500 Roth conversion will be considered as a partial conversion of all existing IRA assets, not as a standalone transaction. The downside here is the tax benefits are issued on a pro-rata basis, meaning if $5,500 represents 5% of all your combined IRAs, only 5% of the $5,500 can be converted tax-free into a Roth (the remainder will be considered a taxable distribution – not the desired outcome). Note the rule only aggregates IRA accounts, so 401(k)’s, spouse’s accounts, or other Roth accounts are not counted (SIMPLE and SEP IRA assets are included).

Roth Supercharge Strategy: Unlock Extra Savings From Your 401(k)

Investors can save $5,500 per year into a Roth via the backdoor strategy; this a good start, but high-income earners may want to do more. If your 401(k) allows for both after-tax contributions and in-service distributions, you can quickly accumulate significant Roth IRA assets by using a supercharged strategy.

Many people are familiar with the $18,000 limit for 401(k) contributions ($24,000 for those over 50). But there is a lesser-known overall limit of $53,000; this includes employee contributions, employer match and profit sharing. If a 401(k) plan allows for after-tax contributions, an employee can make additional contributions above and beyond the standard $18,000 limit. Here’s an example of how it works:

William is age 49 and maxing out his 401k salary deferrals…………………….$18,000

The company matches at 50%……………………………………………………….$9,000

Amount under overall $53K limit William can contribute “after-tax”…………….$26,000

If the 401(k) also allows for “in-service distributions,” William can then rollover the $26,000 after-tax 401(k) contribution into his Roth IRA, regardless of his income level. Combined with the $5,500 backdoor Roth strategy, William can now put away $31,500 into a Roth IRA, every year!

Not everyone will have this opportunity as it depends largely on your 401(k) plan’s flexibility and design. But for those eligible it can be an outstanding way to accumulate assets into a Roth IRA. Ask your 401(k) administrator if your plan allows for 1.) after tax contributions and 2.) in-service withdrawals. If so, call or email and we can discuss how a supercharged Roth IRA strategy can advance your retirement planning.


Perritt Capital Management, Inc. is the Registered Investment Advisor for Windgate Wealth Management accounts.  Windgate does not provide tax advice. Consult your professional tax advisor for questions concerning your personal tax or financial situation.

Data here is obtained from what are considered reliable sources as of 6/30/2017; however, its accuracy, completeness, or reliability cannot be guaranteed.

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