3 Advanced Roth IRA Conversion Strategies for High-Income Professionals

Roth IRAs offer several benefits, including tax-free growth and withdrawals during retirement. However, not everyone can contribute directly to a Roth account due to income restrictions imposed by the IRS. 

This caveat can pose challenges for high earners seeking to benefit from a Roth IRA’s unique tax advantages. Fortunately, if your income exceeds the threshold for direct Roth contributions, various strategies make it possible to move money into a Roth IRA while adhering to IRS guidelines.

In this blog article, we’ll explore three key strategies for funding a Roth IRA indirectly, including a Roth Conversion, Mega Backdoor Roth Conversion, and strategically timing multiple Roth Conversions. 

Understanding Roth IRA Basics

Like traditional IRAs, Roth IRAs have annual contribution limits. In 2024, individuals under age 50 can contribute up to $7,000, while those 50 and above can contribute up to $8,000. 

However, unlike traditional retirement accounts, Roth IRAs have income limits based on modified adjusted gross income (MAGI) that restrict who can contribute directly to these accounts. For 2024, single filers with a MAGI above $161,000 and married couples filing jointly with a MAGI above $240,000 are not eligible to make direct Roth IRA contributions.

The primary appeal of Roth IRAs lies in their tax advantages. Although you make contributions with after-tax dollars, the account grows tax-free over time, and qualified withdrawals in retirement are also tax-free. This can be particularly beneficial if you expect to be in a higher tax bracket in retirement or if tax rates increase in the future.

This differs from traditional IRAs, which offer tax-deductible contributions and taxable withdrawals in retirement. Traditional IRAs also require minimum distributions (RMDs) starting at age 73, while Roth IRAs have no such requirement during the owner’s lifetime.

Even if your income exceeds the IRS limits for direct contributions, you can still take advantage of a Roth IRA’s unique tax benefits. In fact, there are several alternative strategies available to high earners for funding a Roth IRA indirectly. 

#1: Roth IRA Conversion

A Roth conversion, often referred to as a Backdoor Roth, is a sophisticated tax planning strategy that allows high earners to indirectly fund a Roth IRA. This approach can be particularly advantageous for those in higher tax brackets who are looking to maximize their retirement savings and benefit from the tax-free growth and withdrawals that Roth IRAs offer.

Here’s how it typically works:

1. Contribute to a Traditional IRA. High earners start by contributing to a traditional IRA. Unlike Roth IRAs, traditional IRAs don’t have income limits for direct contributions. However, the ability to deduct these contributions may be limited based on your income and participation in an employer-sponsored retirement plan.
2. Convert to a Roth IRA. The next step is to convert all or some of your traditional IRA funds to a Roth IRA. During the conversion, you’ll pay taxes on any pre-tax contributions and earnings in the traditional IRA. However, if the contribution was non-deductible (which is often the case for high earners), only the earnings on those contributions are taxable. 

Benefits of a Roth Conversion

A Roth conversion offers several benefits, including:

• Tax-Free Growth and Withdrawals. Once the funds are in the Roth IRA, they grow tax-free. You can also make tax-free withdrawals in retirement, provided certain conditions are met (such as holding the account for at least five years and being over age 59½ at the time of withdrawal).
• No Required Minimum Distributions (RMDs). Unlike traditional IRAs, Roth IRAs aren’t subject to RMDs during the account holder’s lifetime. This allows the funds to grow for a longer period, potentially increasing the tax-free benefits.
• Tax Diversification. Having a mix of tax-deferred (traditional) and tax-free (Roth) accounts in retirement can provide greater flexibility in managing taxable income. This can be particularly beneficial for high earners who may find themselves in a high tax bracket even after they retire.

Considerations and Potential Drawbacks

Despite the benefits, high earners should carefully consider the potential drawbacks before initiating a Roth IRA conversion. These include:

• Tax Implications. The conversion is a taxable event, which means the amount converted will be added to your taxable income for the year. It’s important to plan for this additional tax liability and consider whether it might push you into a higher tax bracket.
• Pro-Rata Rule. If you have other traditional, SEP, or SIMPLE IRAs, the IRS will look at the total amount across all your IRAs to determine the taxability of your conversion. This means that if you have both pre-tax and after-tax contributions in your IRAs, the conversion will be subject to the pro-rata rule, which can complicate the tax calculation.
• Timing and Strategy. You’ll want to carefully time the Roth conversion and ensure it’s in alignment with your overall financial plan. 

While a Roth conversion can be a powerful tax planning tool, it may not make sense in every situation. Given the complexity of this strategy, it’s wise to consult with a fiduciary financial advisor or tax professional to maximize the benefits and mitigate potential risks. 

#2: Mega Backdoor Roth 

The Mega Backdoor Roth is an advanced strategy that allows high-income earners to contribute significantly more to a Roth account than traditional methods permit. This approach can be particularly beneficial for individuals who have maximized their traditional retirement contributions and are looking for additional ways to leverage tax-free growth for their retirement savings.

Here’s how it typically works:

1. Maximize 401(k) Contributions. The first step involves contributing the maximum allowable amount to a traditional 401(k) plan, including both the employee contribution limit and any employer match. For 2024, the contribution limit is $23,000, with an additional $7,500 catch-up contribution allowed for those age 50 and older.
2. Make After-Tax Contributions. Some 401(k) plans allow for after-tax contributions beyond the traditional pre-tax contribution limits. In 2024, the total 401(k) contribution limit, including employee, employer, and after-tax contributions, is $69,000 (or $76,500 for those 50 and older). Be sure to confirm whether your 401(k) plan allows for these additional contributions. 
3. Convert After-Tax Contributions. Once you’ve maximized your after-tax contributions, the next step is to convert these contributions to a Roth IRA or an in-plan Roth 401(k). This is where the “Mega Backdoor Roth” term comes into play. Any earnings on the after-tax contributions before the conversion will be subject to tax. However, the conversion can often be done immediately to minimize your potential tax liability. 

Benefits of a Mega Backdoor Roth 

If available, a Mega Backdoor Roth offers several key benefits, including: 

• Significant Tax-Free Growth Potential. By maximizing after-tax contributions and converting them to a Roth account, you can significantly increase your tax-free retirement savings beyond the standard contribution limits.
• No Income Limits. The Mega Backdoor Roth strategy circumvents the income limits for direct Roth IRA contributions, allowing for substantial contributions regardless of income level.
• Flexibility and Control. Funds in a Roth account grow tax-free and can be withdrawn tax-free in retirement, provided certain conditions are met. This offers greater flexibility in managing retirement income and tax liabilities.

Considerations and Potential Drawbacks

While a Mega Backdoor Roth can be a valuable retirement planning strategy, it’s crucial to consider the potential risks and drawbacks. These include: 

• Plan Limitations. Not all employer-sponsored 401(k) plans offer the ability to make after-tax contributions or to convert those contributions to a Roth account. Be sure to review your specific plan’s provisions and confirm that these options are available.
• Tax Implications. While the contributions themselves are after-tax and thus not taxable upon conversion, any earnings on those contributions before conversion are subject to income tax. It’s important to understand the tax implications and manage the timing of conversions to minimize tax liability.
• Complexity and Compliance. The Mega Backdoor Roth strategy involves navigating complex IRS rules and plan-specific regulations. It’s a good idea to consult with a financial advisor or tax professional to execute the strategy correctly and ensure it aligns with your overall financial plan.

While powerful, the Mega Backdoor Roth conversion isn’t for everyone. It’s most beneficial for those who’ve maxed out other retirement savings options and have additional cash flow to save. It’s wise to consult with a financial advisor or tax professional to determine if this strategy is right for you.

#3: Strategically Timing Roth Conversions

A key advantage of the Roth conversion strategy is that you don’t have to convert all your funds at once. This flexibility allows you to strategically time multiple conversions to maximize the after-tax dollars you ultimately transfer to your Roth IRA. 

By spreading out conversions over several years, you can manage your tax liability and potentially benefit from a lower overall tax burden. Here’s how this strategic timing can work:

• Avoiding Higher Tax Brackets. Converting a large sum in a single year could push you into a higher tax bracket, resulting in a higher tax rate on the converted amount. By spreading the conversion over several years, you can keep each year’s conversion amount within a lower tax bracket, minimizing your overall tax liability.
• Utilizing Lower Tax Years. If you anticipate years with lower taxable income (such as early retirement years, career changes, or years with significant deductions), it might be advantageous to plan conversions during those periods. This can help you take advantage of lower tax rates, reducing the taxes owed on the converted amounts.
• Taking Advantage of Down Markets. Converting during a market downturn can be advantageous, as you’ll owe taxes on a lower account value. When the market eventually recovers, the growth will be tax-free in your Roth account. 

Considerations for Strategic Timing of Roth Conversions

To maximize the benefits of strategically timing your Roth conversions, consider the following: 

• Current and Future Tax Rates. Be sure to analyze your current tax rate and compare it to your expected future tax rates (both federal and state level). If you anticipate being in a higher tax bracket during retirement, converting now at a lower rate can be beneficial.
• Impact on Social Security. Roth conversions can increase your income in the year you convert, potentially affecting the taxation of your Social Security benefits. By spreading conversions, you can manage this impact more effectively.
• Medicare Premiums. High income can lead to increased Medicare premiums due to Income-Related Monthly Adjustment Amounts (IRMAA). Strategic timing of conversions can help manage these premiums.
• Use of Tax Credits. It’s important to be mindful of how conversions might impact your eligibility for certain tax credits, as higher income could phase out or eliminate these benefits.

Strategically timing your Roth conversions to minimize your overall tax liability can be challenging and time-consuming. Consider working with a trusted financial professional who can help you develop and execute a comprehensive conversion strategy tailored to your specific financial situation and goals. 

TrueNorth Wealth Is Here to Help

A Roth conversion, Mega Backdoor Roth, and strategically timing multiple Roth conversions offer three effective methods for high earners to indirectly fund a Roth IRA. However, it’s important to note that retirement planning isn’t a one-size-fits-all approach, and this isn’t an exhaustive list of strategies. An experienced financial advisor can help you determine the right strategy for your situation and take steps to maximize the potential benefits. 

If you’re looking for personalized tax and retirement planning guidance, TrueNorth Wealth is here to help. Our team of fiduciary CFP® professionals will work with you to create a comprehensive plan that helps you make the most of your financial resources and minimize your potential tax burden in retirement. 

TrueNorth Wealth is among the top Wealth Management firms in Utah and Idaho, with offices in Salt Lake City, Logan, St. George, and Boise. At TrueNorth Wealth, we focus on helping our clients build long-term wealth while maximizing the enjoyment they receive from their money. We do this by pairing our clients with a dedicated CFP® professional backed by an incredible team.

For our team at TrueNorth, it’s about so much more than money. It’s about serving families all across Utah and helping them achieve freedom and flexibility in their lives. To learn more or schedule a no-cost consultation, visit our website at TrueNorth Wealth or call (801) 316-1875.