If you do a quick search to find out how much you can contribute to a Roth 401k, you’ll usually find that the most you can defer from your salary into a Roth 401k is $22,500*. In reality, with the right combinations of circumstances, the maximum that can get into a Roth environment is $66,000*.
*If you’re over 50, add $7,500 to both of these numbers.
How can you fund the difference between that $22,500 and the true maximum of $66,000+?
The difference between the salary deferral limits and the maximum allowable can be made up in several ways with different tax implications. Each can be useful for different financial planning strategies. Here are two common situations we see during annual meetings with our clients:
- Most dental practice owners who sponsor a 401k for their employees know how to get more than $22,500 into their 401k. A practice owner can fund the difference with a discretionary (optional) pre-tax profit-sharing contribution with money from the practice. To qualify for this, funding for eligible staff is also required, on a pro-rata basis. Several formulas for funding the staff profit sharing can be tested for best results. Profit-Sharing contributions are funded by the practice on a pre-tax basis.
- Another way to contribute funds in excess of the $22,500 ($30,000) salary deferral is to make Non-Roth Post-Tax contributions, up to the $66,000 ($73,500) maximum, eventually rolling the post-tax contributions to a Roth IRA.
The Non-Roth Post-Tax contribution is personally taxable, both FITA and FICA, but it has the potential to grow tax free if rolled to a Roth IRA. Some are calling this a “Mega Backdoor Roth”. Over enough years, the tax hit on the front end may be well worth years of tax-free growth.
Who can make Mega Backdoor Roth contributions?
Dental practice owners can, but like profit sharing contributions, funding still is subject to 401k testing to make sure retirement plans are fair to all employees.
Even if you’re not a practice owner, an employee with a 401k can fund the difference themselves, but only if your 401k plan allows it – not many do. This would be a great strategy for anyone wanting to get more money into a Roth environment, and is particularly attractive for someone in a lower tax bracket.
This can all be in addition to a Roth or Backdoor Roth IRA contribution outside of your employer retirement plan.
There are several design features that need to be included in the 401k plan to fully take advantage of this strategy, but this could be a great way to super-charge your ability to get money into a Roth IRA environment. We are glad to discuss your current situation in depth to see if this is the best wealth management strategy for you. Click here to schedule a time to talk.