Mega Backdoor Roth Solo 401k & Checkbook IRA

In this post you’ll learn how to get up to $120,000 into Roth retirement accounts (Mega Roth), annually. If you don’t already know the value and power of that – this is a must read. If you already know the value and power of Roth…you’ll read (devour) this without my saying so.

Roth 401(k)s & Roth IRAs: The value of Tax-Free Roth Money

If you invest in assets that generate high returns you know that Mr. Roth is your best friend. Unlike “traditional” tax deferred contributions to retirement accounts – for which you get a tax deduction up front, but pay your marginal income tax rate upon distribution – Roth contributions are taxable income in the year received, but grow completely tax-free thereafter. Tax-deferred vs. tax-free.

In addition, being that with Roth money the IRS receives their tithe up front, there are no required minimum distributions (RMDs) for Roth IRAs. This gives you complete flexibility with regard to those funds, allowing them to keep growing tax free and asset protected, indefinitely.

Roth vs. Traditional: Which is better?

There are many factors to consider when choosing whether to make a Roth or traditional contribution to your retirement account. Among those are the value of a current tax deduction, expectations regarding future taxation, and the nature of the investment strategy being pursued.

Roth vs. Traditional: When Roth is the Clear Winner

If the investment strategy may generate very high returns, Roth is the way to go. Case closed.

When an asset will grow manifold over time, all that growth will be taxable as ordinary income – and will be decimated. With Roth accounts, you pay the tithe upfront on the initial investment and enjoy tax free returns on all the astronomical returns.

Just ask Peter Thiel (PayPal). And Mitt Romney (Bain). And Max Levchin (Yelp).

And, yes, you can invest your IRA and Solo 401k in almost any type of investment

Roth IRAs: The Limitations, the Backdoor Roth IRA, and the Limitations

Roth IRAs are limited to $5,500 annual contribution (plus a $1,000 catch-up for those 50 and older). Furthermore, high earners are ineligible to contribute to Roth IRAs – married filing jointly at $194,000 of adjusted gross income and most other filers at $132,000 of AGI.

A workaround is to use the backdoor Roth IRA strategy, in which you make contributions to a traditional IRA and, subsequently, roll those over to a Roth IRA – aka a Roth conversion. There are no income limitations for Roth conversions.

The backdoor Roth IRA is a great strategy – that’s limited to $5,500.

Mega Backdoor Roth: How to Get $54,000-$120,000 of Roth Every Year

The same concepts that are used in for backdoor Roth IRAs are at play in the Mega Backdoor Roth strategy.

Standard 401k vs. Structured Solo 401k

Overall annual contributions to the 401(k) account of any individual are limited to $54,000 or$60,000 for those 50 and older. The standard 401(k) contribution types are (a) employee tax-deductible salary deferral and (b) employer-deductible profit sharing. Employee deferrals are limited to $18,000 (plus a $6k catchup) and employer profit sharing contributions are deductible to the extent they don’t exceed 25% of employee compensation.

The key to the Mega Backdoor Roth are additional features that can be built into a Solo 401k.

Solo 401k plans can be structured to accept 3 types of contributions: pre-tax, after-tax, and Roth. Solo 401(k) plans can be structured to allow for in-plan conversions.

Pre-tax 401k contributions: These are the types of contributions you’re used to seeing in 401k plans.

Roth 401k contributions: Solo 401k plans can include a Roth subaccount to which after tax contributions can be made of up to $18,000 per year, which grows tax free like a Roth IRA.

After tax contributions: A Solo 401k plan can allow for employee after tax nondeductible contributions. Such contributions grow tax deferred until withdrawal, just like a nondeductible IRA contribution. These are not subject to the $18,000 limit.

In-plan conversions: In-plan conversions allow you to take pre-tax and after tax contributions and convert those to Roth money.

Mega Roth Money: Bringing it All Together

Step 1: Max out tax deductible and nondeductible contributions to your Solo 401k – up to $54,000 for those single and under 50, up to $120,000 for those married and aged 50.

Step 2: Do an in-plan Roth conversion on that money. Voila! Roth money.

Step 3: Invest in assets that will throw off great returns – all tax free!