How The Rich Avoid Paying Taxes (Tax-free Wealth Creation)

One of the most popular investment strategies on the planet: roll money from your IRA to a Roth IRA. Anyone can convert any amount. Now, this conversion will probably cost you some tax, but that'll be the last tax you pay on that bucket of money, regardless of the growth.

Let's talk about some real money: the mega backdoor Roth. This allows you to do something far and away greater than what you can do in a traditional IRA. If you really want to build wealth free from tax, both on the growth and distribution, it's a no-brainer.

Is the Roth strategy here to stay? In recent years there has been legislation that works towards getting rid of these mega backdoor Roth opportunities.

Welcome back to our channel and another edition of We're Talking Money. I'm Phil Clark, and today we're going to cover one of the most popular investment strategies on the planet. We're talking back doors here: backdoor Roth IRA and the mega backdoor Roth 4 401K.

Now, you're probably thinking your income may be too high. If your income as a single filer is $61,000 or more, or as a married couple filing jointly if you're at $24,000 of household income, you're right, your income would be too high. But there is an easy workaround for this, and that is simply to transfer or roll money from your IRA to a Roth IRA. You can do this without penalty, hence the back door. There are no conversion or income limits on this strategy, so anyone can convert any amount from a traditional IRA to a Roth IRA.

Now, this conversion will probably cost you some tax, but that'll be the last tax you pay on that bucket of money, regardless of the growth. So if you're already contributing to a traditional IRA, now might be a good time to consider transitioning to a Roth IRA. If you have a significant amount in your traditional IRA, before you start converting it might be wise to talk with a financial professional, maybe your CPA, to be sure that such a strategy makes sense for you.

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Okay, so let's assume that you've converted your traditional IRA to the Roth IRA, and now every time you make a contribution to your traditional IRA, that is immediately converted to the Roth IRA every year using the backdoor strategy. Now let's talk about some real money. Meet the mega backdoor Roth. This is a game changer. This allows you to do something far and away greater than what you can do in a traditional IRA using the traditional backdoor Roth strategy. But there's a caveat: it requires a 401k plan through your employer that allows for some different kind of planning.

Keep in mind, the mega backdoor Roth is just one of a handful of ways to take advantage of tax-free investing and tax-free distribution. If you're under the income limits, the mega backdoor Roth really plays no role in your situation; you can contribute to a Roth anyway. If your employer offers a Roth 401k, you can contribute regardless of your income up to 23,000 through payroll deferral, and that can go into the Roth portion of the plan. Under SECURE Act 2.0, your employer can even give you a match that is directed to the Roth side of the plan. If you're over 50 years old, you can add an additional $7,500, which is called a catch-up contribution.

All right, with that out of the way, let's dig into the mega backdoor Roth and how it works in 2024. First, I want you to know that the mega backdoor Roth, it has huge benefits, but it is a little more complicated. It requires some additional steps. Your employer must have a 401k plan that allows for after-tax contributions; that is requirement one. Requirement two: your employer must provide in the 401K plan an in-plan conversion or something called an in-service distribution. Now, that simply means that you can distribute monies from your 401k plan even though you're still employed.

Now, a couple of steps that you'll have to take. First, you'll make after-tax contributions to your plan. Second, immediately following those contributions, you'll either use the in-plan conversion feature or you'll use the in-service distribution, which allows you to roll the money out of your plan and into your Roth IRA.

So the key to this strategy, it's after-tax 401K contributions. That's different from a traditional 401k contribution or Roth contribution. Remember, in a traditional 401k plan with a Roth provision, you can contribute 100% of your deferral amount, and you can have your employer's matching contribution go into the Roth as well. In addition, if you're over 50 years of age, you can have another $7,500 head towards Roth. But it's the after-tax contributions that allow you to exceed the traditional deferral amounts and the match and the catch-up contribution.

Let's take a look at how this works. So for 2024, you can start with a traditional backdoor Roth of $7,000, or $88,000 if you're at least 50 years old, and frankly I recommend this strategy. It's available; take advantage of it. Suppose you're 45 years old and you're deferring the maximum of 23,000, and that can be in pre-tax or Roth contributions, and suppose your employer has contributed a match of $122,000. In that case, the maximum you can contribute would be $33,500. That's a total of $69,000 in just one year, and best of all, it's all going to Roth, so never to be taxed again. If you're over 50, you can defer an additional $7,500 in catch-up contributions, and that can be pre-tax or Roth contributions.

Now that you've done all this work and we've started creating this tax-free environment, you've got to make sure that you can convert using either the in-plan provision to move it into the Roth side of the plan, or you can use the in-service distribution, whichever one your plan offers. And that in-service plan distribution, if that's your choice, that allows you to move it out to your Roth IRA.

So are you ready to take your wealth building to the next level? Here's a couple things you need to do. First, check with your employer and be sure that your 401k plan allows for after-tax contributions. Second, talk with your financial advisor or maybe your CPA and be sure that Roth conversions, Roth in general, makes sense for your financial situation.

You might be asking, is the mega backdoor really worth it? If you really want to build wealth that is free from tax, both on the growth and distribution, and transferring it to the next generation, it's a no-brainer.

I want to answer one more question many people are asking: is the Roth strategy here to stay, or is it potentially going away? The answer is, no one really knows. But what I can tell you is, in recent years there has been legislation that works towards getting rid of Roth and getting rid of these mega backdoor Roth opportunities. So far it's still legal. No legislation has been voted on, and certainly nothing has been signed into law. You have the green light to use a mega backdoor Roth, a traditional backdoor Roth. Both are great, and they'll both help you build tax-free wealth.

Now, I hope this edition of We're Talking Money has inspired you to look a little more closely at how you're saving, how you're building wealth. Are you considering taxes, and will tax-free be something that can help you? I think it can. If you're not sure about these strategies or any of the others that we talk about, feel free to reach out to us by visiting omnistarfinancial.com. We're happy to help.

In the meantime, please subscribe to our channel, give us a thumbs up if you like today's show, and ring that bell so that you never miss a great episode. And I'll see you next time on We're Talking Money.