Summary/TLDR
In recent years, there have been four trends driving more financial professionals to advise that their clients save into a Roth IRA as opposed to a pre-tax account. If you fall above a certain income threshold, however, you are not allowed to contribute to a Roth IRA. Luckily, there are still plenty of ways that high income earners can access Roth IRAs and take advantage of the tax-free growth that they offer. These include Roth savings through your employer retirement plan, Roth conversions, “backdoor” Roth contributions, and “mega backdoor” Roth rollovers/conversions. When done correctly, some of these strategies could end up saving you hundreds of thousands of dollars throughout the remainder of your life. However, before pursuing any strategy that you read about below, you should consult with a competent professional (usually a financial planner, CPA, or both) to ensure that they are a good fit for you and are properly executed. Failing to do so could lead to unnecessary headaches and tax penalties.
When utilized properly, a Roth IRA can be an extremely powerful savings vehicle. Unfortunately, current tax law prohibits those above a certain income threshold ($228,000 Modified Adjusted Gross Income, or MAGI, for a married couple filing jointly, or $153,000 MAGI for a single tax filer at the time of this writing) from making Roth IRA contributions at all. The door is not completely closed to high income earners, however, and when understood properly and facilitated with the help of a financial professional, even extremely high income earners can benefit from the power of tax-free compounding growth found in a Roth IRA. In this post, I am going to explain:
- The four trends driving Roth savings today
- Ways to access Roth accounts as a high income earner
- The difference between a Roth contribution and a Roth conversion
- How a “backdoor” Roth IRA contribution works and how to do it properly
- What is a “mega backdoor” Roth?
- The importance of not attempting to do advanced tax planning by yourself
Does Roth savings even make sense if I’m in a high tax bracket?
The short answer is yes, it can (especially if you are reading this before 2026)! There are four trends driving the popularity of Roth strategies:
- The Tax Cuts and Jobs Act (discussed below) will be ending after 2025
- The stock market is in the midst of the worst bear market since the 2008 financial crisis. If you save into a Roth IRA now, all the growth that those savings would experience when the market recovers will be tax free, as opposed to fully taxable if they took place in a Traditional IRA or taxable investment account
- We currently have exceptionally low (relative to history) marginal tax brackets and all-time high deficits at the Federal level. This makes the probability of the marginal income brackets being raised substantially over the coming decades very high, in my opinion.
- The Secure Act (discussed below) has changed the rules for inheriting Traditional IRAs that are far less favorable (to say the least) than previous law
The Secure Act
A quick detour is needed regarding the Secure Act of 2019 and how it affects the non spousal beneficiaries of a Traditional IRA. If you are not interested in the legislative background, click here. If you inherited an IRA before 2020, you were required to distribute the funds over the duration of your life. An annual distribution (known as a Required Minimum Distribution, or RMD) had to be evaluated every year and the beneficiary would take a distribution from the Traditional IRA in the amount of the RMD and pay taxes on it. Since most beneficiaries usually have at least 30 years remaining in their own lives by the time they inherit their parent’s assets, these annual distributions were relatively modest for most taxpayers.
The Secure Act changed this. Beneficiaries of IRAs are still required to make annual Required Minimum Distributions from any IRAs that they inherit, but they are also now required to take all of the funds out of the IRA (and, yes, pay taxes on them) within 10 years of inheriting the funds. Take into account the fact that most people will be inheriting assets during their highest income earning years when they are already likely in some relatively high tax brackets, this new provision will ensure the government gobbles up far more of any pre-tax assets passed on to the next generation than before.
Beneficiaries of a Roth IRA are still required to take annual distributions and withdraw all funds from the IRA within 10 years, but none of it is taxable! Therefore, many people are deciding to pursue some of the Roth strategies discussed below even if they expect their heirs to be the primary beneficiaries of the power of tax-free growth offered in Roth accounts.
Accessing Roth IRAs as a High Income Earner
Once you’ve established that Roth savings will be advantageous for you, the next step is to explore the different ways to access Roth funds. Luckily, there are plenty of ways to do this, even if you are above the income thresholds in which you can make a Roth contribution. In this section, we will explore the various ways that everyone with earned income can access Roth accounts.
Roth 401k, 403b, 457, SIMPLE IRAs, and SEP IRAs
By far and away, the easiest option for accessing Roth savings is your employer retirement plan, such as a 401(k), 403(b), or 457. Most companies are offering Roth contributions to a 401(k), and many providers of 403(b)s and 457s offer them as well. When you retire, you can then rollover the Roth portion of your 401(k) to a Roth IRA. If you are a small business owner, the SECURE Act 2.0 has opened the door for Roth contributions to be made to your SEP or SIMPLE IRA as well.
It is important to note that only your contributions will go to a Roth 401(k). Your employer’s matching contributions will still go to a pre-tax account that will have to be rolled over to a Traditional IRA. Technically, the SECURE Act 2.0 now allows employers to offer plan participants the option of receiving their employer match as a Roth contribution. This is still a very new piece of legislation, however, and it is yet to be seen how popular of a provision it will be. The recordkeeper of your 401(k) keeps track of all of your pre-tax, Roth, and employer contributions (and the earnings attributable to each category) for you, so making Roth contributions requires no extra diligence from you either.
Be mindful that contributing to your employer retirement accounts either Roth or after-tax will make your paycheck smaller than if you were to contribute pre-tax (because you are now paying taxes on your contributions).
Roth Conversions
High income earners also have access to Roth savings through Roth conversions. The IRS considers a conversion and a contribution as two completely different kinds of transactions that are subject to two completely different sets of rules. In the cases of both a conversion and a contribution, the destination of the funds is obviously a Roth IRA. The source of the funds that enter the Roth IRA, however, are what constitutes the difference.
In a contribution, the source of the funds is a taxable account, such as a bank account or a brokerage account. There is an annual limit ($6,500-$7,500 depending on your age) to the amount of contributions one is allowed to make every year. Furthermore, as mentioned above, if you are above a certain income threshold, you are prohibited from making any contribution at all. In a conversion, however, the source of the funds is a pre-tax retirement account, such as a 401(k) or Traditional IRA. There are no income limits that restrict eligibility to make a conversion, nor are there limits to the amount of funds one can convert every year.
Every dollar that is converted is taxable as ordinary income in the calendar year of the conversion. There is no 10% premature distribution penalty for those under the age of 50 either. Conversions are usually facilitated through the transfer of funds in a Traditional IRA to a Roth IRA, but many employer retirement plans offer in-plan conversions of pre-tax and after-tax contributions to Roth as well (discussed below).
A couple of things to be mindful of with these. Each conversion is subject to the “5-year rule”, which states that a Roth IRA must be opened for 5 years before it qualifies for tax-free distributions. Second, it’s not uncommon to convert so much that you go into a higher IRMAA tax bracket. The IRMAA tax brackets are really only relevant to those 65 and older who are on Medicare. Essentially, the higher up on the IRMAA brackets you are, the higher your Medicare premiums will be. Neither of these things should intimidate or dissuade you from exploring Roth conversion, however, Your financial planner and tax professional will make you aware of both of these things (and any other nuance to be mindful of) they are relevant to your situation.
Obviously, the fact that every dollar moved to a Roth account via a conversion is taxable requires some very careful tax planning to be sure that it is right for you. However, one of the four trends that I mentioned above, The Tax Cuts and Jobs Act of 2017, has made conversions far more attractive for far more people.
The Tax Cuts and Jobs Act
Very briefly, let’s look at the importance of the Tax Cuts and Jobs Act to this equation (click here to skip ahead if this bores you). The Tax Cuts and Jobs Act, passed in 2017, temporarily lowered marginal income tax brackets at the federal level and is set to expire, or “sunset”, after 2025. Below is a picture of current marginal income tax rates on the right and what they will revert back to after 2025 on the left. This is an old picture, so don’t be confused by the brackets on the left being labeled as “Current Law”. As of the time of this writing, the brackets on the right are current law, and the brackets on the left will become current law in 2026, adjusted for inflation. For the purposes of my analysis below, I will be ignoring any effect that inflation has had on the pictured income brackets since it doesn’t change my conclusion.
Let’s say we have a married couple living in the great state of Texas who are both 45 years old with a taxable income of $350,000. Ignoring tax credits, they would fall under the 32% tax bracket and would have a tax liability of approximately $75,000 (an effective tax rate of 21.5%). After the expiration of these brackets, however, their tax liability would be closer to $90,000 (an effective tax rate of 25.8%).
Clearly, this type of environment is ripe for Roth conversions. This couple could convert large amounts of their Traditional IRA to a Roth IRA and pay taxes now (on funds that they will have to pay taxes on anyway) at lower tax rates than they would in the future, assuming their income remains approximately the same in retirement. Furthermore, all future growth on these funds will be 100% tax free once it is in the Roth, whereas it would be completely taxable if it remained in the Traditional IRA.
Furthermore, Roth accounts are exempt from the dreaded Required Minimum Distributions that must begin at your age 73 (more on these in a future post, perhaps!). These distributions are required by the government, and it’s not uncommon for people to end up in a higher tax bracket during retirement than they might otherwise have planned on if they didn’t have to take these distributions.
A full analysis of the “tradeoff” between pre-tax and Roth savings is complex and involves many variables. Luckily, you can work alongside a financial professional who can walk you through whether or not the math behind making conversions makes sense for you.
One final (and, in my opinion, highly overlooked) advantage to making Roth conversions is that they can open up the door to the so-called “backdoor” contribution. We’ll take a look at these next.
“Backdoor” Roth IRA Contributions
Simply put, a “backdoor” Roth contribution is one in which a contribution is made to a Traditional IRA, but is not deducted from your taxes (known as an after-tax contribution), and is then immediately converted to a Roth IRA. Since the IRA contribution was made after-tax, there are no taxable consequences to this method either, assuming it has been done properly.
If you are a high income earner who has an employer retirement plan, then you likely already know that you cannot make a deductible contribution to a Traditional IRA due to your income. This makes a “backdoor” Roth contribution your best option when it comes to saving in a tax-advantaged fashion. Usually, these contributions will be funded via cash or the transfer of cash from a taxable investment account into a Traditional IRA.
Backdoor Roth IRA contributions are not something that you want to start making willy-nilly due to some nuances in the tax code that could lead to penalties or headaches come tax time. One such nuance is the so-called “pro-rata” rule, which states that IRAs with “commingled” pre-tax and after-tax contributions will be taxable on a pro-rata basis upon distribution of the funds from any IRA in your name. Generally speaking, therefore, it is usually advised that one prioritize Roth conversions first and turn to making “backdoor” contributions only once all Traditional IRAs have been emptied of any basis and growth from pre-tax contributions. Also keep in mind that this rule does not apply to employer retirement accounts, so you can have a large 401(k) with pre-tax savings and still make “backdoor” Roth contributions without any trouble. This is just one of many examples of why you should seek guidance from a professional before utilizing any of these strategies.
After-tax 401(k) Contributions and “Mega-Backdoor” Roth Rollovers/Conversions
This last strategy is not open to everyone and is usually the “last resort” strategy. It can still be extremely powerful, however, if you have the means to make it happen. In order to make “mega-backdoor” Roth contributions, you first must participate in your employer’s 401(k), assuming they offer one. Furthermore, your 401(k) must allow for after-tax contributions (discussed below). Finally your 401(k) plan must allow for in-service withdrawals or in-plan rollovers.
If you are a high income earner, then you likely know your annual 401(k) contribution limit ($22,500 in 2023 for all income earners, and $30,000 for those above the age of 50). What you might not know, however, is the maximum that can actually go into a 401(k) every year is $66,000 ($73,500 if you’re older than 50). This $66,000 is the ceiling for funds that enter the 401(k) from all sources: your contributions, your employer’s matching contributions, any discretionary employer profit sharing, etc. Most 401(k) participants, however, fall far short of the $66,000 maximum every year. To allow participants to contribute additional funds up to the $66,000 maximum, some employers will allow after-tax contributions to be made to the plan. You will know if you fall in this camp by simply going to the page on your 401(k) portal where you can change your contributions. If you see three options, “pre-tax”, “Roth”, and “after-tax”, then you’re good to go.
After-tax 401(k) contributions are different from pre-tax and Roth contributions. The latter two types of contributions are subject to the $22,500 contribution limit, and can’t be made to reach the $66,000 maximum. Furthermore, the taxation of after-tax contributions are different as well. After-tax contributions are made to a 401(k) on an after-tax basis (obviously), so when they are taken out in retirement they remain tax free. Growth on those contributions, however, is 100% taxable when distributed (assuming you didn’t utilize the “mega-backdoor” strategy”!).
If you “max out” your 401(k) by contributing up to the $22,500 elective deferral maximum, then contribute additional funds on an after-tax basis, you can then rollover the after-tax contributions to a Roth account! This means that all growth on the funds will be completely tax-free upon their distribution. This is usually done either through an in-service withdrawal of the after-tax funds to a Roth IRA, or an in-plan conversion (this is a Roth conversion that takes place inside of a 401(k) plan instead of an IRA) of the after-tax funds to a Roth 401(k). One thing to be mindful of, however, is that any growth on the after-tax contributions will be taxable as ordinary income upon their rollover to a Roth IRA or conversion to a Roth 401(k). Once in the Roth, however, they are protected from future taxation (assuming all other IRS rules are followed). For this reason, “mega-backdoor” conversions/rollovers are usually done soon after the after-tax contributions are made, when growth on the funds is likely very small.
Finally, even if your plan doesn’t allow for in-service withdrawals or in-plan conversions, after-tax 401(k) contributions can still be worthy of pursuit for the simple fact that all contributions can get rolled over to a Roth IRA upon your termination from the company, and all growth on those contributions remains tax-deferred until their eventual withdrawal.
The Importance of Utilizing Professional Assistance
While I have done my best to make this post thorough, there are tons of tiny nuances in the tax code that, if you are not aware of them, could cause these strategies to blow up in your face and lead to painful penalties. It is imperative that you work with a team of financial professionals who can help you plan and execute on the strategies above. Generally speaking, this is a financial planner and a CPA.
I’m not saying this “just to say it”! You can create a big mess for yourself by trying to tackle these types of transactions on your own. I recently had some people in my office who didn’t consult a tax or financial professional before making “backdoor” Roth contributions. They are now going to have to pay penalties on these funds and the end result (after all of the fees paid to accountants to untangle their mess) is that they will be worse off than if they hadn’t done anything at all. Even if you escape without having to pay penalties, the headaches and stress you would create for yourself simply aren’t worth it. The cost of working with a professional is far less than the risk of overlooking something when trying to do-it-yourself. When you consider the total amount of tax savings you could realize from utilizing these strategies properly, the fees charged by financial planners and CPAs for some help pale in comparison.
Wrapping Up
Even if you make too much to contribute to a Roth IRA, there are still plenty of ways you can access Roth accounts and the extremely powerful tax-free growth that they offer. There are literally full-length books written on strategies like the ones I’ve discussed above, and new strategies are constantly being invented or modified as the legislative environment changes.
In short, don’t be afraid to get creative with your tax planning! Doing so can save you and your beneficiaries hundreds of thousands, and in some cases millions, of dollars in taxes throughout your lifetimes.
