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Pushing the Limits of Your Roth IRA

Make it a mega.

Christine Benz: Hi, I'm Christine Benz from Morningstar. How can you supersize your Roth IRA balance? Joining me to discuss the mega backdoor Roth IRA is author and tax-planning expert Ed Slott.

Ed, thank you so much for being here.

Ed Slott: Great to be back with you, Christine. Thanks.

Benz: It's great to have you here. Let's talk about this mega backdoor Roth IRA. Businessman Peter Thiel made headlines recently for getting $5 billion into a Roth IRA. Most people don't have the strategies at hand that he was able to use, but there is a strategy that people can enlarge their Roth IRAs with, and it involves using aftertax 401(k) contributions. Can you talk about that? Because that does seem like that's the starting point for being able to get more funds into a Roth IRA than you would be able to get if you're just contributing the $6,000 per year that you're able to do?

Slott: Well, first with Peter Thiel: He didn't do anything illegal. Remember, people think he had billions of dollars. You know, it's like the old joke: How do you become a billionaire? First, you have to have $1 billion and then... He didn't have $1 billion. Back in 1999, he contributed the legal amount of $2,000--that's what it was back then--to his Roth IRA. He was under the income limits, so he was allowed to do it. Then he invested $1,700 of that $2,000. The $2,000 is the only money he ever put in a Roth IRA. And of course, it took off like a lottery ticket type of investment--it should only happen to everybody! So there's nothing wrong with what he did.

It got people thinking, as you say, How can I do that? Well, you know, unless you have that information and that intuitive--whatever it is. I don't want to say inside information. But unless you're a super-investor and lucky, maybe, too, that's probably not going to happen to you. But you can make it happen using the tax law through your employer's 401(k). So that's the starting point for this thing we call the mega backdoor Roth IRA. Because there's a separate backdoor Roth IRA. This is the mega backdoor. This involves being in a company plan, which means you have to be employed by a company. So there's a few obstacles here. It's not all it's cracked up to be. It sounds good because, in some cases, you can put up to $58,000 in an aftertax account in a company plan, and then take it out and roll it to your Roth IRA tax-free, $58,000 a year. 

So there's a few hurdles. The biggest hurdle is the company has to qualify. There are discrimination and testing rules to prevent higher-income employees from gobbling up all the benefits and leaving lower-paid employees without the benefit. So there's discrimination rules that some big companies can handle because they have a bigger pool of employees to get that average over more people. But a smaller company, like, let's say you have a group of doctors or lawyers, maybe 10 people or so or a little more, but you have this wide gap between higher-paid people and lower-paid people. They probably wouldn't qualify under the discrimination testing. So that's one thing. You know who does qualify? People with no employees. You have a solo 401(k)--you don't have to worry about any of that. So if you have your own business, and you have a solo 401(k) without any employees besides you or a spouse, you don't have to worry about that hurdle. 

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