What is a “Mega” Backdoor Roth Contribution?

Jun. 25, 2024

This is a question we receive from time to time, and it always makes our ears perk up. Not everyone is fortunate enough to have access to the “mega” backdoor Roth contribution strategy, but for those that do, it is one of the most powerful ways to supercharge your retirement savings.

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What’s a normal backdoor Roth?

To really understand what makes a backdoor Roth IRA strategy “mega,” we first need to understand how the classic backdoor strategy works.

Anyone with earned income can contribute to an IRA or a Roth IRA, even if they already contributed to another retirement account, like a 401(k). The 2024 IRA contribution limit is $7,000. (Bonus: if you’re over 50, you can contribute an extra $1,000).

Everyone can contribute to a traditional IRA regardless of income, but if you want to contribute to a Roth IRA, you need to make below $161,000 if single, or $240,000 if married filing jointly.

If you make too much and want to get assets into a Roth IRA, you can do what is called a “backdoor” Roth conversion. It works by first making an after-tax (non-deductible) contribution to a traditional IRA (preferably if you don’t already have one to avoid the IRS’s pro-rata rule) and then immediately converting or moving the amount to a Roth IRA. As long as you have no other traditional IRAs, no taxes will be owed on the conversion since the contribution was already made after-tax (i.e., you already paid the taxes).

Now make it mega

A mega backdoor Roth strategy takes it to the next level. However, like we alluded to in the beginning, there are two big caveats to implementing the strategy: your employer must offer this option through a 401(k) plan, and allow in-service rollovers (while still employed) of after-tax contributions from that plan. But first, let’s begin with IRS 401(k) contribution limits.

For tax year 2024, the 401(k) pre-tax and Roth employee contribution limit set by the IRS is $23,000 and you can do an extra $7,500 if 50 or older. However, if your 401(k) plan allows it, the total 2024 contributions (pre-tax and/or Roth employee deferrals, employer match & after-tax) goes all the way up to $69,000 if you are under 50 and $76,500 if 50 or older. According to Vanguard, only about 20% of all 401(k) plans offer this option.

Here’s a quick breakdown of a maximum 401(k) contribution of $69,000 for someone under 50 in 2024:

  • $23,000 pre-tax and/or Roth employee contribution
  • $10,000 employer match & profit sharing (likely pre-tax)
  • $36,000 after-tax contribution

But wait, aren’t Roth and after-tax contributions the same thing? They’re often used interchangeably so it’s a common point of confusion, but there’s one significant difference: any growth on after-tax contributions is taxable as income when withdrawn. Withdrawals of Roth contributions, including the growth, are entirely tax-free. This is why having the ability to make in-service rollovers is so important. Instead of keeping the after-tax money in the 401(k), where the growth is taxable, you can immediately roll the after-tax contributions directly to a Roth IRA and avoid any potential growth.

For some, the in-service rollover process can be a bit burdensome, so they wait until the end of the year to make the entire after-tax contribution in a lumpsum instead of making smaller contributions throughout the year. This also reduces the potential for any growth on the contributions. Even if the contributions do experience some growth, don’t sweat it, you can still roll the after-tax portion to a Roth IRA and leave the pre-tax growth or earnings in the 401(k).

Other considerations

This strategy is appropriate for those who can afford to sock away a lot of extra cash and have already maxed out their pre-tax or Roth 401(k) employee contribution limit. It’s also a powerful savings tool for those who are self-employed and have their own solo 401(k) plans. It can involve a bit more paperwork upfront when setting it up, but it can certainly be worth it!

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Please consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. The information in this article is not intended as legal or tax advice.

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