Mega Backdoor Roth IRA: What Is It & How Does It Work?
JA
Summary:
A mega backdoor Roth IRA strategy allows you to bypass the IRS income restrictions on Roth IRA contributions and save a significant amount of money for retirement. By converting after-tax 401(k) contributions to a Roth account, you could stash an extra $43,500 into a Roth IRA or Roth 401(k) and avoid paying income taxes on the earnings upon retirement.
Are you a high-earner looking to maximize the tax-free money you can save for retirement? If so, you may want to consider a mega backdoor Roth IRA. While a regular backdoor Roth strategy can result in $6,500 of tax-free growth, a mega backdoor Roth allows you to save up to $43,500 (in 2023) and shelter your investment growth from taxes.
Of course, this strategy may not be available or suitable for everyone. That said, it’s worth learning how one works if you’re looking to supercharge your retirement savings and build a cushy nest egg.
Compare Investment Advisors
Compare the services, fees, and features of the leading investment advisors. Find the best firm for your portfolio.
What is a mega backdoor Roth IRA?
A mega backdoor Roth refers to a tax-saving strategy that allows high-income earners (who are ineligible to directly contribute to a Roth account) to transfer up to $43,500 of after-tax 401(k) contributions into a Roth IRA and/or Roth 401(k).
As of 2023, the IRS won’t allow you to make Roth IRA contributions if you earn more than $153,000 as a single taxpayer or more than $228,000 as a married-filing-jointly taxpayer. Using the mega backdoor Roth strategy, you could bypass the IRS’s income limitations on Roth contributions and save large sums of cash for retirement (up to $43,500).
Mega backdoor Roth vs. regular backdoor Roth IRA conversions
A regular backdoor Roth IRA also allows high-income earners to bypass the IRS income limits. But instead of making after-tax contributions to a 401(k) plan, they make a nondeductible contribution to a traditional IRA and then convert it to a Roth IRA.
So with a backdoor Roth IRA, you can contribute up to $6,500 ($7,500 if you’re over 50) to a Roth IRA when your income exceeds the limits. In contrast, a mega backdoor Roth IRA is a way to contribute significantly more after-tax money to your retirement portfolio and eventually convert it to a tax-free Roth IRA.
How does a mega backdoor Roth work?
There are two steps to the mega backdoor Roth strategy:
- First, you must make after-tax contributions to your 401(k) or workplace retirement plan.
- Then you must roll that money over into a Roth IRA and/or Roth 401(k).
So, what exactly is an after-tax 401(k) contribution, and how is it different from a Roth or pre-tax 401(k) contribution? Here’s a breakdown of the different types of 401(k) contributions to help you better understand.
Types of 401(k) contributions
- Pre-tax contributions. The money you invest into your retirement plan before taxes are deducted. You’ll have to pay taxes on pre-tax contributions and earnings upon retirement.
- Roth contributions. Roth contributions are the exact opposite of pre-tax contributions. You’ve already paid taxes on the amount invested into your retirement plan, so you won’t have to pay taxes on it again upon retirement.
- After-tax contributions. After-tax contributions are made with after-tax dollars. Though you won’t have to pay taxes again upon withdrawal of the contribution amount, you’ll have to pay ordinary taxes on earnings.
- Employer contributions. The amount that your employer pays into your retirement plan. (These can be made on a tax-deferred or after-tax basis.)
As of 2023, if you’re under 50, the IRS allows you to contribute up to $22,500 in pre-tax and/or Roth contributions ($30,000 if you’re older than 50). If you make after-tax contributions and take advantage of an employer match, the IRS allows you to increase your total 401(k) contribution to $66,000 ($73,500 if you’re 50 or older).
However, one major downside of after-tax contributions is that your earnings will be taxed upon withdrawal at ordinary income tax rates. To avoid getting taxed again at retirement, you can use the mega backdoor strategy to convert the after-tax contributions to a Roth account.
While the after-tax contributions you make to your 401(k) are not tax-deductible, the earnings on those contributions are tax-deferred. — Doug Carey, CFA and owner of WealthTraceClick to Tweet
Are you eligible for mega backdoor Roth conversions?
Whether you’re eligible for mega backdoor Roth conversions depends on the specifics of your employer retirement plan. For the mega backdoor Roth strategy to work, you must have:
- Access to after-tax 401(k) contributions
- The ability to convert those after-tax contributions to a Roth IRA and/or Roth 401(k)
Note that not every employer allows you to make after-tax 401(k) contributions and convert those contributions to a Roth. So, if you want to take advantage of this strategy, check with your plan administrator to see if it’s available to you.
What to know before using the mega backdoor Roth strategy
Before using a Mega Backdoor Roth conversion strategy, here are three things Doug Carey — a Chartered Financial Analyst (CFA) and owner of WealthTrace — says you should know:
- Plan rules. You need to ensure your employer’s 401(k) plan allows for after-tax contributions and in-service distributions, which is the ability to move money out of the plan while you’re still working for the employer. Carey says, “Not all plans offer this option, and the rules can vary, so check with your plan administrator to ensure you’re eligible.”
- Tax implications. Another thing Carey says to be aware of is that “while the after-tax contributions you make to your 401(k) are not tax-deductible, the earnings on those contributions are tax-deferred.” In other words, when you convert those contributions to a Roth, you’ll owe taxes on any earnings at the time of conversion.
- Contribution limits. The limit for all 401(k) contributions, including after-tax contributions, cannot exceed $66,000 in 2023 ($73,500 if you’re over 50). So, Carey says you should “be aware of your contribution limit and plan accordingly to avoid over-contributing to your retirement account.”
Pro Tip
Not sure if you’re on track for retirement? Use the U.S. Department of Labor retirement planning tool to determine how much you’ll need to save to retire comfortably.
Should you invest in a mega backdoor Roth?
The mega backdoor Roth IRA conversion strategy can be particularly useful for those who earn too much to contribute to a Roth IRA directly. However, before deciding whether or not to invest in a mega backdoor Roth, always consult with a qualified financial advisor, or one of the investment advisors below, to determine if this strategy aligns with your long-term financial goals.
Other Roth IRA options
If you aren’t eligible for the mega backdoor Roth conversion strategy, don’t fret. While this strategy is a sweet way to get a significant amount of money into your retirement accounts, it makes the most sense for folks with lots of money to put aside for savings.
If you’re below the Roth IRA income limits, you can simply contribute to a Roth IRA without jumping through hoops. And if you’re above the Roth IRA contribution limit but don’t plan on making anywhere close to $43,500 in after-tax contributions, you could opt for a regular backdoor Roth conversion strategy instead to bypass the income limit for Roth IRAs.
FAQs
Is a mega backdoor Roth still allowed in 2023?
Yes, the mega backdoor Roth strategy is still allowed in 2023. To determine whether you’re eligible for the conversion strategy, check with the plan administrator of your retirement accounts. Your plan must permit after-tax contributions and in-plan Roth conversion so you can take after-tax contributions and convert them to a Roth IRA.
Is a mega backdoor Roth worth it?
The mega backdoor Roth strategy can be complicated to implement. Still, it could be worth it if you’re a high-income earner who wishes to bypass the Roth IRA income limits and contribution limits for the given year.
With this strategy, you can contribute up to $43,500 in after-tax dollars to a 401(k) plan and roll it over into a Roth IRA or Roth 401(k). This will allow your contributions to grow tax-free, and you won’t have to worry about paying taxes on your withdrawals in retirement. So, if you’re already maxing out your 401(k) contributions and want other tax-advantaged options, the mega backdoor Roth could be a worthwhile option to explore.
Key Takeaways
- Mega backdoor Roth IRA conversions are a tax-saving strategy that allows high-income earners to make after-tax 401(k) contributions and roll them over into a Roth.
- There are four types of 401(k) contributions: pre-tax contributions, Roth contributions, after-tax contributions, and employer contributions.
- The mega backdoor strategy allows you to bypass the IRS income limits on Roth contributions and add up to $43,500 in annual retirement savings.
- To be eligible for the mega backdoor conversion, you must have access to after-tax 401(k) contributions and the ability to convert them into a Roth IRA.
- Before making a mega backdoor Roth conversion, consult with your plan administrator to ensure you’re eligible. You may also want to talk to a qualified financial advisor to determine whether this strategy makes financial sense for you.
Share this post: