A mega backdoor Roth IRA is a retirement strategy that allows high-income earners to make after-tax contributions to a Roth IRA.
In 2024, individuals earning more than $161,000 in modified adjusted gross income (MAGI) are not eligible to contribute to a Roth IRA. For couples, the combined 2024 MAGI threshold for a Roth IRA is $240,000.
Anyone with income exceeding these amounts cannot contribute to a Roth IRA. The Backdoor Roth IRA strategy solves that problem by allowing high-income earners to make after-tax contributions to a traditional IRA. People with high incomes following this strategy can then convert those funds to a Roth IRA.
When done correctly, the strategy does more than only allow high-income earners to contribute to a Roth IRA. It also allows them to contribute more after-tax dollars than they could make in direct contributions alone.
Keep reading for a deep dive into the Mega Backdoor Roth IRA with us. Learn more about this strategy and if it could be right for you and your retirement plan.
Why a Roth Over a Traditional IRA or 401k?
Depending on your income, effective tax rate, and retirement goals, a traditional IRA or 401k may be the perfect approach for your retirement strategy. However, there are some situations where the Roth IRA and 401k offer several advantages over a traditional IRA or 401k.
First and foremost, the traditional IRA and 401K are tax-deferred. That means you don’t pay taxes on the money you contribute until you withdraw it in retirement. That allows your money to grow tax-free. However, it also means principal and returns on investments made are taxed at withdrawal.
The Roth IRA is funded with after-tax dollars. That means you don’t get a deduction for your contributions. However, you also won’t pay taxes on the money when you withdraw it in retirement (if you’re over 59 1/2 and have had the Roth IRA for at least five years).
Paying those taxes now can be a big benefit if you’re in a higher tax bracket at retirement than you are now. This is a key distinction between traditional and Roth IRAs and 401ks.
Second, the Roth IRA has no required minimum distributions (RMDs). Avoiding RMDs means you can leave your money invested for as long as you want and never have to take it out. With a traditional IRA, you’re required to start taking withdrawals at age 73.
Finally, the Roth IRA has more flexible withdrawal rules than the traditional IRA. For example, you can withdraw your contributions at any time without penalty. Additionally, you can withdraw your earnings before age 59 1/2 if you meet one of the IRS’s hardship conditions.
For all of these reasons, the Roth IRA can be a great tool when saving for retirement.
Definition of a Mega Backdoor Roth IRA
A Mega Backdoor Roth IRA is a retirement savings strategy that allows high-income earners to make after-tax contributions to a 401k and then convert those funds to a Roth 401k.
There are two steps to the strategy. First, you make after-tax contributions to an after-tax bucket in your 401k. Second, you convert those after-tax contributions to a Roth 401k.
The mega backdoor Roth IRA is sometimes called the two-step backdoor Roth IRA.
Backdoor Roth IRA vs. Mega Backdoor Roth IRA
The backdoor Roth IRA and the mega backdoor Roth IRA are similar in that both allow high-income earners to make after-tax contributions to a Roth IRA.
The difference is in how the contributions are made and how much you can contribute. With the backdoor Roth IRA, you make after-tax contributions to a traditional IRA and then convert those funds to a Roth IRA. In 2024, the backdoor Roth IRA contribution limit is $7,000, or $8,000 for those over age 50.
With the mega backdoor Roth IRA, you make after-tax contributions to an after-tax account within your 401k and then convert those funds to a Roth 401k.
Who Benefits from a Mega Backdoor Roth?
Several types of people can benefit from the mega backdoor Roth IRA. Let’s consider a few scenarios and see if you might fit into one or more.
Those who max out traditional 401k contributions: Have you already maxed out your traditional 401k contributions? The mega backdoor Roth can be a great way to save even more for retirement.
Those who have extra income to contribute on an after-tax basis: Do you have extra income that you can contribute on an after-tax basis? The mega backdoor Roth IRA can be a useful destination for that income.
Those who are not eligible for direct Roth IRA contributions due to high income: The mega backdoor Roth can offer an easy path for high-income earners to get money into a Roth IRA.
Those who have already achieved other important financial goals: Have you already achieved other important financial goals, such as paying off debt or saving for a down payment on a house? The mega backdoor Roth can help you direct more money to your retirement savings and investment strategy.
Those whose company allows for after-tax contributions and in-service withdrawals: If your company allows for after-tax contributions and in-service withdrawals to a Roth IRA, the mega backdoor Roth IRA can be an attractive retirement savings option.
Mega Backdoor Roth IRA Eligibility
There are a few important eligibility requirements for the mega backdoor Roth to keep in mind. If you’re considering using the mega backdoor Roth strategy, make sure you meet the three following rules for eligibility:
- You must have earned income: You must have earned income in order to contribute to your 401k through work.
- You must have a traditional 401k: In order to make after-tax contributions, you must have a traditional 401k account established.
- You must be able to make after-tax contributions and in-service withdrawals to your 401k: In order to make after-tax contributions to your 401k, you must be have that ability through your plan.
If you meet these eligibility requirements, you should have the ability to pursue the Mega Backdoor Roth strategy. The bigger question will be whether it is a smart retirement strategy for you. A conversation with a fiduciary financial advisor can help you create a confident retirement strategy.
How Do Mega Backdoor Roth and Backdoor Roth IRAs Work?
There are two steps to the mega backdoor Roth: making after-tax contributions to an after-tax bucket in your traditional 401k and then converting those funds to a Roth 401k.
Step One: Backdoor Roth IRA Conversion
The first step is to make after-tax contributions to a traditional 401k. In 2023, the contribution limit for a traditional 401k was $22,500. Traditional 401k limits increased to $23,000 in 2024.
Not all 401k plans will allow for direct contributions. That means it’s important to check with your plan administrator to ensure you can make the deposit into your 401k. You should also confrim that you can make in-service withdrawals so you can make the conversion successfully.
Step Two: Make the Conversion
The second step is to convert the after-tax funds from your traditional 401k into a Roth 401k or a Roth IRA. You can do this by making a direct transfer or by rolling the funds over into a Roth IRA.
This can be initiated by your wealth management professional after you confirm your choice, making the process more convenient. You can also start the process by contacting your 401k and IRA plan administrator directly.
Roth IRA Income Limits for 2024
Roth IRAs have income limits that restrict high-income earners from utilizing this retirement strategy. If you earn beyond these limits, you are essentially unable to contribute to a Roth IRA without a strategic approach like the mega backdoor Roth IRA.
There is a phase-out range, meaning you can contribute to a Roth IRA until you cross a certain level of earnings. At that point, you are limited to how much you can contribute to your Roth IRA. You can contribute up to the full amount if you earn below the phase-out range.
If you earn within the range, you can contribute a reduced amount. If your earnings surpass the phase-out range, you will need to take an alternative approach like the mega backdoor Roth IRA.
Single filers: the 2024 contribution phase-out range is $146,000 to $161,000. In 2023, the contribution phase-out range for single filers was set at a range of $138,000 to $153,000.
Married filing jointly: the contribution phase-out range for 2024 is $230,000 to $240,000. In 2023, the contribution phase-out range for those who are married and filing jointly was set at a range of $218,000 to $228,000.
Is a Mega Backdoor Roth Worth It?
A mega backdoor Roth IRA has plenty of benefits, but this strategy isn’t suitable for everyone. It can be difficult to compare all the pros and cons and determine if such an approach is truly an effective option.
A financial advisor can help you understand whether the mega backdoor Roth IRA is right for your retirement strategy on a personal level. A trustworthy advisor can consider a mega backdoor Roth IRA in the broader context of your overall financial position and goals for retirement.
A holistic and targeted strategy for reaching your goals is ultimately what’s most important for stable and secure finances in retirement.
There are some clear advantages to the mega backdoor Roth IRA. The biggest advantage is that it allows high-income earners to get around the Roth IRA income limits. So, if you cannot contribute to a Roth IRA because you earn too much money, the mega backdoor Roth can be a great way to get those funds into a Roth IRA.
Tax Guidelines for a Mega Backdoor Roth IRA
The Mega Backdoor Roth IRA is a legal way to save for retirement. There is no gray area here. The IRS has specific guidelines around the mega backdoor Roth IRA and how the associated taxes obligations work.
The key fact to remember is that you will owe taxes on the after-tax contributions you make to your traditional 401k. When you convert those funds to a Roth IRA, you will owe taxes on that money.
However, any growth in the account will then be tax-free. Similarly, withdrawals from your Roth IRA will come tax-free as well. That can make budgeting easier in retirement, as well as provide a clearer picture of the funds available to you with each distribution.
Tips for Your Own Mega Backdoor Roth IRA
If you are considering utilizing the mega backdoor Roth IRA for your retirement strategy, these tips can help you make more informed decisions.
Remember the Pro Rata Rule for the Mega Backdoor Roth
The pro rata rule says that you cannot only convert the after-tax contributions you have made to your traditional 401k. You convert any of the pretax contributions or earnings in the account.
This can get tricky if you have been contributing to your traditional 401k for a long time. You will need to work with your wealth management professional or your plan administrator to figure out how much of your account is after-tax contributions.
The net effect of the IRA aggregation rule is that only a portion of the non-deductible contributions can actually be converted tax free. That’s true even if the non-deductible contribution is made to a new account and converted separately. Why? Because the IRA aggregation rule combines all the accounts for tax purposes anyway.
This can be a major tax trap most investors are not aware of. You should consult with a fiduciary financial advisor before considering this strategy to make sure you are not going to be hit with large tax liabilities.
Check the Rules on Your Own 401k Plan
It is never good to accidentally lock up a large sum of money. Not all 401k plans allow for after-tax contributions.
Before you decide to utilize the mega backdoor Roth IRA, make sure your plan allows for after-tax contributions. That’s a foundational requirement for this retirement strategy.
Contribute the Maximum Post-Tax Dollars
The whole point of the mega backdoor Roth IRA is to get as much money into a Roth IRA as possible. It probably wouldn’t make sense to go through the trouble of setting up a Mega Backdoor Roth IRA for a small contribution.
The benefit comes from the ability to contribute and ideally max out your contributions each year. So, contribute as much as possible to get the most benefit from your efforts.
Roll Your Post-Tax Contributions into the Roth IRA
Once you have made your after-tax contributions to your traditional 401k, you will need to roll those funds into a Roth IRA. You cannot stop partway through the process and leave the money in your traditional 401k.
The good news is that most 401k providers offer a way to easily roll over your funds into a Roth IRA.
Why Is the Mega Backdoor Roth Not Allowed at Some Companies?
The Mega Backdoor Roth IRA is an IRS-sanctioned way to contribute to a Roth IRA. So, why wouldn’t all companies allow it?
The answer has to do with the way that 401k plans are structured. Some 401k providers don’t have the ability to handle after-tax contributions, or they simply choose not to offer it as an option.
Unfortunately, the mega backdoor is shut if your company’s 401k plan doesn’t allow for after-tax contributions. However, you can explore other options for optimizing retirement savings and investments with a fiduciary financial advisor.
Even if a mega backdoor Roth IRA isn’t available to you, an experienced and trustworthy advisor will put your best interests first. They will determine if other strategies and processes can help boost retirement savings and ensure those decisions fit into your big picture of retirement.
Will the Backdoor Roth Ever Be Eliminated?
While there is little way to know what the future holds, it seems unlikely that the backdoor Roth IRA will be eliminated. The strategy is legal, not particularly controversial, and doesn’t attract much, if any, negative attention in general.
The IRS has been clear that the backdoor Roth IRA is a legal way to save for retirement. That’s a strong signal of the continued availability and usefulness of this strategy.
Mega Backdoor Roth Alternatives
If your company’s 401k plan doesn’t allow for after-tax contributions, there are a few other ways to get money into a Roth IRA.
One option is to simply contribute the maximum amount to your traditional 401k and then roll the funds into a Roth IRA when you retire. This approach isn’t quite as good as the mega backdoor Roth because you will owe taxes on the money when you retire. However, when a mega backdoor Roth IRA isn’t in play, this alternative offers a way to get money into a Roth IRA.
The Bottom Line
The mega backdoor Roth IRA is a great way for high-income earners to get money into a Roth IRA if your company’s 401k plan allows for it. If not, there are other ways to get money into a Roth IRA.
Connect with an advisor at Dechtman Wealth Management to unlock the Mega Backdoor Roth IRA and explore other creative solutions that will have your retirement ready.
