MORE LIKE THISInvestingRoth and Traditional IRAs
Many investors choose the Roth IRA for a tax break in retirement, but it does have a restriction: income levels. This means high-income earners could be locked out of contributing to a Roth IRA.
That’s where the mega backdoor Roth comes in: if fortune smiles on you, this strategy could allow you to stash an extra $46,000 into a Roth IRA or Roth 401(k) in 2024, then roll it into a mega backdoor Roth. But that “if” is big. You could even call it mega.
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First, some background
Roth and traditional IRAs: With Roth IRAs, you put in money after paying income tax on it, and then those dollars grow tax-free. But income rules restrict who can contribute to a Roth, and there’s a maximum IRA contribution limit of $7,000 in 2024 ($8,000 if age 50 or older). A traditional IRA gives you an immediate tax break on your contribution, your money grows tax-deferred and you pay income tax when you pull out your money in retirement.
» Get started: See our picks for the best Roth IRA plans
Backdoor Roth: A strategy for people whose income is too high to be eligible for regular Roth IRA contributions. You simply roll money from a traditional IRA to a Roth. There are no income or conversion limits — that is, anyone can convert any amount of money from a traditional to a Roth IRA. But you risk a hefty tax bill on the rollover if you have pretax money — either contributions you’ve deducted or investment earnings — sitting in any traditional IRAs, thanks to the IRS’ pro-rata rule.
» Read more about that rule in our backdoor Roth IRA guide.
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What is a mega backdoor Roth?
A mega backdoor Roth takes it to the next level. It’s for people who have a 401(k) plan at work. They can put up to $46,000 of post-tax dollars in 2024 into their 401(k) plan and then roll it into a mega backdoor Roth, which is either a Roth IRA or Roth 401(k).
The caveat: Creating a mega backdoor Roth is complicated, with many moving parts and the potential to get hit with unexpected tax bills, so consider consulting with a financial planner or tax pro before trying this at home.
» Are you on track for retirement? Run your numbers through our retirement calculator to see.
Mega backdoor Roth 2024
The mega backdoor Roth allows you to save a maximum of $69,000 in your 401(k) in 2024. How does this add up? The regular 401(k) contribution for 2024 is $23,000 ($30,500 for those 50 and older). You can put an additional $46,500 of after-tax dollars into your 401(k) account, assuming you don't get an employer match.
If you do get an employer match, you'll need to deduct your employer contributions from the $46,000.
If you have a Roth 401(k) at work (and the plan allows for the mega option as described below), generally you can choose whether the final destination of your mega contributions is the Roth 401(k) or a Roth IRA. If your employer offers only a traditional 401(k), then your mega contributions would end up in a Roth IRA.
Here’s a quick summary of what you need to have in place for the ideal mega backdoor Roth strategy:
A 401(k) plan that allows “after-tax contributions." After-tax contributions are a separate bucket of money from your traditional 401(k) contributions. The dollars you put into an after-tax bucket are post-tax, so you've already paid taxes on them.
In-service distributions. Your employer has to offer either in-service distributions to a Roth IRA — that is, you can take money out of the 401(k) plan while you’re still working at the company — or lets you move money from the after-tax portion of your plan into the Roth 401(k) part of the plan. If you’re not sure, ask your human resources department or plan administrator.
Spare cash. You’ve got money left over to save, even after maxing out your regular 401(k) and Roth IRA contributions.
Here’s more detail on each of those bullet points:
Your 401(k) plan allows after-tax contributions
This is pretty straightforward: Either your employer plan allows after-tax contributions or it doesn’t.
If your 401(k) plan allows for after-tax contributions, the maximum that you and your employer combined can put into your 401(k) is $69,000, or $76,500 for individuals 50 and older in 2024.
Your 401(k) lets you move your after-tax money
If your plan doesn’t allow in-service withdrawals to a Roth IRA or in-plan rollovers to a Roth 401(k), then your opportunity to do the mega backdoor Roth is delayed until you leave your job. If that’s the case, you might want to reconsider this strategy.
Ideally, executing the mega backdoor Roth means throwing all of your after-tax savings into your after-tax bucket (once you’ve maxed out your regular 401(k) contribution limit). Then, you’re almost immediately getting your money out of that bucket and into either a Roth IRA or Roth 401(k) before it starts accruing investment earnings. That’s because if you leave your after-tax contributions in the after-tax bucket, which is a tax-deferred bucket, you’re going to eventually owe tax on those earnings. But once that money is in a Roth, it grows tax-free.
The point is to get as much money into the Roth as soon as possible to get as much tax-free growth as soon as possible. If your after-tax contributions accumulate investment earnings, the IRS has said it’s OK to split up that money, by rolling your after-tax contributions into a Roth IRA and the investment earnings into a traditional IRA. That means your contributions will still grow tax-free, and your investment earnings will grow tax-deferred — you’ll pay income taxes when you take them out in retirement.
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You’ve got money left over for savings
A mega backdoor Roth IRA is a sweet way to get a lot of money into a Roth IRA, but it’s really for folks who have a lot of money to put aside for savings. In general, it makes sense to first max out a regular or Roth 401(k) and a Roth IRA, if you’re eligible. Here’s why:
With a regular 401(k), you get an upfront tax break — your taxable income is reduced in the year you make your contributions, and you defer taxes on your investment earnings until you make a withdrawal.
If you opt for the Roth 401(k), you contribute money that you’ve already paid taxes on. Your tax break is delayed, but your money grows tax-free and you get tax-free income in retirement.
If you’re below the Roth IRA income limits, it’s easier to simply contribute directly than to jump through all the hoops required for the mega backdoor Roth IRA. If you’re above the Roth IRA income limits, then a backdoor Roth — the non-mega kind — is also an option.
If you’ve maxed out your 401(k) and a Roth IRA and you still have money to save this year, that’s when you’d consider a mega backdoor Roth.
Note: On rare occasions, a 401(k) plan may be forced to return your contribution to you. This generally happens only if you're among the highest paid workers at your company. That's because IRS nondiscrimination tests require that retirement plans don't offer a substantially bigger benefit to high-income employees than rank-and-file workers. If the highest paid workers are saving at a much higher rate than other workers, the plan may be forced to return some of that money.
Bottom line
A mega backdoor Roth allows high-earning investors — who otherwise couldn't put money in a Roth account because of income or contribution restrictions — to move money from a 401(k) plan to a Roth IRA or Roth 401(k) plan. Although it sounds simple, it’s an involved process that could come with a tax bill, so consulting with a financial advisor or tax professional may be helpful.
The mega backdoor Roth is just one of a handful of ways to take advantage of the Roth treatment and earn tax-free withdrawals. Here are some others:
If you’re under the income limits, you can contribute directly to a Roth IRA.
If you’re over the income limits, you can get in with a backdoor Roth.
If your employer offers a Roth 401(k), you can contribute to that.
I'm an expert in personal finance and investment strategies, and I'm excited to delve into the topic of Roth IRAs, traditional IRAs, and the intriguing concept of the mega backdoor Roth. My expertise comes from years of practical experience in the financial industry, helping individuals navigate the complexities of retirement planning and tax-efficient investment strategies.
Now, let's break down the key concepts discussed in the article:
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Roth and Traditional IRAs:
- Roth IRAs involve post-tax contributions, and the earnings grow tax-free. However, there are income restrictions and a maximum contribution limit.
- Traditional IRAs provide an immediate tax break on contributions, with tax-deferred growth, and taxes are paid upon withdrawal in retirement.
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Backdoor Roth:
- A strategy for high-income individuals ineligible for regular Roth IRA contributions.
- Involves rolling money from a traditional IRA to a Roth, but the IRS' pro-rata rule can result in a significant tax bill.
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Mega Backdoor Roth:
- Targeted at those with a 401(k) plan at work.
- Allows individuals to contribute up to $46,000 of post-tax dollars in 2024 to their 401(k) and then roll it into a mega backdoor Roth (Roth IRA or Roth 401(k)).
- Complex process with potential for unexpected tax implications, requiring consultation with a financial planner or tax professional.
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Maximum Contribution in Mega Backdoor Roth:
- Enables a maximum savings of $69,000 in the 401(k) in 2024.
- Breakdown: Regular 401(k) contribution limit of $23,000, plus an additional $46,500 of after-tax dollars.
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Requirements for Mega Backdoor Roth:
- 401(k) plan allowing "after-tax contributions."
- Availability of in-service distributions for a Roth IRA or in-plan rollovers to a Roth 401(k).
- Spare cash after maxing out regular 401(k) and Roth IRA contributions.
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Considerations for Mega Backdoor Roth:
- Swift movement of after-tax contributions into a Roth to maximize tax-free growth.
- The strategy is suitable for individuals with substantial savings capacity.
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Other Roth Strategies:
- Direct contributions to Roth IRA if below income limits.
- Backdoor Roth for those above income limits.
- Contribution to a Roth 401(k) if offered by the employer.
In conclusion, while the mega backdoor Roth presents an opportunity for high-earning individuals to leverage Roth benefits, it requires careful consideration due to its complexity and potential tax implications. It's crucial to consult with a financial advisor or tax professional before attempting this strategy.
