If you’re a high-income earner and super saver, you may find the limits of traditional and Roth IRAs too restrictive. However, there’s a legal loophole that may enable you to save in a Roth IRA, even if your income exceeds the limit to contribute to one directly, it’s a strategy called The Mega Backdoor Roth.
What Is Mega Backdoor Roth?
A Mega Backdoor Roth allows high-income earners to make additional contributions to their retirement accounts beyond the limits of traditional IRAs. This strategy takes advantage of the higher contribution limits for 401(k) and other employer-sponsored plans, enabling you to contribute more after-tax dollars into these accounts and convert them into a Roth IRA.
If you’re single and your earnings are above $153,000, or if you’re married and filing jointly with an income above $228,000, you can't contribute directly to a Roth IRA. With a Mega Backdoor Roth, however, some individuals can contribute to a non-Roth 401(k) and convert it into a Roth IRA.
Options For Funding your 401(k)
As you might already know, there are two options on how you can fund a 401(k):
Traditional 401(k) contributions:
- Money is taken directly from your paycheck and placed into your 401(k) before it gets hit with taxes (lowering your taxable income for the year)
- Money grows tax-free
- All contributions and earnings are taxed as ordinary income when withdrawn in retirement
Roth 401(k) contributions:
- Money is taxed now as ordinary income in your paycheck, then added to the 401(k)
- Money grows tax-free
- All contributions and earnings are tax-free when withdrawn in retirement
But there may be a third option.
After-tax contributions:
After-tax contributions may enable you to save in your workplace retirement plan beyond the annual contribution limit for pre-tax and Roth contributions. In order to complete the Mega Backdoor Roth strategy, you’ll need the ability to do this type of contribution.
- Money is added to the account after-tax
- Money grows tax-free
- Only the earnings are taxed upon withdrawal as ordinary income. The original contributions are returned tax-free.
Mega Backdoor Roth Pre-qualification
There’s a misconception that after-tax contribution is the only prerequisite for a Mega Backdoor Roth. This strategy is complex and can have severe tax implications if done wrong. Therefore, consulting a financial professional is a necessity.
First, your employer must allow after-tax contributions to 401(k) or other employer-sponsored plans.
Second, your 401(k) or employer-sponsored plan must allow you to do a Roth IRA and/or Roth 401(k) conversion. There are two options you have:
- In-service distribution
- In-plan Roth conversion
In-service distribution allows you to make an after-tax contribution to your employer-sponsored plan and transfer it directly to a Roth IRA.
As the name suggests, in-plan Roth conversion allows you to make an after-tax contribution to your employer-sponsored plan and convert it into a Roth through the 401(k) platform.
How Does a Mega Backdoor Roth Work?
Once you have determined that your employer allows after-tax contributions and you can transfer to a Roth IRA or Roth 401(k), the next step is to contribute after-tax dollars into your employer-sponsored plan.
Examples
If you’re below 50 years old with a 401K plan and your employer allows after-tax contributions, you can contribute up to $66,000 in 2023. With the employee max being $22,500, that gives you an after-tax contribution availability of $43,500, of which you can complete the Mega Backdoor Roth strategy.
If you’re over 50 years old, there are higher limits ($73,500 in 2023). The employee max would be $30,000, leaving you with the same $43,500 of availability for after-tax contributions and the Mega Backdoor Roth strategy.
(It’s important to note that if your employer offers any “match” or makes any contributions to your retirement plan, that money must be included in the overall limit, reducing the amount of after-tax contributions you can make in that calendar year.)
Key Takeaways
- A Mega Backdoor Roth enables high-income earners and strong savers to make after-tax contributions to their retirement accounts beyond the limits of traditional and Roth IRAs.
- To qualify for a Mega Backdoor Roth, your employer must allow after-tax contributions and you must be able to transfer to a Roth IRA or Roth 401(k).
- The maximum contribution for a Mega Backdoor Roth strategy is $66,000 if you are below 50 years and $73,500 if you are 50 and above, making $43,500 available for Mega Backdoor Roth (minus any employer contributions).
We Can Help
If you’d like to learn more about this excellent opportunity, please feel free to contact me or a member of my team. We’re in the business of helping you build a strong, robust portfolio and the Mega Backdoor Roth may be just the strategy missing from your financial planning. Contact us today!
Neither MML Investors Services nor any of its subsidiaries, employees or agents are authorized to give legal or tax advice. Consult your own personal attorney, legal or tax counsel for advice on specific legal and tax matters. CRN202605-4403362