Understanding How Mega Backdoor Roth IRAs Work
Many investors turn to Roth IRAs to enjoy tax-free withdrawals in retirement, but there's a catch: income limits. If you earn too much, you may be excluded from directly contributing to a Roth IRA.
Enter the mega backdoor Roth. This strategy could allow you to funnel an extra $46,000 (or more) into a Roth IRA or Roth 401(k) in 2024, by using after-tax contributions. But there’s a big “could” here—it's not a guaranteed option for everyone.
What is a Mega Backdoor Roth?
A mega backdoor Roth is an advanced version of the traditional backdoor Roth strategy, designed for people with a 401(k) that allows after-tax contributions. In 2024, you can contribute up to $46,000 in after-tax dollars to your 401(k) and then move it into a Roth IRA or Roth 401(k).
However, this strategy is complicated, involving multiple steps and potential tax surprises. Be sure to consult a financial advisor or tax professional to navigate this properly.
Quick Overview of Roth IRAs, Traditional IRAs, and Backdoor Roths 🤓
Roth vs. Traditional IRAs: Both are tax-advantaged retirement accounts, but they work differently. With a Roth IRA, you contribute after-tax money and withdraw tax-free in retirement. Traditional IRAs, on the other hand, offer a tax deduction on contributions but are taxed upon withdrawal.
Contribution Limits: For Roth and traditional IRAs, the combined limit is $7,000 in 2024 ($8,000 if you’re 50 or older). High-income earners may face restrictions on contributing to a Roth IRA, but can still contribute to a Traditional IRA (though they may not get the tax deduction).
Backdoor Roth: This strategy allows high earners to contribute to a Roth IRA by converting funds from a Traditional IRA. There are no income limits on conversions, but you may face taxes if you have pre-tax money in your IRA.
Mega Backdoor Roth Contribution Limits (2024-2025)
In 2024, you can save up to $69,000 in your 401(k) through the mega backdoor Roth strategy ($76,500 if you're 50 or older). Here's how:
Regular 401(k) Contribution: $23,000 ($30,500 if 50+)
After-Tax Contributions: Up to $46,000 (assuming no employer match; if you get a match, subtract that amount from the $46,000)
If your employer offers a Roth 401(k), you can move your after-tax contributions into that or a Roth IRA. If they only offer a traditional 401(k), your after-tax contributions will go to a Roth IRA.
By 2025, this contribution limit increases slightly, with a maximum of $70,000 ($77,500 for those 50+). Thanks to the Secure 2.0 Act, people aged 60 to 63 can contribute an additional $11,250 for a total of $81,250.
Mega Backdoor Roth: What You Need to Know
To execute a mega backdoor Roth, certain conditions must be met:
Your 401(k) Plan Allows After-Tax Contributions
Not all plans do. If your employer’s 401(k) allows you to contribute after-tax dollars (separate from your pre-tax 401(k) contributions), you're good to go.Your 401(k) Allows In-Service Distributions or In-Plan Rollovers
You must be able to move your after-tax contributions out of your 401(k) while you’re still employed—either directly to a Roth IRA or into a Roth 401(k). Check with your HR department to verify your plan’s rules.You’ve Got Extra Cash to Save
The mega backdoor Roth is ideal for high earners who have already maxed out their regular 401(k) and Roth IRA contributions but still want to save more for retirement. You’ll want to make sure you have extra funds to take advantage of this strategy, as it's designed for those with significant savings capacity.
Key Considerations:
Tax Impact: If you leave your after-tax contributions in the 401(k) after you’ve contributed them, they could start to accrue taxable earnings. The goal is to roll them into a Roth as soon as possible to avoid any taxable growth.
401(k) Plan Rules: Not all plans allow for in-service distributions or in-plan rollovers to a Roth account. If your plan doesn’t allow it, you’ll have to wait until you leave the company to take advantage of the strategy.
Contribution Limits & Employer Matching: If your employer offers matching contributions, those counts toward your total 401(k) limit, and you’ll need to account for that in your mega backdoor Roth strategy.
Potential for Nondiscrimination Issues: For highly paid employees, there’s a risk that the 401(k) plan may have to return some contributions if it doesn’t pass IRS nondiscrimination tests.
Bottom Line
The mega backdoor Roth is a powerful tool for high-income earners who want to move more money into Roth accounts, bypassing the typical Roth IRA income limits. But it’s a complex process with tax implications, so it’s wise to work with a financial advisor or tax professional to make sure you’re executing it correctly.
There are other ways to take advantage of the Roth treatment, including:
Contributing directly to a Roth IRA (if you're below income limits).
Using a backdoor Roth IRA (for high earners above the Roth IRA limits).
Contributing to a Roth 401(k) if your employer offers it.
With the right strategy, you can supercharge your retirement savings and enjoy tax-free growth in the future.