What is a Mega Backdoor Roth IRA?
A Mega Backdoor Roth IRA is a retirement savings strategy that allows high-income earners to make additional contributions to a Roth IRA, even if they are ineligible to contribute directly to a Roth IRA due to their income. This strategy can be a powerful tool for high-income earners who want to save more for retirement and grow their savings tax-free.
How does a Mega Backdoor Roth IRA work?
A Mega Backdoor Roth IRA works by making after-tax contributions to a 401(k) plan and then rolling those contributions over to a Roth IRA. After-tax contributions are made with money that has already been taxed, so you won’t have to pay taxes on those contributions again when you roll them over to a Roth IRA.
But with a Mega Backdoor Roth IRA, high-earners can use their after-tax contributions to contribute up to the annual contribution limit in their 401(k). For 2024, the annual contribution limit is $7,000 for those under 50, and an additional $1,000 catch-up contribution for those 50 and older.
After-tax contributions refer to the amount of money you contribute to a 401(k) after you’ve reached your 401(k) employee contribution limit. These contributions are made with after-tax dollars (not pre-tax dollars). This is because you’ll have paid taxes on these amounts, and these contributions won’t reduce your taxable income.
To be clear, you can’t make the after-tax contributions required for a Mega Backdoor Roth until you’ve reached your 401(k) employee contribution limit.
The 401(k), 403(b), and Roth 401(k) contribution limit for 2024 is $23,000 for employee contributions. If you’re age 50 or older, you’re eligible for an additional $7,500 in catch-up contributions, which raises your employee contribution limit to $30,500, raising your employee contribution limit to $30,500.
Once you’ve reached your 401(k) employee contribution limit, you can make after-tax contributions to your Roth IRA and or Roth 401(k), as long as the contributions do not exceed the combined employee and employer contribution limit. Also, your total contributions cannot exceed your annual compensation at your company.
The combined employee and employer 401(k) contribution limit is $69,000 for 2024. For those age 50 or older, the catch-up contribution amount is $76,500 ($69,000 + $7,500) in 2024.
However, not all 401(k) plans allow after-tax contributions or in-service rollovers to a Roth IRA, so you’ll need to check with your plan administrator to see if your plan allows for this strategy.
The key benefits to a Mega Backdoor Roth IRA:
- Allows you to make additional contributions to a Roth IRA, even if you are ineligible to contribute directly to a Roth IRA.
- Allows your contributions to grow tax-free.
- Allows you to withdraw your contributions tax-free in retirement.
- Allows you to retain control over when you take distributions from your Roth IRA.
Other Benefits to the Mega Backdoor Roth IRA
By moving your money to a Roth IRA, your contributions won’t be subject to the required minimum distribution rules, which means that you get to retain control over when you choose to take distributions from a Roth IRA.
Also, If you have a large amount of wealth to pass on, a Roth IRA is one of the best ways to transfer wealth. This is because Roth IRAs allow your savings to grow tax-free while Roth IRAs don’t have required minimum distributions during your lifetime, allowing your Roth IRA assets to pass on to your heirs tax-free.
With a regular Roth IRA, you can withdraw your contributions penalty-free if it’s been more than five years since you first contributed to any Roth IRA. With conversions, you have to wait five years from when you convert. This feature is beneficial because it also allows you to keep less of your emergency savings in cash, and instead, your savings can be invested in stocks, which provide higher growth over the long term.
In addition, by the time you’ve reached 59 ½, you could even reduce your taxable income by covering your living expenses with your Roth IRA after-tax income alone, as Roth IRA qualified withdrawals after 59 ½ are tax-free.
A Mega Backdoor Roth IRA is a good option for high-income earners who:
- Have a 401(k) or 403(b) plan that allows after-tax contributions and in-service rollovers to a Roth IRA.
- Have already maxed out their traditional 401(k) contributions.
- Have additional money that they want to invest for retirement.
- Are willing to wait until age 59 ½ before they anticipate needing to take withdrawals from their Roth IRA.
Mega Backdoor Roth Alternatives
An alternative to this strategy is to contribute to either a Roth 401(k) plan or a solo 401(k) plan. While you won’t be putting away as much as a Mega Backdoor Roth, you are still investing towards your retirement, but without contributing a large amount all at once.
And if your employer’s plan doesn’t allow for in-service withdrawals or distributions, you’ll need to wait until you separate from your employer to roll over any after-tax money in your plan into a Roth IRA.
If you are interested in getting started with a Mega Backdoor Roth IRA, you should:
- Check with your plan administrator to see if your 401(k) or 403(b) plan allows for after-tax contributions and in-service rollovers to a Roth IRA.
- Make after-tax contributions to your 401(k) or 403(b) plan.
- Roll over your after-tax contributions to a Roth IRA.
The Mega Backdoor Roth IRA can be a powerful retirement savings strategy for high-income earners to save more for retirement and grow their savings tax-free. However, it’s important to understand the rules and limitations and consult with a tax advisor before you decide.
