This guide aims to explain the mega backdoor Roth strategy for retirement planning.
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Table of Contents
Mega Backdoor Roth: Definition
The mega backdoor Roth is a strategy for the ultra rich to stash extra savings in their employer sponsored 401k plan.
The mega backdoor Roth allows you to save up to $66,000 ($73,500 for people of age 50 or more) (in 2023) in your employer sponsored 401k account.
For example, the maximum contribution you can make in a 401k in 2023 is $22,500. Whereas, the mega backdoor Roth allows you to save up to $66,000 in your retirement account.
The only caveat is that your 401k account should allow a mega backdoor Roth.
The strategy is as follows.
Step 1: Make after tax contributions in your employer sponsored 401(k).
Step 2: Convert your after tax contributions to a Roth IRA or Roth 401(k).
Not making sense.
Let us explore further.
Check the table below.
| Type of contribution | Withdrawals | Income Range/Threshold | Annual Limits | |
Roth IRA | After tax contributions | Tax free withdrawals after age 59.5 years and when the Roth is at least 5 years old | $153,000 (single) or $228,000 (married filing jointly) | $6,500 or $7,500 if you are 50 years or older |
Upon reviewing the matrix provided above, it becomes evident that the Roth plan has a specific income threshold and an annual contribution limit that must not be exceeded. Once these limits are reached, further contributions are no longer permissible.
In order to supersede the thresholds in the income and annual limits defined by a Roth plan, the concept of backdoor and mega backdoor Roth is introduced for the ultra rich.
The backdoor Roth removes any income and contribution limits in the Roth plan. You just need to rollover your traditional IRA to a Roth IRA. So anyone with any income range, can transfer any amount from a traditional IRA to a Roth IRA.
But what about people entailing the employer sponsored 401k.
For the 401k we have the strategy called mega backdoor Roth.
In a mega backdoor Roth (if your solo 401k allows it), you can make after tax contributions beyond the maximum pre-tax annual limit ($22,500 for 2023). So in case there is no employer match, you could potentially add after tax $43,500 ($66,000-$22,500) in your 401k account.
Post this, you transfer or rollover your after-tax contributions to a Roth IRA or Roth 401k.
Check the table below.
| Type of contribution | Withdrawals | Income Range/Threshold | Annual Limits | |
Roth | After tax contributions | Tax free withdrawals | $153,000 (single) or $228,000 (married filing jointly) | $6,500 or $7,500 if you are 50 years or older |
| Mega backdoor Roth | After tax contributions | Tax free withdrawals | No limit | $66,000 |
Please note: Immediately move all your after tax money from the 401k to Roth, so that it can grow tax free. Otherwise, sitting in the 401k, the funds will start accruing earnings which will be taxed once you withdraw them.
Mega backdoor Roth: Requirements and Eligibility criteria
Let us explore further the requirements and the eligibility criteria for a mega backdoor Roth plan.
401(k) account: You should be enrolled into an employer sponsored 401(k) account.
After-tax contributions are allowed: When your employer 401k allows after tax contributions. This means that beyond the $22,500 limit (for 2023), you are allowed to make contributions from your earnings which are already taxed (after-tax contributions).
In-service distributions are allowed: When the 401k allows in-service distribution. This means the 401k allows you to either take funds from your account (while you are still working with the employer) and convert them to Roth, or convert the after tax portion into a Roth.
If not sure, always ask your plan administrator or the HR for confirmation.
Extra funds to save for retirement: The last criteria is of course when you have additional funds you want to save beyond the $22,500 limit.
Mega backdoor Roth IRA and Mega backdoor Roth 401(k)
When your employer 401k is a Roth plan, it can be rolled over to a Roth IRA or a Roth 401(k).
However if it is a traditional 401k, then it can be transferred to a Roth IRA only.
How to do mega backdoor Roth
You need two retirement accounts.
An employer sponsored 401k and a separate Roth IRA or Roth 401k.
The employer sponsored 401k will have to allow for after tax contributions.
Step 1: Check whether your employer sponsored 401k allows mega backdoor Roth
The first step in employing the mega backdoor Roth strategy is to check with your HR or retirement plan administrator, whether your 401k plan allows a mega backdoor strategy.
You need to check two things specifically.
First, whether the 401k plan allows after tax contributions beyond the maximum defined limit for the year (example $22,500 in 2023).
Second, whether the 401k plan allows in service distribution. This means that we can take out after tax contributions from our employer 401k while still at work and roll them over or transfer them to a Roth IRA or Roth 401k.
If your employer sponsored 401k does not allow after tax conversions and in service distributions then there is no point to think of employing a mega backdoor Roth strategy.
Step 2: Make pre-tax contributions up till the defined annual limit ($22,500 in 2023)
You need to make sure that you have made pre-tax contributions till the annual limit ($22,500 in 2023) in your 401k. Only beyond this amount can you make after-tax contributions.
Also any employer match also counts. That means the pre-tax contributions ($22,500) plus the employer match and your after tax contributions can be up to a maximum of $66,000 for the year 2023.
Step 3: Contribute after-tax money to the employer 401k
Beyond the $22,500 for 2023 (pre-tax contributions), and any employer match, you can contribute additional after-tax contributions to your 401k.
Example: In 2023, your salary is $100,000. You contributed $22,500 in your employer sponsored 401k. There is an employer match which is 6% of your salary, i.e. $6000.
After tax contributions allowed=(Maximum limit for mega backdoor Roth)-(Pre-Tax contributions+Employer match)
After tax contributions allowed in 2023 for the above example=$66,000-($22,500 + $6000) = $37,500
Step 4: Rollover to Roth
The next step is to immediately transfer or rollover your after tax contributions to a Roth IRA or Roth 401k.
Generally when the employer sponsored 401k is a Roth, it can be transferred to a Roth IRA or a Roth 401k. However, if it is a traditional 401k, then it can be transferred to a Roth IRA.
You should do this rollover or transfer as soon as possible, as the after tax contributions, sitting in your employer 401k is accruing earnings which will be taxed once you take it out for the transfer to Roth.
The tax implications become more and more complex with time. It is suggested to consult your financial advisor.
Check the image below for more clarity.
