Mega Backdoor Roths – What makes them so MEGA?
Key Takeaways:
A Mega Backdoor Roth is a great way to save LARGE amounts of money into a Roth IRA
401k Contributions above your maximum employee contributions are made as After-Tax Contributions and then an In-Service Withdrawal to a Roth IRA is done immediately afterwards.
You must have plenty of additional cash flow to implement this retirement boosting strategy.
This must be an important topic because why else would the word MEGA be in the title? There’s Megatron - leader of the Decepticons, Mega Man of the video game series and state lotteries title their big jackpots as Mega Millions. So, this must be a BIG DEAL, right?
Well, it is and so much so that you’ll see political parties trying to ax this strategy every so often. But until that happens, it’s important to know what this is, how it works and when you would want to use this strategy.
What is a Mega Backdoor Roth?
A Mega Back Door Roth is a strategy that allows you to get A LOT of dollars into a Roth IRA when you normally wouldn’t be able to if you’re a high earner. In 2022, if you are filing as a Single or Head of Household, you cannot contribute to a Roth IRA if your income is $144,000 or more. For those Married Filing Jointly filers, the income limit is $214,000. A way around direct contributions into a Roth IRA are Roth Conversions which we covered in a previous blog. We’ve also blogged about Backdoor Roths which then use the Roth Conversion strategy by contributing to a non-deductible IRA and then converting that contribution to a Roth IRA shortly after the nondeductible contribution is made.
So, how can we turn these Backdoor Roths into MEGA Backdoor Roths?
By leveraging your ability to MAKE AFTER-TAX 401(k) contributions. These are contributions made ABOVE your normal 401k contribution limits.
Here’s an example: Let’s say you are age 60, hoping to retire in 5 years and have extra dollars to boost your retirement plan assets. The maximum employee contribution you can make in 2022 is $27,000 ($20,500 + $6500 age 50+ catch up). You’ve already maxed out your employee contributions and have made the maximum after-tax contribution to your Traditional IRA with which you did a backdoor Roth conversion. If your employer’s 401k plan allows – check your 401k Summary Plan Description – you can contribute additional dollars to your plan as long as YOURS AND YOUR EMPLOYERS contributions do not exceed $67,500 ($61,000 + $6500 age 50+ catch up).
Your Employee Contribution $27,000
Your Employer’s Contributions $12,000
Total 401k Contributions $39,000
Your AVAILABLE ADDITIONAL contributions that can be made: $28,500 ($67,500 - $39,000).
This is your MEGA BACK DOOR ROTH Contribution amount. This is STEP 1.
STEP 2 – Take an In-Service Withdrawal from your 401k and immediately roll those dollars into a Roth IRA. You can pull out those after-tax contributions with NO penalties or taxes as long as your employer plan allows for in-service withdrawals (again, check the 401k’s Summary Plan Description).
It’s important to note when you do the in-service withdrawal that there are no penalties/taxes on CONTRIBUTIONS. That is not the case with the EARNINGS on those contributions. In that case you would have to pay taxes on those earning AND if you are younger than 59 ½, a 10% penalty.
What if your plan DOESN’T allow for in-service withdrawals? That would mean you would have to wait until you leave your job to move the money into the Roth IRA. At that point, you can still roll the after-tax contributions into your Roth, but then the EARNINGS on those contributions would be taxed as ordinary income when you take them out of the IRA.
When should you use this strategy?
This is a GREAT strategy to get a TON of money into a Roth IRA, but you MUST have a lot of additional money to put aside for savings.
Generally, you will first max out your contributions to your 401k to get the upfront tax break. Then if you are under Roth income limits, you (and your spouse) will want to max out your contributions to your Roth IRA. Direct contributions to a Roth are much easier than the steps required to do a Mega Backdoor conversion.
The bottom line is this can be an amazing tool if you are a Super Saver and have the excess cash to really boost your retirement savings. Because of the intricacies of this strategy, you may want to consider getting professional advice to implement this the correct way and not cause unintended tax consequences for you now or in the future.
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