What is a “Mega Backdoor Roth?”
A lot people know that you can put a maximum of $23,000 into their 401(k) in 2024 if they are under 50. But what most people don’t know is there is a way to put up to $69,000 into your 401(k) in 2024. This utilizes something called a “Mega Backdoor Roth.”
A Mega Backdoor Roth IRA is a strategy that allows high-income earners to contribute significant amounts of after-tax money into a Roth IRA, bypassing the traditional contribution limits. Keep in mind not all 40k(k) plans allow this but here's an explanation of how it works:
Step-by-Step Process
Maximize Contributions to a 401(k) Plan:
Pre-Tax and Roth Contributions: First, make the maximum allowable contributions to your 401(k) plan, which for 2024 is $23,000 for those under 50 and $30,500 for those 50 and older.
Employer Match: Ensure that you take full advantage of any employer matching contributions.
After-Tax Contributions to 401(k):
After-Tax Contribution: Make additional after-tax contributions to your 401(k) plan. The total limit for contributions to a 401(k) plan, including employee contributions, employer matching, and after-tax contributions, is $69,000 for those under 50 and $76,500 for those 50 and older in 2024.
So lets break that down. Lets say you are under 50 years old, you max you your 401(k) with $23,000 and your employer contributes $6,000 to the plan as a match. That is a total of $29,000. That means you can put $40,000 ($69,000-$29,000=$40,000) into the plan as an after-tax contribution if your plan allows it
In-Plan Roth Conversion or Rollovers:
In-Plan Roth Conversion: If your 401(k) plan allows, you can convert your after-tax contributions to a Roth 401(k) within the plan. This is sometimes referred to as an in-plan Roth rollover or Roth conversion.
Rollover to Roth IRA: Alternatively, if your plan allows in-service distributions, you can roll over the after-tax contributions to a Roth IRA. This can be done either periodically throughout the year or as a lump sum at the end of the year.
Key Considerations
Plan Participation: Not all 401(k) plans allow after-tax contributions or in-service rollovers. Check with your plan administrator to see if these options are available.
Taxes: The conversion of after-tax contributions to a Roth 401(k) or Roth IRA typically does not incur additional taxes on the principal amount since the contributions were made with after-tax dollars. However, any earnings on those contributions will be taxed at the time of the rollover.
You can avoid a tax consequence by moving the funds to a Roth IRA or Roth 401(k) as soon as you can before there is any growth in the account or if there is growth in the account you could roll the amount of the growth above your contributions to a Traditional IRA to defer the taxes until retirement.
Growth: Once the after-tax contributions are in the Roth account, either in a Roth 401(k) or a Roth IRA, they can grow tax-free, and qualified withdrawals in retirement will be tax-free as well.
Benefits
High Contribution Limits: This strategy allows you to contribute significantly more to a Roth account than the standard Roth IRA contribution limits (which are $7,000 per year, or $8,000 if you’re over 50 in 2024).
Tax-Free Growth: Contributions to the Roth account can grow tax-free, providing substantial tax benefits in retirement.
Flexibility: Roth IRAs do not have required minimum distributions (RMDs), giving you more flexibility in managing your withdrawals in retirement.
Example
As mentioned above, let's assume you are under 50 and you have already contributed the maximum $23,000 to your 401(k) plan. Your employer has contributed an additional $6,000 in matching funds. This means you can contribute an additional $40,000 ($69,000 - $23,000 - $6,000) in after-tax contributions to your 401(k). You then convert these after-tax contributions to a Roth IRA or a Roth 401(k), ensuring that these funds will grow tax-free and can be withdrawn tax-free in retirement.
Conclusion
The Mega Backdoor Roth IRA is a powerful strategy for high-income earners to significantly increase their Roth savings. It requires a 401(k) plan that permits after-tax contributions and in-plan conversions or in-service rollovers. By taking advantage of this strategy, you can potentially save a substantial amount in taxes over the long term and increase your retirement savings.
Phil Francois, CFP®
Owner & Financial Advisor
https://www.foundationwealthplanning.com/