The ‘Mega Backdoor’ Roth IRA

Vanessa Carter-Witt, CFP®

Wealth Advisor

We’re big fans of Roth IRAs. Who doesn’t love tax-free growth?

But Roth IRAs come with limitations on who can contribute to them—and how much they can contribute—based on annual income. There’s a workaround, however. One fairly common strategy that skirts these limitations is the “backdoor” Roth conversion—you roll (or transfer) funds from a traditional 401(k) or IRA into a Roth IRA.

Yes, you’ll pay taxes on the amount converted, but if your retirement is many years down the road, the potential to compound tax-free for years and years without having to pay taxes on withdrawals can more than make up for today’s tax bill—especially if you expect to be in a higher tax bracket in the future.

And it gets better. A lesser-known but potentially more effective means of building up your Roth IRA assets is the “mega backdoor” Roth. It doesn’t swing open for everyone, but if it is available to you and you have the means, it may be worth walking through.

Here’s how it works:

A mega backdoor Roth conversion allows you to roll over post-tax funds from a traditional 401(k) into a Roth IRA. Normally, contributions to a 401(k) are pre-tax; however, once you surpass the individual contribution limit, some employers have plans that allow additional after-tax contributions.

In 2022, individuals can contribute up to $20,500 (or $27,000 if you are 50-plus years old) to a 401(k). But if your employer allows after-tax contributions to your 401(k), you can up your contribution to $61,000 (or $67,500 if you are 50-plus years old), then roll that excess into a Roth.

Let’s look at a specific example:

Jane is under age 50. She maxes out her 401(k) contribution and has an employer match of 8%. Her $20,500 individual contribution plus a $1,640 employer match is $22,140. Subtract that amount from the $61,000 maximum limit and Jane has up to $38,860 that could be added to her 401(k) and rolled into a Roth IRA with the mega backdoor option. Talk about a double dose of retirement savings!

Here’s when a mega backdoor Roth IRA may be right for you:

• Your company allows both after-tax contributions and in-service withdrawals to a Roth IRA.
• You’ve already maxed out your 401(k) and IRA contributions.
• You have excess savings after monthly expenses such as an emergency fund, higher education costs and other debt obligations. (Use our Budget Worksheet to get started on determining your expenses, income and potential additional savings.)

The tax implications can be tricky to navigate, so if a mega backdoor Roth sounds like something you or a loved one might be able to use, give us a call. (Legislators have considered eliminating mega backdoor conversions, but they are safe for now.) We’d be happy to help you avoid any unexpected tax hits. After all, we are The Planner You Can Talk To.

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.