The ‘Mega Backdoor’ Roth IRA - Adviser Investments

The ‘Mega Backdoor’ Roth IRA

August 13, 2021

At Adviser Investments, we’re big fans of Roth IRAs. Who doesn’t love tax-free growth?

Roth IRAs come with limitations on who can contribute—and how much they can contribute—based on annual income. However, one fairly common strategy to get around those 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 can more than make up for today’s tax bill—especially if you expect to be in a higher tax bracket in the future.

A lesser known, but potentially more effective, means of building up your Roth IRA assets is the “mega backdoor” Roth. This backdoor doesn’t swing open for everyone, but if it is available to you and you have the means, it’s 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 2021, individuals can contribute up to $19,500 (or $26,000 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 $58,000 (or $64,500 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 $19,500 individual contribution plus a $1,560 employer match is $21,060. Subtract that amount from the $58,000 maximum limit, and Jane has up to $36,940 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, including 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. We’d be happy to help you avoid any unexpected tax hits. After all, we are The Planner You Can Talk To.

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