Is A Mega Backdoor Roth Right For You? How To Figure That Out

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While investing in a mega backdoor Roth isn’t suitable to all investors, if your profile fits the bill, you can avail yourself of a way to super-charge your retirement savings by converting them into tax-free funds that benefit you and your heirs.

“Using a mega backdoor allows for investors to get more money in Roth [tax-free] accounts” than they could when the retirement savings are limited to pre-tax Roths, Michael Brocavich, the director of financial planning at the Center for Financial Planning in Southfield, Michigan, told me in an email. Other financial advisors who spoke with me added that the “mega” strategy prompts their clients to kick-start their retirement savings.

This article lays out the details, tax consequences, potential big rewards and drawbacks of having part of your retirement funds in a mega backdoor Roth. In addition, it describes the investor profile needed to take advantage of the mega backdoor Roth and cites the differences between the mega backdoor Roth and the backdoor Roth.

What Is A Mega Backdoor Roth?

A mega backdoor Roth is a retirement investment strategy that can give high earners a hefty boost to grow their retirement savings more in a tax-free account after they have met the IRS-regulated limit on pre-tax contributions. The financial firm Fidelity Investments noted that “high earner” income translates in 2024 to more than $161,000 for a single taxpayer and $240,000 or more for a married-filing-jointly taxpayer.

According to the Journal of Accountancy, the mega is “a strategy for effectively super-funding a Roth available to some individuals who have a 401(k) or 403(b) account through work.” The journal also noted that the “mega” in the name means that an investor can save more than 10 times the maximum of a Roth IRA when investing in a mega backdoor Roth.

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What Is The Difference Between A Mega Backdoor And A Backdoor?

Opting for a mega backdoor Roth has clear advantages over a backdoor Roth. For example, with the mega, there is no extra tax cost, when the in-service distribution or rollover is done on the same day as the contribution into the nondeductible 401(k) or 403(b), CPA Larry Pon, of Pon & Associates, in Redwood City, California, told me in an email, and there is less legwork involved, as the mega, unlike the backdoor, requires no filing of the IRS Form 8606 or the tracking of an IRA basis in the contribution year to inform the IRS that your contribution is nondeductible.

How Does A Mega Backdoor Roth Work?

A mega backdoor Roth is a strategy in which you make after-tax, not pre-tax, contributions to your employer’s retirement plan. This allows your savings to far exceed what you are able to put away as an annual contribution that is pre-taxed.

To effect the strategy, you make an after-tax contribution to your employer’s retirement plan and then convert that contribution to a Roth. If your plan has a Roth option, you may do an in-house conversion by changing the after-tax 401(k) to a Roth 401(k) amount. If permitted by your plan, another option is to roll over your after-tax contributions to a Roth IRA. Fidelity noted that, “Prorated earnings attributable to the original contribution can be rolled to the Roth IRA, incurring taxes, or separately directed to a traditional IRA without incurring taxes.” You must pay taxes on any earnings in the conversion, but not on those conversions because they have already been taxed.

Basic Steps For A Mega Backdoor Roth Conversion

The conversion process requires three actions, none of them difficult. First, participate in your company’s retirement plan. Then consult with your CPA or other financial professional to see if effecting a mega backdoor conversion works for you, based on your earnings and goals that could impact your expenses.

Financial advisor Robin Giles of Apex Wealth Management in Katy, Texas, cautions individuals to vet any CPA thoroughly to make sure they are well-versed on mega backdoor Roths. “I often get questions from CPAs who do not understand what the mega backdoor Roth is, or don’t see them often enough to know how to account for them on a tax return. A misunderstanding on a tax form could easily turn what should be a non-taxable conversion into a taxable event,” she said.

Then find out from your employer’s retirement plan administrator whether the plan allows for what are known as “after-tax contributions,” according to the Journal of Accountancy, whether it offers Roth options and if it allows you as a participant to convert prior contributions to Roth inside the plan or to roll dollars out of the plan while still participating.

Benefits Of A Mega Backdoor Roth

The mega backdoor Roth is easier to use than the backdoor Roth, according to Pon. Better yet, there is “no additional tax liability, especially when a rollover occurs whenever there is a contribution,” he added, and it’s a “great way to sock away a lot of money into a Roth that will grow tax-free, and your heirs will receive these funds tax-free.”

Tax-Free Growth

“You pay taxes as you contribute in exchange for tax-free growth forever once the funds reach your Roth account,” said Joey Loss, a financial planner at FlowFLOW
Financial in Jacksonville, Florida. After you roll that Roth account of your workplace retirement plan into a Roth, it also frees you from having to take required minimum distributions (RMDs) on it during your lifetime, he added.

Retirement Asset Diversification

To diversify the tax implications in retirement, Brocavich recommends that clients maintain three “buckets” of money. They are: a “tax-deferred bucket with pre-tax retirement savings, a taxable bucket, which uses a brokerage account so investors can access funds without penalty and control capital gain taxes, and a tax-free bucket to be able to pull income from that, which will not affect their tax brackets.” He added that a mega backdoor Roth “increases an investor’s diversification of types of accounts in which they can invest money.”

Estate-Planning Benefits

A mega backdoor Roth “is a good investment account for clients to hold onto and let grow to leave a legacy for their beneficiaries,” said Brocavich, because like the account holders, beneficiaries of those accounts aren’t subject to taxes on that inheritance.

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Who Can Use a Mega Backdoor Roth?

To invest in mega backdoor Roth, you must be eligible to contribute to a 401(k) or 403(b) workplace retirement plan and have maxed out your pre-tax contributions or make too much to fully benefit from your company’s regular retirement plan, have substantial cash flow, so that your mega backdoor contributions do not infringe or your everyday expenses or any other financial commitments.

Is a Mega Backdoor Roth Right For You?

Take an educated look at your retirement savings with the help of a knowledgeable CPA to see if you’re a candidate to invest in a mega backdoor Roth. Ask yourself if you check these boxes: a high earner with positive cash flow that you manage well and a participant in your employer’s retirement plan in which you have maxed out pre-tax contributions. Then it may be right for you.

Bottom Line

If you’re like many astute well-compensated taxpayers saving for retirement, you may want to look into contributing to a mega backdoor Roth. It allows you to kick-start your retirement savings with much larger contributions than you are allowed by the IRS when making pre-tax deposits and sets up a portion of your portfolio that is tax-free forever for you and your heirs.

FAQs

What is a mega backdoor Roth?

It is a retirement investment strategy that can give high earners a boost to grow their retirement savings in a tax-free account after they have met the IRS-regulated limit on pre-tax contributions.

What is the mega backdoor Roth limit in 2024?

In 2024, the mega backdoor Roth limit is $69,000 or $76,500 (includes $7,500 in catch-up contributions) if you’re 50 or older, compared to $23,000 or $30,500 if you’re 50 or older in pre-tax contributions. If your company matches your savings in that account, you would subtract that amount from your contribution so that you don’t exceed the contribution limit, according to Fidelity.

Can anyone use a mega backdoor Roth?

No. To use a mega, you must be working for a company with a retirement savings plan that offers Roth accounts, have maxed out your pre-tax contributions in your company-sponsored plan, work for an employer whose retirement plan allows you to convert prior contributions to Roth inside the plan or permits you to roll dollars out of the plan while still participating.