Mega Backdoor Roth? What is this?
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While the Backdoor Roth strategy allows you to contribute up to $7,000 in 2024 ($8,000 if over age 50), the benefit of the Mega Backdoor Roth is the ability to sock away as much as five times that of normal IRA limits through ‘after-tax’ contributions.
What to Know
First, you should only consider this strategy if you are in a financial position to maximize contributions to your employer-sponsored retirement plan and IRA.
Second, you must ensure your retirement plan offers ‘after-tax’ contributions (not to be confused with Roth contributions), enabling you to contribute beyond traditional ‘salary deferral’ limits.
Lastly, you should ensure your plan offers in-service distributions. This is not mandatory, but it provides the pathway for the most tax-efficient execution of the Mega Backdoor Roth strategy by permitting you to move ‘after-tax’ contributions to a Roth IRA before earnings accrue. If your plan offers a Roth 401k provision and allows for in-service rollovers, this works as well, as the end goal is to get those after-tax assets to a Roth-like account.
This is because, though your contributions are deemed ‘after-tax,’ any accrued earnings will be taxable upon distribution. If all these boxes are checked, the next step is implementation.
The Process
The IRS imposes annual limits to what can be collectively contributed to a 401k. For 2024, that figure is $69,000 (or $76,500 for those over age 50). Thus, in order to take full advantage of the Mega Backdoor Roth, you will want to determine the amount you can contribute to the ‘after-tax’ bucket by taking the following steps:
- Ensure you are set to max out your salary deferrals ($23,000; $30,500 if over age 50)
- Next, determine the employer match dollar figure (if applicable)
- Finally, subtract your deferral amount and employer match from the IRS annual limit
This is the figure you will be contributing as ‘after-tax’ contributions.
For example, Stephen, age 55, maxed out his salary deferrals of $30,500 to his 401k, and his employer matched $10,000, for a total of $40,500 towards the IRS collective limit. That would leave him room to make ‘after-tax’ contributions of $36,000 (the $76,500 limit less his deferrals and company match).
Once you have begun making ‘after-tax’ contributions, you will want to use the in-service distribution provision (or in-plan rollover) to move any ‘after-tax’ contributions to a Roth IRA (or Roth 401K).
As stated above, the expeditious manner in which you roll these assets out will limit or eliminate the prospects of earnings growth (if you encounter a situation where you have earnings, those amounts will need to be rolled into a traditional IRA). Once in the Roth IRA, the rolled amount and all future earnings will be redeemable tax-free.
Summary
The Mega Backdoor Roth is a great way for higher-income earners to take advantage of Roth-like benefits through their employer retirement plan.
As highlighted above, however, there are many aspects to consider before attempting to incorporate this strategy into your savings goals. Can you afford it? Does your plan allow it? Can you consistently and accurately facilitate the required steps to ensure the most efficient return?
As with most financial strategies, it is always best to elicit insight and feedback from your financial advisor. They can walk you through the ins and outs and base their recommendations on a more macro, comprehensive vantage point to ensure any strategy fits within your overall financial picture.
Mathew Ryan, MBA, CFP, EA is a Financial Planning Specialist with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email Mathew at mryan@bedelfinancial.com.