A Primer on “Mega Backdoor” Roth IRAs
Roth IRAs have features that many savers and investors find appealing. Contributions are made with after-tax dollars, earnings grow tax-free, and qualified distributions in retirement (after age 59½ and after the account has been open for at least five years) are also tax-free[1].
The issue is that Roth IRAs are not available to everyone.
The IRS has established guidelines for who can contribute to Roth IRAs, and how much those contributions can be. A person must have taxable compensation but also make less than $161,000 as a single-filer or $240,000 when married filing jointly. In 2024, contribution limits for IRAs and Roth IRAs combined are $7,000, which rises to $8,000 if you’re age 50 or older by the end of the year[i]. These are not significant amounts for high-income earners and high-net-worth individuals, assuming the Roth IRA is even accessible at all.
That’s where the “mega backdoor” Roth IRA strategy may come in, allowing some investors to contribute significantly more to a Roth IRA and/or Roth 401(k) than the contribution limits currently allow.
Before getting into the ins and outs of how mega backdoor Roth IRAs work, it’s important to establish the conditions needed to access them:
Must be employed
Must have a workplace retirement plan that allows after-tax contributions
The workplace retirement plan must have a Roth 401(k) with the option for an in-plan Roth conversion, and/or allow in-service withdrawals of after-tax contributions plus attributable prorated earnings[ii].
The important note here is that all the above conditions must be met, which significantly narrows the field of eligible investors. But for those who check all the boxes, the mega backdoor Roth IRA strategy essentially happens in two steps:
Make after-tax contributions to the workplace retirement plan up to the allowable amount, then
Convert these after-tax contributions either to a Roth IRA or Roth 401(k).
In 2024, the aggregate contribution limit to 401(k) plans and Roth 401(k) plans is $23,000 (or $30,500 for those age 50 and older). But for plans with an employer match that sometimes offer the ability to make after-tax contributions, the limit rises to $69,000 total (or $76,500 if 50 or older)[iii].
Allow me to offer a hypothetical example. Let’s say a person is 55 years old and has a workplace retirement plan with a 50% employer match and the ability to make after-tax contributions. If that person maxes out contributions to the plan, here’s how it would break down:
$30,500 (401k contribution) + $15,250 (employer match) + $30,750 (after-tax contributions) = $76,500 aggregate contribution limit[2].
In this case, it’s the $30,750 after-tax contribution that could be eligible for the mega backdoor Roth conversion. Investors should take care not to over-contribute after-tax dollars to the retirement plan such that you ‘crowd out’ employer contributions. In other words, if your pre-tax contributions plus your after-tax contributions put you at the total aggregate limit, your employer may not be able to contribute on your behalf.
Given all the specific provisions associated with mega backdoor Roth conversions, we think it makes sense to consult with tax professionals, an advisor like a team member at Ascension Capital, and the plan administrator before moving forward. If everything aligns, you may be able to convert your after-tax 401(k) contributions into a Roth 401(k) (called an ‘in-plan conversion), or you can roll your after-tax contributions to a Roth IRA if your plan allows it.
Importantly, taking any of the above actions would trigger a tax event, as you will need to pay taxes on any earnings included in the conversion. Once these taxes are paid and the rollover is complete, however, you would enjoy all the traditional benefits of Roth IRAs: tax-deferred growth, tax-free withdrawals.
An investor could complete periodic conversions of after-tax dollars to Roth IRAs or Roth 401(k)s, but in some cases employer plans offer an auto-convert feature such that any after-tax contributions are automatically converted to a Roth at regular intervals. Again, setting this up would likely require input from a trusted advisor and the plan administrator.
In Conclusion
Mega backdoor Roth IRAs offer a unique retirement strategy for high-income individuals whose workplace retirement plans allow in-plan Roth conversions and/or allow in-service withdrawals of after-tax contributions. By rolling after-tax contributions in a 401(k) into a Roth 401(k) or a Roth IRA, an investor can substantially increase tax-free retirement savings beyond the normal limits. This is especially powerful when compounded over decades, as it may eliminate the future tax burden on investment earnings. What’s more, since Roth IRAs do not have required minimum distributions, funds can remain invested and perhaps be utilized as part of an estate planning strategy.
As of this article’s publishing, there are no limits on the amounts that can be converted to a Roth IRA, and there are also no limits to in-plan conversion amounts. These rules can of course change at any time, but for now the mega backdoor Roth strategy offers many key benefits for those who can access it.
Important Disclaimer: Ascension Capital does not provide tax or legal advice. Individuals must consult their tax advisor prior to taking any action.
Sources and Footnotes
[1] Assuming the investor complies with all rules and regulations governing Roth IRAs.
[2] These dollar amounts are hypothetical and are not meant to constitute a proposed strategy.
[i] Source: IRS, “Traditional and Roth IRAs”
[ii] Source: Fidelity Investments, “What is a mega backdoor Roth?” February 28, 2024
[iii] Source: Fidelity Investments, “What is a mega backdoor Roth?” February 28, 2024