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The Mega Backdoor Roth IRA

March 08, 2023

In recent years, the so-called "mega backdoor Roth" strategy has become increasingly popular among high-earning individuals looking to maximize their retirement savings. In this blog post, we'll take a closer look at what the mega backdoor Roth is, how it works, and whether it might be a good strategy for you.

First, let's define some terms. A Roth IRA is a type of retirement account that allows you to contribute after-tax dollars and then withdraw the money tax-free in retirement. There are income limits on who can contribute to a Roth IRA directly, but there is no limit on converting traditional IRA or 401(k) assets to a Roth IRA. A backdoor Roth IRA is a strategy where someone makes non-deductible contributions to a traditional IRA, and then immediately converts those funds to a Roth IRA. This allows high earners to bypass the income limits on Roth IRA contributions.

So, what is the mega backdoor Roth? Essentially, it's a way to contribute even more money to a Roth IRA by taking advantage of a lesser-known feature of some 401(k) plans. While the annual contribution limit for 401(k) plans is $22,500 in 2023 (plus an additional $7,500 catch-up contribution for those over 50), some plans allow for after-tax contributions beyond that limit. This is where the mega backdoor Roth comes in.

Here's how it works: Let's say your employer's 401(k) plan allows after-tax contributions up to $66,000 per year. You contribute the maximum pre-tax amount of $22,500, leaving you with $43,500 in after-tax contribution room. You can then contribute that $43,500 to the 401(k) as an after-tax contribution. From there, assuming your employer allows in-service distributions and you qualify for one, you can then convert those after-tax contributions to a Roth IRA, since they have already been taxed. Voila - you've just contributed $43,500 to a Roth IRA.

So, what are the benefits of the mega backdoor Roth? First and foremost, it allows you to contribute even more money to a tax-advantaged retirement account. This can be particularly appealing for high earners who are already maxing out their other retirement accounts. Additionally, since Roth IRAs allow tax-free withdrawals in retirement, the mega backdoor Roth can help you reduce your tax burden in retirement.

However, there are some potential downsides to consider as well. For one, not all 401(k) plans allow for after-tax contributions or in-service distributions. Additionally, the rules around after-tax contributions can be complex, and there are potential tax implications to be aware of. It's important to consult with a financial advisor or tax professional to ensure you're following the rules correctly and taking advantage of the strategy in a way that makes sense for your specific financial situation.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA and 401(k) account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.