Mega Backdoor Roths: A Powerful Retirement Option for High Earners

Mega Backdoor Roths are a retirement savings strategy that allows individuals to contribute more to their traditional 401(k) or 403(b) plans beyond the annual contribution limits. These excess contributions are then converted to Roth accounts, providing potential tax-free growth and withdrawals in retirement. This strategy can be helpful to those who earn too much to contribute directly to a Roth IRA. In addition to this strategy, you can also do a regular Backdoor Roth where you use a traditional IRA account to contribute after-tax money and then convert it to a Roth IRA.

How Do Mega Backdoor Roths Work?

• Excess Contributions: Individuals make after-tax contributions to their traditional 401(k)/403(b) plans above the annual limit but less than the total IRS contribution limit. The 2024 limit for pre-tax and/or Roth contributions is $23,000 for those under 50 years old. The total 2024 combined amount that can be contributed (including after-tax and employer contributions) to a 401(k)/403(b) is $69,000 for those under age 50.
• Conversion: The excess contributions can be converted from traditional 401(k)/403(b) accounts to Roth 401(k)/403(b) within the same plan. This conversion is often referred to as an “in-plan conversion.” Or, those excess contributions could be added via a rollover distribution to a Roth IRA. Some plans simplify the mega backdoor Roth process by offering an auto-convert feature, allowing participants to automatically convert their after-tax contributions to Roth at regular intervals. Other plans may have a more manual process and only allow a certain number of conversions per year which could limit your flexibility to convert funds quickly.
• Roth Benefits: The converted funds grow tax-free within the Roth account. When withdrawn in retirement, the earnings are also tax-free, providing a significant tax advantage.

Who is Eligible for Mega Backdoor Roths?

Not everyone can take advantage of Mega Backdoor Roths. To be eligible, you need to meet the following criteria:

• Employer-Sponsored Plan: Your employer must offer a 401(k)/403(b) plan that allows for after-tax contributions with an option for in-plan conversions and/or in-service withdrawals of after-tax contributions.
• Contribution Limits: You must stay within your overall contribution limits for your 401(k)/403(b) plan.

Benefits of Mega Backdoor Roths

• Increased Contribution Limits: Mega Backdoor Roths allow you to contribute more to your retirement savings than the annual limits for traditional or Roth IRAs.
• High-Earners Benefits: The mega backdoor Roth allows high-income earners to take advantage of the tax-free growth potential of Roth accounts, even if they exceed the income limits for direct Roth IRA contributions.
• Tax-Free Growth and Withdrawals: The earnings on converted funds grow tax-free within the Roth account. This can lead to significant tax savings in retirement.
• Diversification: Converting excess contributions to a Roth account can help diversify your retirement portfolio and reduce your reliance on tax-deferred accounts.

Potential Drawbacks

• Complexities: Setting up and managing Mega Backdoor Roths can be more complex than traditional retirement savings strategies.
• Income Limitations: High-income earners may face limitations on Roth IRA conversions, which can reduce the effectiveness of Mega Backdoor Roths.
• Employer Restrictions: Some employers may not allow in-plan conversions or have other restrictions that can limit your ability to use this strategy.
• Tax implications: While the after-tax contributions themselves have already been taxed, any earnings on those contributions will be taxed at the time of conversion.

Considerations for Using Mega Backdoor Roths

Before implementing Mega Backdoor Roths, it’s important to consider the following factors:

• Your Financial Situation: Assess your income level, retirement goals, and overall financial health to determine if Mega Backdoor Roths are a suitable strategy.
• Tax Implications: Consult with a tax advisor to understand the potential tax implications of converting excess contributions to a Roth account.
• Employer Plan Rules: Review your employer’s 401(k)/403(b) plan to ensure that in-plan conversions are allowed and to understand any specific requirements or limitations.

At Axias, we frequently discuss this strategy with clients in or above the 32% tax bracket. Many choose to first maximize all their pre-tax contributions to their employer-sponsored plan. Then, they contribute any remaining amount they can, up to the overall contribution limit, using the mega backdoor Roth strategy.

Mega Backdoor Roths can be a powerful tool for increasing your retirement savings and potentially reducing your tax burden. However, it’s essential to understand the complexities, eligibility requirements, and potential drawbacks before implementing this strategy. Consulting with a financial advisor can help you determine if Mega Backdoor Roths are the right choice for your retirement goals.

Speak with one of our financial professionals about your situation.

CONTACT US