The Mega Backdoor Roth is a common planning strategy for high income earners looking to allocate money to Roth accounts. In most cases, their income exceeds the contribution threshold, which disqualifies them from making Roth IRA contributions.

High-income earners can circumvent the income limitations by utilizing the Backdoor Roth strategy. While the backdoor Roth gets some money into a Roth, the IRS caps the amount you can contribute annually. A high-income earner who is looking to increase their Roth contributions may be able to do so by using the Mega Backdoor Roth Strategy.

The Mega Backdoor Roth

In 2020, the IRS limits annual contributions to employer-sponsored plans to the lesser of 100% of the participant’s compensation or $57,000 ($63,500, including catch-up contributions). If your employer offers a Roth 401(k), a Mega Backdoor Roth provides an avenue to contribute up to an additional $37,500 into a Roth through after-tax contributions in the 401(k) plan.  There are three requirements to implement the Mega Backdoor Roth strategy:

1. Your company plan must allow after-tax contributions
2. The company plan must allow in-service distributions or non-hardship withdrawals
3. You intend to save more than $25,500 or $33,000

Your Company Plan Must Allow After-Tax Contributions

According to a survey in 2017, Less than half of 401(k) plans allow after-tax contributions. If your plan does, you’ll need to determine the maximum amount you can contribute. Use the equation below to determine your allowable after-tax contribution amount.

Calculation to determine allowable after-tax 401(k) contributions
Calculation to determine allowable after-tax 401(k) contributions

The Company Plan Must Allow In-Service Distributions or Non-Hardship Withdrawals

If your employer’s plan doesn’t allow in-service distributions to a Roth IRA or in-plan rollovers to a Roth 410(k), you may want to rethink using this strategy.

Unlike a typical Roth conversion, after-tax 401(k) dollars do not get taxed at the conversion. However, earnings above the amount contributed will be considered pre-taxed and subject to taxes. Ideally, you’ll convert the entire after-tax account with no gains.

There may be a scenario where you do have gains and still want to convert after-tax contributions. Fortunately, the IRS allows the splitting of after-tax contributions and earnings between accounts. The after-tax money can be rolled into a Roth IRA and the investment earnings into a Traditional IRA.

You Intend to Save More Than $25,500 or $33,000

The only people that should consider a Mega Backdoor Roth are those that plan on maxing out their 401(k) and IRA and still want to save more. If you’re under 50 and do not plan on saving more than $25,500, this isn’t the strategy for you. Additionally, if you’re over 50, and not planning on saving more than $33,000, you should look at other saving options available. In both of these scenarios, you may be able to achieve your savings goal through a 401(k) and an IRA.

The strategy becomes even more impressive when couples can each take advantage of their own Mega Backdoor Roth opportunity. The chart below shows the potential for individuals and couples under age 50.

Potential IRA & 401(k) annual contributions for individuals and couples under 50 years old
Potential IRA & 401(k) annual contributions for individuals and couples under 50 years old

The chart below shows the potential for individuals and couples 50 and over.

Potential IRA & 401(k) annual contributions for individuals and couples over 50 years old
Potential IRA & 401(k) annual contributions for individuals and couples over 50 years old

It’s important to remember you don’t need to pick between funding your Traditional- or Roth 401(k) if you have both options available to you. Based on your unique tax situation and your financial plan, you may want to allocate the contributions differently than the charts above.    

Disclosures