Mega Backdoor Roth: What It Is and How It Works

A mega backdoor Roth is a strategy that involves contributing post-tax dollars to a 401(k) and rolling them over to a Roth IRA.
Last updated May 13, 2022 | By Rebecca Safier | Edited By Yahia Barakah
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A mega backdoor Roth is a retirement plan for high-income earners who want to enjoy the benefits of a Roth account. While traditional 401(k) plans have a 2022 contribution limit of $20,500, some might allow you to contribute an additional $40,500 of after-tax dollars and roll them over immediately into a Roth IRA or Roth 401(k).

You would need to check with your plan’s manager and review its rules to see if it allows you to use the mega backdoor Roth conversion strategy. You could also consult with a financial planner before making any moves.

However, if successful, this plan could significantly increase your contribution to your retirement savings. But how does it work?

In this article

What is a mega backdoor Roth IRA?

Roth IRAs are retirement savings vessels that allow you to contribute post-tax dollars and let your earnings grow tax-free. You could also make tax-free qualified withdrawals in retirement since you already paid taxes on your contributions.

You can only contribute to a Roth IRA if you make less than certain income limits. The limit in 2022 is $144,000 as a single filer or $214,000 If you're a married couple filing jointly. Roth IRAs have an annual contribution limit of $6,000 in 2022. The limit is increased to $7,000 if you’re 50 or older to allow you to catch up on your retirement savings.

A backdoor Roth IRA conversion is one way to get around these IRS limits. With a backdoor Roth, you would contribute money to a traditional IRA or 401(k) and immediately transfer it into a Roth account.

A mega backdoor Roth is a specific type of backdoor Roth where you contribute after-tax dollars to a traditional 401(k) that you hold with your employer. You would then immediately roll over this amount from your 401(k) to your Roth IRA. Knowing how to roll over 401(k) to an IRA is essential for this step.

The IRS typically allows you to contribute up to $20,500 to a 401(k). If your plan allows a mega backdoor Roth strategy, you might be able to contribute an additional $40,500 in after-tax dollars. Altogether, that’s a total of $61,000 in contributions.

How does a mega backdoor Roth IRA work?

To use the mega backdoor Roth strategy, you need two retirement accounts. The first is an employer-sponsored 401(k), while the second would be a Roth IRA account or Roth 401(k) account.

The difference between Roth 401(k) and 401(k) mainly relates to when they are taxed. A traditional 401(k) is mostly taxed in retirement, while Roth 401(k) is taxed when you make your contributions.

In addition to having these two accounts, your traditional 401(k) must allow after-tax contributions, which are listed in a separate bucket from your regular contributions.

Your employer plan must also allow in-service distributions, allowing you to take your after-tax contributions out of your 401(k) plan while you’re still working and move them into a Roth account. If it doesn’t, you wouldn’t be able to transfer the money into a Roth IRA until you’ve left your job.

However, your contributions may have earned some money if you wait until you leave the job, making your income tax situation more complicated.

What is the contribution limit for a mega backdoor Roth?

The contribution limit for a mega backdoor Roth is $40,500 of after-tax dollars in 2022. That’s on top of the pre-tax $20,500 401(k) contribution limit, which stays in your 401(k) account and isn’t rolled over to your Roth account. This gives you a total contribution limit of $61,000.

The mega backdoor Roth strategy is typically best for high-income earners who have already maxed out their 401(k) and could save additional money. It’s also a way to get around the income and contribution limits associated with direct contributions to a Roth account.

How is a mega backdoor Roth IRA taxed?

A traditional 401(k) mainly receives pre-tax contributions, and you’d pay taxes on your withdrawals in retirement. With a mega backdoor Roth, you use your post-tax money to contribute to a 401(k) before rolling it over, so you don’t need to pay taxes on them again in retirement.

If you roll over these post-tax savings contributions from your 401(k) to your designated Roth IRA immediately, you won’t have to pay taxes on earnings. But if you wait, you may have to pay taxes on the money you earn.

You may also be subject to a pro-rata rule, which prevents you from separating your pre-tax and post-tax contributions when you make an in-service withdrawal from your 401(k). You may be able to get around this difficulty if your employee tracks your pre-tax and post-tax amounts and their growth.

It’s usually a good idea to talk to a financial advisor rather than doing a mega backdoor Roth on your own. The tax implications of a mega backdoor Roth IRA could be complicated, and you risk increasing your tax bill if you don’t go about it the right way.

3 steps to create your mega backdoor Roth IRA

Learning how to do a mega backdoor Roth IRA might involve a learning curve. These are the steps you would need to follow to get started:

1. Check your 401(k) plan rules

First, check with your plan administrator to make sure it allows for a mega backdoor Roth. Your plan needs to accept post-tax contributions. It also needs to allow in-service distributions.

In other words, your plan needs to allow you to roll over the post-tax money you contribute into a Roth IRA while you’re still working for your employer. You could also discuss your plan with a financial consultant.

2. Contribute post-tax dollars up to the limit

Once you confirm that your plan allows this mega backdoor Roth strategy, your next step is to contribute post-tax dollars. It’s generally a good idea to reach the limit of your traditional 401(k) contributions before investing additional money. This limit is $20,500 in 2022.

Once you reach that limit, you could contribute up to $40,500 in post-tax dollars in 2022.

3. Rollover your post-tax contributions into a Roth IRA

Your final step would be to immediately roll over your post-tax contribution into your Roth account before it starts accruing investment earnings.

Keep in mind that if your employer doesn’t track the pre-tax and post-tax amounts in your account, you might need to deal with the complex tax implications of the pro-rata rule.

Once your money is in your Roth account, it could receive tax-free growth. You would be able to make qualified withdrawals of your earnings starting at age 59 1/2. Unlike a traditional IRA, you wouldn’t have any required minimum distributions in retirement.

Who would benefit from a mega backdoor Roth IRA?

People with high incomes who have already met their other savings goals might benefit from a mega backdoor Roth IRA. Here are some situations when this retirement strategy might make sense:

  • You’ve already maxed out your 401(k) contributions and employer-matching benefit.
  • Your income makes you ineligible for direct Roth IRA contributions, or you’d like to save more than the annual IRA limits.
  • Your company’s 401(k) plan makes this strategy possible because it allows after-tax contributions and in-service withdrawals.
  • You’ve already taken care of other financial priorities, such as creating an emergency fund or college fund and paying down debt.

Suppose you’re not able to do a mega backdoor Roth IRA. You could still save in your employer’s 401(k) and max out any matching benefit your employer offers, such as matching contributions or fixed employer contributions. Plus, you might be able to open a traditional IRA or contribute to a Roth 401(k) up to the annual IRA contribution limits.

FAQs

Is a mega backdoor Roth worth it?

A mega backdoor Roth could be worth it if you have extra money to save for retirement after maxing out your 401(k) and you don’t qualify for direct Roth IRA contributions. However, this strategy can have complex tax implications, so it’s generally a good idea to speak with a financial advisor about your particular situation.

Who is eligible for a mega backdoor Roth?

You might be eligible for a mega backdoor Roth if you hold a traditional 401(k) with your employer, and your plan allows for post-tax contributions and in-service distributions. You could contribute up to $40,500 of post-tax money as part of your mega backdoor Roth strategy in addition to your pre-tax contributions, capped at $20,500 in 2022.

Note that some employers don’t allow post-tax contributions. Doing so might unfairly benefit highly-compensated employees over taxpayers who are not as highly compensated. If they offered this feature, their company 401(k) plan might not pass the IRS non-discrimination test.

Will the backdoor Roth be eliminated?

The backdoor Roth strategy has been criticized for unfairly benefiting highly-compensated employees in corporations that design plans to allow these tax shelters. The Build Back Better bill, which President Biden announced, has provisions that would eventually eliminate mega backdoor Roth IRAs. The House has passed the bill, but as of May 2022, the Senate has not yet approved it.

Bottom line

The mega backdoor Roth IRA offers a way to increase your retirement contributions while enjoying the tax benefits of a Roth account. However, before pursuing this strategy, make sure that your 401(k) plan allows you to contribute after-tax dollars and immediately roll over this amount into a Roth account.

Since the pro-rata rule might complicate in-service withdrawals, it might be best to consult with a financial advisor or tax professional rather than attempting the mega backdoor Roth on your own.

If your financial situation doesn't make this mega backdoor strategy worth the effort, you could still make the most of other retirement savings strategies.

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Author Details

Rebecca Safier Rebecca Safier is a personal finance writer and certified student loan counselor who loves helping consumers make informed financial decisions. Her work has been featured on MarketWatch, U.S. News & World Report, Business Insider, and other leading publications.