What is a mega backdoor Roth IRA, and is it going away?

A mega backdoor Roth is a unique 401(k) rollover strategy for high-income earners to contribute funds to a Roth IRA.

This lesser-known strategy is effective only in particular circumstances, catering to individuals with ample surplus funds seeking to maximize their retirement dollars.

Here’s everything you need to know about how a mega backdoor Roth works, including contribution limits, special requirements, and the future state of the program. 

If you’re not a big retirement saver, this may not be for you

So we don’t waste the valuable time you could be spending reading our hundreds of other exceptional articles, stop reading if you don’t do (or have) the following already:

• Max out your 401(k)s and IRAs - $23,000 (under 50 years) | $7,500 (over 50 years)
• Make enough to deduct your IRA contributions
• Have an employer that allows after-tax contributions for your 401(k)

Comparing other retirement accounts

Here’s a quick overview of other popular retirement accounts to give you a baseline to compare from:

Traditional IRAs and Roths

• Traditional IRA: You get an upfront tax break when you contribute. As your funds grow, anything you earn is tax-deferred. You pay income tax when you withdraw your money in retirement.
• Roth IRA: You contribute after-tax money and enjoy tax-free growth and withdrawals.
• Limitations: High-income earners are phased out, and contribution limits are relatively low (see above).

>> Related: Roth IRA vs. traditional IRA: Differences, limits, pros and cons

Backdoor Roths

• These are only for people whose income exceeds the regular Roth IRA limits. This strategy involves rolling traditional IRA money into a Roth account. No income or contribution limits apply, but there are a few tax traps to avoid for a successful conversion.

>> Complete Backdoor Roth Guide

Mega backdoor Roths

• People with an employer-sponsored 401(k) can contribute a maximum of $46,000 of post-tax money into their 401(k) and subsequently roll that into a mega backdoor Roth IRA. A mega backdoor Roth IRA setup is complex, so it’s best to seek the help of a financial planner and not try to do it alone.

Mega backdoor Roth contribution limits

In 2024, the mega backdoor Roth strategy allows 401(k) contributions up to $69,000 for those under age 50 and $76,500 for people 50+.

Here’s the breakdown:

• Regular 401(k) contribution: 2024 limits - $23,000﹤50 years | $30,500 50 and over
• If your employer doesn’t match your contributions, you can add $46,000 more after-tax dollars to your 401(k)

*If you get an employer match, those contributions must be deducted from the $46,000.

Your optimal mega backdoor Roth scenario

This strategy allows you to roll your after-tax contributions into a Roth IRA. So, if you already have a Roth 401(k) (and your employer plan permits the mega option), you typically have the flexibility to decide whether your mega contributions will be directed to a Roth 401(k) or Roth IRA. 

However, if your employer only offers a traditional 401(k), your mega backdoor Roth contributions will land in a Roth IRA.

Here’s a brief overview of what you need for an optimal mega backdoor strategy:

• A 401(k) that permits after-tax contributions: After-tax contributions are separate from traditional and Roth 401(k) contributions.
• In-service transactions:
  • Your employer must allow you to convert your Roth 401(k) to Roth IRA while employed and/or;
  • Allow in-service withdrawals of your after-tax contributions
• Disposable income: You have surplus funds available for savings, even after reaching the maximum limit on your traditional 401(k) and Roth IRA contributions.

*If you’re uncertain, ask your HR department or plan administrator.

Do mega backdoor Roths also work for solo 401(k)s?

If you’re self-employed and have a solo 401(k) plan, you can still maximize your Roth dollars with this strategy.

When you have a solo 401k, you are limited to contributing approximately 25% of your pre-tax income to your 401k plan. But for many, this amount may not reach the $69,000 threshold for 2024. 

Despite that, there’s a loophole that comes with being your own boss: You have the right to make sure your plan permits after-tax contributions and in-service withdrawals.

Here’s a hypothetical example of how this could work:

Say you have $20k in elective contributions and $15k in profit-sharing contributions for a total of $35k. The rules allow you to contribute an additional $34k in after-tax contributions to your solo 401(k) (69,000 - 35,000). You can then take these funds and roll them into a mega backdoor Roth.

The key here is to set up a plan that permits this. Some solo 401(k) providers prohibit these features, so be sure to check the plan details before signing up.

What are the benefits of a mega backdoor Roth?

This strategy has several great advantages if executed correctly:

• A mega backdoor Roth allows high earners who wouldn’t normally qualify for a traditional Roth IRA to contribute additional funds at significant tax savings.
• You get access to significantly larger contribution limits.
• You get the benefit of tax-free growth and withdrawals in retirement through a Roth IRA.
• Money in your standard 401(k) is still subject to income tax, but the mega backdoor Roth allows you to shelter some of that income from taxation.

What are the drawbacks of a mega backdoor Roth?

There are also some potential drawbacks to consider with a mega backdoor Roth:

• You are subject to taxes on the money you roll over into the Roth, so it’s important to understand how this will impact your financial situation before executing.
• As you move funds around in different retirement accounts, various tax rules and penalties must be accounted for. So, it’s best to seek the help of a qualified financial planner.

Will the mega backdoor Roth still be available in 2024 and beyond?

While the mega backdoor Roth strategy is currently allowed, it could be eliminated in the future, depending on legislation.

The Build Back Better Act sought to end this strategy by prohibiting after-tax 401(k) contributions from being converted to Roths.

While the act stalled in the Senate, a similar measure is back in the 2024 fiscal-year budget proposal. For now, mega backdoor Roth conversions remain possible in plans that allow them unless legislation prohibits the strategy.

Final word

Overall, the mega backdoor Roth strategy can be a great way to increase tax-free savings in retirement. As long as you understand the tax implications and have access to a plan that allows after-tax contributions and in-service withdrawals, this strategy can help you maximize your Roth IRA contributions and get closer to your financial goals.

Remember, it’s best to consult a qualified financial planner to ensure you understand all the rules and regulations associated with this strategy. With careful planning, the mega backdoor Roth can be an effective tool for increasing your retirement savings.

Set up a call with Facet’s team of experts today to see if this strategy is right for you.