(4 minutes to read)
Mega Backdoor Roth is a valuable tax-free saving strategy. It was nearly taken away in 2021 in the originally proposed Build Back Better legislation, but fortunately, those changes were not included in the final version of the legislation, which was later renamed Inflation Reduction Act and became law in 2022. Last year also held another massive new piece of legislation—the retirement-focused Secure Act 2.0—that could have possibly eliminated this strategy, but it didn’t.
Mega Backdoor Roth survived!
At least for now. If you can use this strategy, it’s worth looking into while it’s still available.
It’s important to note that Mega Backdoor Roth is not for everyone. The strategy allows you to contribute to your 401(k) beyond the regular contribution limits, so it works best for people with high income who are already maxing out their regular pre-tax 401(k) contributions at work. The regular contribution limits for 401(k) plans in 2023 are $22,500 for people younger than 50 years old, and $30,000 for people 50 years old and older. Using the Mega Backdoor Roth 401(k) strategy, you can save up to an additional $43,500 in 2023 (regardless of your age), allowing your total yearly contributions to go as high as $66,000 and $73,500, respectively.
One note: If your company matches your 401(k) contribution, the amount of that matching contribution is subtracted from the total amount you can contribute. The limits of $66,000 and $73,500 are maximum amounts that can be contributed by both you and your company together.
The power of the Mega Backdoor Roth 401(k) strategy comes from the fact that your additional contributions can be saved into your tax-free savings bucket. When you take the money out later in retirement, you won’t owe any tax on the amount you contributed or on the money’s growth. That’s in comparison to regular pre-tax 401(k) contributions in which you contribute money before tax—with these, there is no tax on the money while it’s growing, but you do have to pay tax on the money (including growth) when you take it out later in retirement.
The other powerful aspect of Mega Backdoor Roth is that it’s a way to get around limits on the amount you can contribute to a Roth IRA. The maximum Roth IRA contribution amount for 2023 is $6,500 (or $7,500 if you’re age 50 or older). That amount is reduced if your income is too high; in fact, many people can’t make Roth IRA contributions at all due to the size of their income.
By now you probably have a sense of whether this strategy could be a useful one for you. If it is, there’s one more thing to consider about how much additional money you should direct to a Roth 401(k) account, which you may not be able to access tax-free for many years: liquidity. You need to consider how much money you have in taxable brokerage accounts that you can access anytime versus pre-tax and Roth retirement accounts that you can’t access without penalty until age 59½ in most cases. It’s important to have at least some money in account types that don’t limit your ability to withdraw funds in case of emergencies or to fund big goals or projects, like buying or remodeling a home. So just keep this in mind.
Now let’s talk about how Mega Backdoor Roth works. Here’s a simplified rundown:
You max out your regular (usually pre-tax) 401(k) contributions.
You contribute up to an additional $43,500 to your 401(k) plan as after-tax contributions. (You’ve already paid income tax on these amounts.)
You convert your after-tax contributions to Roth 401(k) inside of the 401(k) plan (a so-called in-plan rollover or conversion), or you withdraw your after-tax contributions to an external Roth IRA account (a so-called in-service distribution).
A crucial point here is that to use the Mega Backdoor Roth strategy, your company’s 401(k) plan must have certain features: it must allow you to make after-tax contributions, and it must allow you to perform an in-plan conversion or an in-service withdrawal. Not all 401(k) plans offer these features, and if your company’s plan doesn’t, you cannot execute the Mega Backdoor Roth strategy. Check your 401(k) plan website or ask your employee benefits specialist whether your company’s 401(k) plan has the required features.
Many tech firms have added the features needed for Mega Backdoor Roth strategy to their 401(k) plans, due to strong demand. Employees from leading tech companies, such as Apple, Cisco, Google, Intel, Meta, Microsoft, PayPal, and ServiceNow, have access to this strategy, and many make good use of it.
If you find you have access to the strategy and want to use it, great.
One important feature to set up, if it’s available in your 401(k) plan, is automatic in-plan Roth conversions. Some 401(k) platforms allow you to configure an automatic conversion of your after-tax contribution to Roth 401(k) every time you make a contribution—for example, each pay period. If automatic in-plan Roth conversion isn’t available, you may have to manually convert your after-tax contributions to Roth 401(k) each pay period. That can be an incredible hassle and could lead you to not convert immediately each pay period. And if you don’t convert immediately, any growth on your after-tax contribution will be taxed as ordinary income when you do finally convert. That’s why the automatic in-plan conversion feature is so useful.
While it can be tricky to initially get the strategy set up in your 401(k) plan—there isn’t a lot of standardization in terminology or set-up processes among 401(k) platform providers, and the documentation and help can be scarce—just know that it can be well worth the trouble.
Legislators may take another pass at eliminating Mega Backdoor Roth in coming years. So now’s the time to explore it. If you’re already maxing out your 401(k) and still have extra cash to save, check into whether your company’s 401(k) plan allows the Mega Backdoor Roth features. Then if it makes sense for you, consider boosting your tax-free savings while you still have the chance.
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you’d like help understanding Mega Backdoor Roth and whether it makes sense for you, schedule a complimentary consultation.
