Retirement savers typically use a mega backdoor Roth conversion, in addition to a backdoor Roth 401k, when they have already maximized their contributions and want to continue saving for retirement beyond those annual limits.With a backdoor Roth 401(k), you will pay taxes upfront on contributions with the goal of making tax-free withdrawals in retirement. And a mega backdoor Roth conversion could help you maximize retirement savings even further with additional after-tax contributions that are converted to a Roth IRA. Here’s how it works. For hands-on help with your retirement savings, consider working with a financial advisor.
How a Mega Backdoor Roth Conversion Works
A backdoor Roth 401(k) involves converting after-tax contributions in your 401(k) to a Roth account within the same plan. A mega backdoor Roth conversion, on the other hand, specifically involves making additional after-tax contributions beyond standard limits and converting them into a Roth IRA for additional tax-free growth.
Both traditional and Roth 401(k)s allow a maximum employee contribution in 2024 of $23,000 annually. A total contribution limit, which includes employer contributions, can reach $69,000. But, if your employer doesn’t match contributions up to that limit, you could have the option to make after-tax contributions up to the total allowable contribution limit.
So, if you contribute the maximum $23,000 to a Roth 401(k), then you could potentially add another $46,000 as after-tax contributions. But, take note: These after-tax contributions are different from Roth contributions, as their earnings are taxable upon withdrawal.
In order to take advantage of this strategy, you must participate in a 401(k) plan that allows after-tax contributions. These are contributions made from your income after all applicable taxes have been deducted and they differ from pre-tax contributions that reduce your taxable income.
How to Make a Mega Backdoor Roth Conversion
The mega backdoor Roth conversion process can be broken down into four basic steps:
- Eligibility check: First, determine if your 401(k) plan allows after-tax contributions and supports in-service withdrawals or rollovers—meaning the ability to move funds while still employed.
- Make after-tax contributions: If eligible, contribute after-tax dollars to your 401(k) up to the current legal limit.
- Initiate the conversion: Transfer the after-tax funds from your 401(k) to a Roth IRA. This can be done through a direct rollover or an in-plan conversion, then a rollover, depending on your employer’s plan.
- Report the conversion: Report the transfer to the IRS using Form 1099-R, ensuring all documentation is accurate to avoid future tax issues.
Earnings on after-tax contributions may be subject to tax upon conversion. When filing your taxes, use IRS Form 8606 to track non-deductible contributions and avoid double taxation.
Benefits of a Mega Backdoor Roth
A mega backdoor Roth 401(k) could benefit you in five common ways:
- Tax-free growth: Your money will continue to grow without incurring additional taxes on those investment gains.
- Higher contribution limits: By contributing above the annual 401(k) limit, you will also boost your overall retirement nest egg over time.
- Tax-free withdrawals: As long as you hold the funds in your account for a certain period of time and are older than age 59 1/2, you could avoid penalties and taxes on distributions.
- Tax diversification: By having both pre-tax and Roth accounts, you can withdraw funds strategically in retirement, which can offer you flexibility and potentially reduce overall taxes.
- Estate planning benefits: Assets held in a Roth IRA through a mega backdoor conversion can be passed on to heirs tax-efficiently, thereby providing a valuable estate planning tool to transfer wealth to future generations.
Bottom Line
A mega backdoor Roth conversion involves transferring after-tax contributions from a 401(k) to a Roth IRA, and can provide an opportunity to maximize retirement savings with potential tax-free growth. This is a common strategy for high-income earners who are restricted by income limits.
Tips for Retirement Planning
- A financial advisor can help you create a financial plan to reach your retirement goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you canhave a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- You may want to estimate how much you need to save for retirement. SmartAsset’s free retirement calculator can help you make sure that you’re saving enough for your goals.
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