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A mega backdoor Roth is a way to save up to $43,500 annually in tax-advantaged Roth accounts. Watch for the contribution limits we’ll explore in this guide.
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We’ll explore the basics behind a mega backdoor Roth, touch on contribution limits, note steps to set one up, and lay out the pros and cons. Then, you can figure out whether you want to start saving for retirement with a mega backdoor Roth or if another strategy would be best for you.
A mega backdoor Roth allows you to contribute more than the typical limit to a Roth 401(k) or IRA. The mega backdoor Roth limit for 2023 is $43,500.
If your employer matched any of your yearly contributions, your mega backdoor Roth amount will be that much less than $43,500.
It involves moving 401(k) contributions into a Roth IRA or Roth 401(k): In any given year, you’re allowed to contribute a certain amount to your 401(k) from pretax dollars. To utilize a mega backdoor Roth, you subtract that amount from the total IRS retirement contribution limit, giving you your mega backdoor amount.
That mega backdoor amount is the post-tax dollar amount you can contribute to your 401(k) before moving it into a Roth 401(k) or Roth IRA. Doing so helps you avoid taxes on future gains so that your retirement account can grow without the impediment of future taxes.
The mega backdoor Roth limit for 2023 is $43,500, regardless of your age. This is the total IRS limit minus the 401(k) contribution limit.
For 2023, the traditional 401(k) limits are:
To get your mega backdoor Roth amount, subtract your 401(k) contributions and any employer-matched additions from the IRS contribution limit.
For 2023, the total IRS contribution limits are:
This is the IRS contribution limit to all of your retirement accounts from any sources, including any employer contributions. Remember, these contribution limits change annually, so make sure you have the most current numbers from the IRS.
The mega backdoor Roth strategy isn’t for everyone looking to contribute to a Roth retirement account.
There are a few pre-qualifications you should meet to take advantage of this tactic:
In-service withdrawals are distributions from your 401(k) while you’re still employed. This allows you to move money from the 401(k) into a Roth account. And you should still have money to move around if you want to use a mega backdoor Roth: This locks up your savings until retirement (unless you pay steep penalties).
Finding yourself with extra income after maxing out your retirement contributions means you can save extra money for retirement.
A mega backdoor Roth strategy lets you add tens of thousands more to your 401(k) and transfer that to a tax-advantaged Roth account so you can watch those funds grow tax-free. These are the steps to take advantage of this retirement hack:
First, you need to contribute the maximum amount to your 401(k). For 2023, that’s a hefty $22,500 if you’re under 50 and $30,000 if you’re 50 or over. This sets the stage for the mega backdoor Roth.
Not all employer plans allow for the mega backdoor Roth. You’ll need to check if your plan permits after-tax contributions and in-service withdrawals, which are crucial for this strategy.
More than one-fifth (22%) of Vanguard plans offered after-tax employee-elective deferrals to participants in 2022. Large plans were even more likely to offer this after-tax feature, accessible to 36% of participants.
To check if your plan is eligible, use the following template to reach out to your HR representative:
Once you’ve confirmed your plan allows it, start making after-tax contributions. These differ from the pretax contributions you’d normally make to your 401(k). Between your pretax contributions, after-tax contributions, and any additions your employer makes, your 401(k) can accept up to $60,000 in 2023 if you’re under age 50, and $73,500 if you’re 50 or older.
Now, the magic happens. You convert your after-tax contributions to a Roth IRA or Roth 401(k) – similar to an IRA rollover or transfer. You’ll need to pay income taxes on any earnings when you convert, but then you can enjoy tax-free growth on your investments and tax-free withdrawals in retirement.
Watch out for the pro rata rule when converting. If you have other traditional IRAs, the IRS may consider them when calculating the tax owed on your Roth conversion.
The pro rata rule determines the ratio you should use when calculating how much of your conversion is pre-tax dollars and how much is after-tax – you can’t choose to only convert your after-tax dollars.
For example, you contribute $40,000 in after-tax dollars to your 401(k), and you have a total 401(k) balance of $200,000. Dividing your after-tax contribution by your total balance ($40,000/$200,000) tells you that 20% of any Roth rollover amount will be taxable.
Once your after-tax contributions are safely in your Roth account, they grow tax-free. That means you won’t owe a dime in taxes when you start withdrawing your savings in retirement. It’s a legal way to have your cake and eat it, too.
If you can take advantage of a mega backdoor Roth, doing so can provide some excellent benefits for your retirement fund. However, the strategy can be too complex for those looking for a simple, straightforward retirement plan.
Take a look at these pros and cons to help you decide.
Check out these mega backdoor Roth benefits:
Roth accounts are tax-free investments as long as you adhere to contribution and withdrawal guidelines, so they’re a great way to reduce your tax liability later in life when you want to enjoy your retirement free from Uncle Sam’s prying eyes.
As with any financial strategy, there are potential pitfalls to keep in mind with a mega backdoor Roth:
Ah, the plot thickens! With all these retirement options, knowing which is which can give you a leg up in the long run.
The mega backdoor Roth and a regular backdoor Roth may sound similar, but they have distinct differences when it comes to contribution limits and tax treatment.
The chart uses numbers from the IRS’s 2023 contribution limits.
Right now, the mega backdoor Roth is not going away as long as your employer plan allows it. That’s good news! But it’s not permanent news – there could be legislation on the way that eliminates the option to make after-tax contributions.
A mega backdoor Roth is a retirement option that allows you to invest significantly more tax-advantaged money into a Roth IRA or 401(k) than you’d otherwise have the ability to. But it doesn’t come without the risk of significant tax penalties.