In this video The White Coat Investor does a Deep Dive into How To Do A Mega Backdoor Roth IRA.

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00:00 Mega Backdoor Roth IRA
00:20 Multiple 401(k) Rules
02:39 After Tax Employee Contributions
04:12 How To Do A Mega Backdoor Roth IRA…(read more)

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As a high-income earner, it can be a challenge to find ways to save for retirement without hitting contribution limits. One strategy that can help is the Mega Backdoor Roth IRA, which allows you to contribute more after-tax dollars to a Roth IRA than the standard annual limit. In this article, we’ll take a deep dive into the Mega Backdoor Roth IRA and how to set one up.

First, let’s briefly review what a Backdoor Roth IRA is. With a Backdoor Roth IRA, you make nondeductible contributions to a Traditional IRA and then convert them to a Roth IRA. This is a way to get around the income limits for contributing directly to a Roth IRA. However, the annual contribution limit for a Roth IRA is $6,000 (or $7,000 if you’re over 50), which may not be enough for high-income earners who want to save more for retirement.

That’s where the Mega Backdoor Roth IRA comes in. This strategy allows you to contribute up to an additional $37,500 (as of 2020, subject to annual adjustments) per year to a Roth IRA on top of the standard annual limit. Here’s how it works:

Step 1: Maximize Your 401(k) Contributions

The first thing you need to do is max out your regular 401(k) contributions. In 2020, the limit is $19,500 (or $26,000 if you’re over 50). This is important because you can only make after-tax contributions to your 401(k) if you’ve already hit the regular contribution limit.

Step 2: Check If Your Plan Allows After-Tax Contributions

Not all 401(k) plans allow after-tax contributions, so you’ll need to check with your plan administrator to see if this is an option. If it is, you can move on to the next step.

Step 3: Make After-Tax Contributions

Assuming your plan allows after-tax contributions, you can start making them. The maximum amount you can contribute is the difference between the overall contribution limit and the regular contribution limit. For example, if the overall limit is $57,000 (including employer contributions) and the regular contribution limit is $19,500, the maximum after-tax contribution limit is $37,500. Note that this is subject to annual adjustments.

Step 4: Convert After-Tax Contributions to a Roth IRA

Once you’ve made after-tax contributions to your 401(k), you can convert them to a Roth IRA. This is where the “Backdoor” part of the Mega Backdoor Roth IRA comes in. Unlike with a regular Backdoor Roth IRA, where you convert Traditional IRA contributions to a Roth IRA, with a Mega Backdoor Roth IRA you’re converting after-tax contributions from your 401(k) to a Roth IRA.

It’s important to note that you’ll owe taxes on any earnings that accrue on the after-tax contributions before you convert them to a Roth IRA. However, if you convert the funds quickly (within a few days or weeks), the amount of earnings should be minimal.

Step 5: Repeat Annually

The Mega Backdoor Roth IRA strategy is something you can do every year, assuming your 401(k) plan allows after-tax contributions. It’s a great way to save more for retirement and take advantage of the tax-free growth and withdrawals of a Roth IRA.

In conclusion, the Mega Backdoor Roth IRA is a powerful strategy for high-income earners who want to save more for retirement. By making after-tax contributions to their 401(k) and converting them to a Roth IRA, they can potentially accumulate significant tax-free retirement savings over time. If your plan allows it, consider giving the Mega Backdoor Roth IRA a try.