What’s a Mega Backdoor Roth IRA?

The backdoor Roth IRA is a roundabout way to contribute to a Roth IRA for high earners by first making a non-deductible traditional IRA contribution and then converting it to a Roth.

A mega backdoor Roth IRA takes the backdoor Roth IRA concept further by allowing larger after-tax 401(k) contributions above the $22,500 pre-tax limit and converts them to a Roth IRA. Just know that not all employers allow this.

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What’s a Mega Backdoor Roth IRA?

When it comes to saving for retirement, options like the traditional 401(k) or IRA are often the go-to choices for individuals. However, there is a lesser-known strategy called the Mega Backdoor Roth IRA that provides an additional way to boost retirement savings. In this article, we will dive into what exactly is a Mega Backdoor Roth IRA and how it can benefit your long-term financial planning.

To understand the Mega Backdoor Roth IRA, it is essential to have a basic understanding of the Roth IRA and the traditional 401(k). A Roth IRA is an individual retirement account where contributions are made with after-tax dollars. The funds within the account grow tax-free, and withdrawals during retirement are also tax-free. On the other hand, a traditional 401(k) is a workplace-sponsored retirement plan where contributions are made with pre-tax dollars. The invested funds grow tax-deferred, but withdrawals in retirement are taxed at ordinary income rates.

With the Mega Backdoor Roth IRA, high-income earners who are already maxing out their 401(k) contributions can potentially contribute even more to a Roth IRA. This strategy allows individuals to take advantage of the benefits of both the Roth IRA and the traditional 401(k). Unlike a typical backdoor Roth IRA, which involves converting a traditional IRA into a Roth IRA, the Mega Backdoor Roth IRA takes advantage of the additional contribution limits allowed by your employer.

Here’s how it works: some employers offer a provision within their 401(k) plans that allow employees to make after-tax contributions beyond the standard annual contribution limit. These after-tax contributions are subject to different contribution limits that are often significantly higher than the traditional 401(k) limit, which, for 2021, stands at $19,500 for individuals under 50. The annual limit including employer contributions, known as the total contribution limit, for 2021 is $58,000.

Once you’ve made your after-tax contributions to your 401(k), you can then convert that money to a Roth IRA. By doing this, you’re essentially utilizing the Mega Backdoor Roth IRA strategy. The converted amount will be subject to income taxes in the year of conversion, but it will grow and be withdrawn tax-free in retirement. This strategy allows you to maximize your retirement savings by taking full advantage of the tax advantages offered by the Roth IRA.

Keep in mind, however, that the Mega Backdoor Roth IRA strategy may not be available to all individuals. It depends on whether your employer offers the after-tax contribution option within their 401(k) plan. Additionally, some employers may have restrictions or rules surrounding the conversion, such as a waiting period before conversion or limitations on the frequency of conversions. Therefore, it is essential to consult with your employer and financial advisor to determine if this strategy is feasible for you.

In conclusion, the Mega Backdoor Roth IRA is a sophisticated strategy that can potentially boost your retirement savings by taking advantage of higher contribution limits and the advantageous tax treatment of a Roth IRA. While it may not be accessible for everyone, it is worth exploring if you are a high-income earner and are looking to increase your savings beyond the traditional retirement savings vehicles. Remember to consult with a professional advisor to determine if this strategy aligns with your financial goals and circumstances.