Your Guide to the Mega Backdoor Roth IRA

What is it, and how does it work?

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What if you could supercharge your Roth 401(k) or IRA contributions and save even more for retirement? Sounds a little too good to be true, but it's entirely possible. There's a backroad way of increasing your eligible Roth IRA contributions by up to $37,500 using what's known as the Mega Backdoor Roth IRA.

What Are the Roth IRA Limits?

The IRS determines who can contribute to a Roth IRA and how much they can contribute.

Here are some basic rules:

  • The contribution limit is $6,000 per individual, or $7,000 if you're age 50 or older.
  • If you are a single filer who makes less than $124,000, you can contribute the full amount to a Roth IRA.
  • If you make more than that and up to as much as $139,000, you can contribute a reduced amount.
  • As a single filer, if you make more than $139,000, you cannot contribute to a Roth IRA.
  • For married and joint filers, the cutoffs are $196,000 and $206,000.

If you make more than these income limits and you'd like to stash more money away for retirement somewhere, you can still contribute to a traditional IRA. Here's where the Backdoor Roth IRA comes into play. It converts contributions to a traditional IRA into a Roth IRA account.

What Is the Mega Backdoor Roth IRA, and How Does It Work?

The Mega Backdoor Roth IRA is an even bigger version of the Backdoor Roth IRA. It allows for after-tax contributions to a 401(k) plan to be converted into a Roth IRA. The numbers are bigger, and the accounts are different.

To take advantage of the Mega Backdoor Roth IRA, you must have an employer-sponsored 401(k) that allows after-tax contributions.

After-tax contributions to a 401(k) plan are different from Roth IRA contributions. The IRS limits on 401(k) contributions are $57,000 in 2020. That means individuals can contribute $19,500 pre-tax, and your employer can contribute up to $37,500 on your behalf. (Note: Each brokerage and plan has its own rules, so some plans may allow employees to contribute more as after-tax contributions after employer contributions are counted.)

With the Mega Backdoor Roth, you're taking your after-tax 401(k) contributions ($19,500, or $26,000 if you're age 50 or over), converting them into a traditional IRA and then converting them into a Roth IRA. It's a few more steps, and there are specific rules about who has access to this.

Who Can Use the Mega Backdoor Roth IRA?

To do a Mega Backdoor Roth IRA, your 401(k) plan needs to offer:

  1. After-tax contributions above the $19,500 pre-tax limit
  2. In-service distributions (or non-hardship withdrawals)

Both of these work together to make sure that you can contribute the maximum allowed annually in your 401(k) so that that money can then be converted.

Here's your step-by-step process if you meet the above criteria:

  1. Max out your 401(k) with after-tax contributions. Make sure to check with your employer's plan so that you are following the rules. Remember, these are after-tax contributions, not Roth IRA contributions.
  2. Withdraw that money into a traditional IRA, and do the same process as with a Backdoor Roth IRA.

If your company allows in-service, non-hardship withdrawals, you can withdraw your 401(k) contributions into a Roth IRA right away.

Beyond how to do this, it's essential to consider if this is a good move for your money. This conversion is best for high-income earners and high savers. It's for people who are already maxing out their other retirement options and possibly even have different plans like a health savings account (HSA) or a 529 college savings plan and still find themselves with more money they want to save.

If you are a middle-income earner or you're not able to max out your 401(k), this conversion isn't worth your time. From our experience, we think TD Ameritrade and E*TRADE are the top picks for Roth IRA brokerage accounts.

What About Self-Employed People?

Even those with a solo 401(k) can use the Mega Backdoor Roth IRA. And actually, it might be a little easier, since you create your own 401(k) plan.

In a solo 401(k), you are allowed to contribute 25% of your pre-tax income to your plan. As mentioned, the contribution limit is $57,000 in 2020, but this is often more than 25% of pre-tax income.

Here's where it's good to be the person in charge of the plan. You can set up your plan so that it allows after-tax contributions and in-service withdrawals.

This way, you can still use the Mega Backdoor Roth IRA by following the steps above. For example, say you're able to contribute $10,000 in elective contributions and $10,000 as profit-sharing contributions. That's still $37,000 below the contribution limit of $57,000.

You could then contribute that remaining $36,000 in after-tax contributions to your plan and then convert it all using the Mega Backdoor Roth.

The Final Word

While the Mega Backdoor Roth has more steps than most other retirement accounts and more limits on who can use it, it is a way of really stepping up your retirement savings. It's best for people earning enough to want to save more after already maxing out their existing retirement accounts. If you're not worried about building cash savings or other financial needs, this can be a great option.

Please note: As with all financial decisions, you should consult a professional financial advisor. This is especially true of those decisions related to tax issues — such as this rather complicated Mega Backdoor Roth IRA process — consult a tax professional.

Kara Perez

Kara Perez is a freelance personal finance writer. She is the founder of bravelygo.co, a company that connects women and money. Kara lives in Austin, TX and believes in the power of budgeting and peanut butter.

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