Key Points
- The Mega Backdoor Roth strategy could allow you to save an additional $46,000 per year into a Roth IRA or a Roth 401(k) in 2024.
- This strategy is not available to everyone, and the process can be quite complicated.
- You will need to be enrolled in a 401(k) plan that allows after-tax contributions and in-service distributions to take advantage of this strategy.
There are many ways to save for retirement and one very popular way is utilizing retirement accounts. As most people know, retirement accounts offer tax advantages, but the IRS limits how much we can contribute to them each year.
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What if I told you that you could save more, and I mean a lot more, than the traditional contribution limits for IRA’s and 401(k)’s?
Retirement accounts that have the Roth designation, such as Roth IRA’s or Roth 401(k)’s, offer the ability to contribute after tax dollars. These contributions then grow tax-free, just like traditional IRA’s and 401(k)’s, but they offer the additional advantage of tax-free withdrawals in retirement.
The Mega Backdoor Roth strategy could allow you to save an additional $46,000 per year into a Roth IRA or a Roth 401(k) in 2024. Put simply - for those who meet the qualifications, one being that you need to be enrolled in a 401(k) plan at work, you can contribute up to $46,000 of after-tax dollars into your 401(k) plan, then roll it into a Mega Backdoor Roth.
Let’s delve more into the details of this saving strategy and whether it is something that could benefit you.
How Mega Backdoor Roth Conversions Work
The mega backdoor Roth strategy involves making an after-tax contribution to your company 401(k) plan, and then converting it into a designated Roth account that is either held within the plan or by rolling the contribution into a Roth IRA. If you are eligible for this strategy, you and your employer can contribute up to $69,000 (in 2024) which is $46,000 above the 2024 elective deferral limit.
A huge benefit of saving money for retirement in Roth accounts is that those funds will grow tax-free, allow for tax-free withdrawals in retirement and there are no required minimum distributions.
The contribution limit of $69,000 ($76,500 if you are 50+) consists of three separate sources:
- Pre-tax and/or Roth contributions – up to $23,000 ($30,500 if you are 50+)
- Employer contributions
- After-tax contributions – this is where the Mega Backdoor Roth Strategy comes in
To calculate your maximum after-tax contribution, simply subtract your pre-tax and/or Roth contributions, and your employer match, from the total contribution limit. For example, if you are below 50 and you have contributed the max amount of $23,000 to your 401(k), and your employer contributes $5,000, you can contribute an additional $41,000 in after-tax dollars.
When you have made your after-tax contribution, you can elect to make an in-plan Roth conversion (if your plan allows this), or you can roll the after-tax contributions into a Roth IRA.
Saving in a Roth vs a Brokerage Account
If you have the ability to save more to a Roth IRA using this strategy, it likely means that currently you are saving this money to a taxable brokerage or bank account. To model the difference in saving for retirement in a Roth vs a Brokerage account over time in WealthTrace, we will look at Jessica’s retirement plan.
In this scenario, we will look at the difference between putting $46,000 annually into a brokerage account vs into a Roth IRA account over the next 15 years. Both accounts will have the exact same asset allocation and investment return.
If Jessica invests her extra $46,000 into a brokerage account, her Monte Carlo probability of funding all of her financial goals is at 78%.
If Jessica instead invests her extra $46,000 into a Roth IRA, her probability of funding all goals jumps up to 84%. She will also have much less tax liability in retirement.
A 6% difference might not seem like a lot, but in Jessica’s case it means she is projected to have an additional $167,973 at the end of her life expectancy.
You will need to be enrolled in a 401(k) plan that allows after-tax contributions and in-service distributions to take advantage of this strategy. If you are unsure if your plan allows this, contact your Human Resources department or Plan Administrator.
If your plan does not allow for after-tax contributions or in-service distributions, there are still other ways to contribute to a Roth account. If you are under the income limit then you can contribute directly to a Roth IRA. Go here to read about the 2024 income limits. Another option is to contribute to a Roth 401(k) if your employer offers it.
The Bottom Line
The Mega Backdoor Roth strategy has been around since 2010. However, in recent years critics have proposed legislation that would limit or eliminate this strategy. There are those who feel that this strategy is an unfair way for high-income earners to exploit the tax advantages of Roth accounts, since they wouldn’t otherwise be able to contribute to a Roth account.
This strategy is also not available to everyone and the process can be quite complicated. It also requires additional work during tax season. If you are a high-income earner, and do not mind the additional tax return burden, then this could be a great strategy for you that can save you many thousands of dollars over the long run.
Will a Mega Backdoor Roth conversion help you save money? If you want to find out, sign up for of free trial of WealthTrace to get started on your financial and retirement planning.