The Mega Backdoor Roth: Supercharging Roth Savings Through Your 401(k)

If you’ve already maxed out your regular 401(k) contributions and want to save more in Roth accounts, which offer tax-free growth and tax-free qualified withdrawals in retirement, the mega backdoor Roth may be an option, if your employer’s plan allows it. This strategy can allow some high earners to save substantially more in Roth accounts each year than would otherwise be possible.

Why Roth savings are valuable

Roth accounts are funded with after-tax money, but qualified withdrawals in retirement, including all investment earnings, are tax-free. Roth IRAs also don’t require minimum distributions during the original owner’s lifetime, and Roth 401(k)s no longer do either. These features make Roth accounts valuable for tax diversification in retirement and for passing wealth to heirs.

However, high earners face limits on Roth savings. Direct contributions to Roth IRAs are phased out above certain income levels, and annual contribution limits apply to Roth IRAs and to employee contributions to 401(k)s.

How the mega backdoor Roth works

The IRS sets two different contribution limits for 401(k) plans. The first is the limit on employee elective deferrals, which applies to your own pre-tax and Roth contributions combined. The second is a higher overall limit on total contributions to your account from all sources, including your elective deferrals, employer matching and profit-sharing contributions, and after-tax contributions.

The gap between these two limits can be substantial. If your plan allows after-tax contributions, which are different from Roth contributions, you can contribute additional after-tax money up to the overall limit.

The mega backdoor Roth strategy generally involves three steps. First, max out your regular employee contributions, either pre-tax or Roth. Second, make additional after-tax contributions, up to the total plan limit, after accounting for any employer contributions. Third, convert those after-tax dollars to Roth, either through an in-plan Roth conversion within your 401(k) or by withdrawing them and rolling them over to a Roth IRA.

Once converted, the money grows tax-free in a Roth account, and qualified withdrawals in retirement are tax-free.

Plan requirements

The mega backdoor Roth isn’t available to everyone, because it depends on your employer’s plan features. Your plan must allow after-tax contributions, which are separate from Roth contributions, beyond the regular employee deferral limit. It must also allow in-plan Roth conversions or in-service withdrawals of after-tax contributions, so you can move the money to a Roth account while still employed.

Many plans don’t offer these features, so check with your plan administrator or review your plan documents. Some employers have added these features in response to employee interest.

Plans must also pass nondiscrimination testing, which can limit after-tax contributions for highly compensated employees in some plans.

Understanding the taxes

After-tax contributions themselves aren’t taxed again when converted to Roth, since you already paid tax on that money. However, any investment earnings on after-tax contributions before conversion are generally taxable when converted.

Converting quickly after making after-tax contributions can minimize taxable earnings. Some plans offer automatic in-plan Roth conversions, which convert after-tax contributions shortly after they’re made, keeping taxable earnings minimal.

If you roll after-tax contributions out of your plan, IRS rules generally allow you to direct the after-tax contributions to a Roth IRA and the pre-tax earnings to a traditional IRA, helping you avoid paying tax on the earnings at the time of the rollover.

The mega backdoor Roth versus the backdoor Roth IRA

The mega backdoor Roth is different from the standard backdoor Roth IRA strategy. The standard backdoor Roth involves making a nondeductible contribution to a traditional IRA and then converting it to a Roth IRA, a strategy used by high earners who exceed Roth IRA income limits. The standard backdoor Roth is limited to the annual IRA contribution limit, while the mega backdoor Roth can allow much larger contributions. Some people use both strategies.

The standard backdoor Roth can be complicated by the pro-rata rule if you have other pre-tax IRA balances, which can make part of the conversion taxable.

Is the mega backdoor Roth right for you?

The mega backdoor Roth is generally most useful for high earners who have already maxed out other tax-advantaged options, such as regular 401(k) contributions, health savings accounts and possibly a backdoor Roth IRA, and who have extra cash flow to save.

Before pursuing it, make sure you have a solid emergency fund, have paid off high-interest debt and are comfortable committing additional money to retirement savings. Consider whether you might need access to the money before retirement, since withdrawals of earnings before meeting Roth requirements may be taxed and penalized, though converted amounts have their own rules.

Consider your overall tax situation, including whether you expect to be in a higher or lower tax bracket in retirement, since that affects the value of Roth versus pre-tax savings.

Get professional guidance

The mega backdoor Roth involves plan-specific rules and tax considerations. Check with your plan administrator about available features, review current IRS limits and talk with a tax professional or financial planner to determine whether the strategy fits your situation.