A Backdoor Roth isn’t cool. You know what’s cool? A Mega Backdoor Roth.

This piece was actually inspired by a good friend. I figured if my bud had some questions, there’s likely a ton of other young professionals who need some clarity on Roth IRAs.

First off, let’s review the difference between a Roth IRA and a Roth 401(k). A Roth IRA is an account that is completely separate from your employer’s retirement plan (aka 401(k)). I’m sure most of you have heard about this type of account or maybe you even have one set up. Roth dollars are after-tax dollars that grow tax-free and are distributed tax-free upon reaching age 59.5.

If you’re just joining the workforce and expect your modified adjusted gross income (MAGI) to be above $161,000 for 2024 as a single filer, I’ve got some mid news for you. You can’t make outright Roth IRA contributions. Womp womp.

Now, there is actually a phaseout range for your MAGI ranging from $146,000 - $161,000. After $161,000, you are entirely phased out of making Roth IRA contributions. For the married folks, the range is $230,000 - $240,000.

These limitations are strictly for Roth IRAs, NOT your 401(k). So, that’s pretty beat. You’re finally making all this money and you can’t even contribute to a Roth IRA??

Well, my friends, you are in for a treat. Allow me to introduce the Backdoor Roth or Roth conversion. There are going to be a lot of moving parts here so try to stay with me.

Essentially, you cannot contribute outright to a Roth IRA, but you can contribute to a Traditional IRA (although the contribution is not deductible given your income). The IRS allows you to convert Traditional IRA dollars over to your Roth IRA at any time.

Voila, we have now max-funded a Roth IRA for the year and completely skirted the income limitations. All that was needed was an after-tax contribution to a Traditional IRA and the subsequent conversion of those dollars to your Roth IRA.

Note: Any pre-tax dollars existing in a Traditional IRA will make this conversion a taxable event. This unnecessary taxable event can be sidestepped by rolling pre-tax IRA dollars to your pre-tax 401(k).

I am going to avoid anything regarding tax forms on the subject as I am not a tax professional. There are tax forms that will be generated with the Roth conversion, usually to prove the basis that is then in your Roth IRA. These are very important. Keep them on file.

One note: Pay attention to how much total income is projected for 2024. Will it be well under $146,000? Then the Roth conversion is not yet needed. Will it be much more than $161,000 in 2025? Then avoid making an outright Roth Contribution in 2025. Undoing the contribution will be an absolute headache. 

Are you guys still with me? Now we get to nerd out and get into the weeds of a more advanced planning topic.

Honestly, I am going to hastily sum up what the Mega Backdoor Roth is. This topic is nuanced and some hoops must be jumped through on top of the fact that your 401(k) plan has to have multiple different features to allow for it.

I will likely revisit the Mega Backdoor Roth topic in the future. There are not many young professionals who are really in the realm of being able to take advantage of this strategy to its fullest extent.

To give you an idea, I’d generally want to see $500,000 in total compensation for a single filer to take full advantage of this strategy. This is a super-saver strategy.

Between your Roth IRA and your 401(k), there is the potential to contribute a whopping 76,000 dollars for 2024. ($7,000 to your Roth IRA and $69,000 to your 401(k)).

Your 401(k) has a limit of $23,000 on the employee side. However, between your contributions, the employer contributions (think matches, profit-sharing, or qualified non-elective contributions), and after-tax contributions, the real maximum is $69,000.

Yes, some 401(k) plans allow you to contribute after-tax dollars to the plan that do not count towards the pre-tax or Roth employee deferral.

You can achieve the Mega Backdoor Roth in one of two ways: in-plan conversions or through in-service distributions. In my experience, I have found that in-plan conversions are not only much easier from a logistic point but also more likely to be included as a provision in a 401(k) plan.

That’s right, these provisions must be included in the plan. If the plan does not allow for them, then the Mega Backdoor Roth strategy does not apply to you.

I’m not going to get into the weeds of in-service distributions from the plan, but I will give you a hypothetical in-plan conversion scenario.

Let’s assume there is no employer match for the sake of simplicity. Person A contributes $23,000 as their employee Roth deferral throughout 2024, but their plan also allows for in-plan conversions. This means they could contribute an additional $46,000 in after-tax dollars to the plan.

They’d simply elect to have additional compensation deferred to the plan on an after-tax basis and immediately have that contribution converted from the after-tax bucket of 401(k) monies to the Roth 401(k) bucket of monies. (Usually, initiating in-plan conversions is done over a one-time phone call to ensure the funds are being converted immediately).

Bam, there you have it. The potential for $76,000 in Roth dollars in a single year.

Our brains are terrible at understanding the power of compounding and long-time frames. There is nothing our generation likes more than instant gratification. So, here’s a calculation below showing what $76,000 becomes at 7% over the course of a 40-year time horizon with no additional contributions.

It is probably unlikely that anyone could do this for 40 years straight, but theoretically, it is possible. Let’s see what doing the Mega Backdoor Roth gets us then:

The content shared in this piece does not constitute financial or tax advice and is for informational purposes only. Readers should consult their financial and tax professionals for advice tailored to their situation.

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Have a more specific question or want to get your finances in order? Feel free to reach out to [email protected] for a free consultation!