How to do a Mega Backdoor Roth

Many retirement savers only know about the standard salary deferral limit for 401(k) plans, which is $23,000 in 2024 for those under 50. Most don’t need to know how to contribute more, as only 15% of employees max out their workplace retirement plan. For some super savers, maybe Financial Mutants even, they max out their salary deferrals and look for additional places to invest. The salary deferral limit of $23,000, or $30,500 for those 50 and older, does not apply to after-tax 401(k) contributions. The annual additions limit applies to salary deferrals, employer matches, and after-tax contributions, and is $69,000 in 2024 (or $76,500 for the 50+ crowd).

What does this mean? Well, for someone under 50 that doesn’t get an employer match, it means they may be able t0 make $46,000 in after-tax contributions to their employer-sponsored plan. There is a big catch: not all employers allow after-tax contributions. Even if your employer allows after-tax contributions, they must allow in-plan Roth conversions in order for you to convert those after-tax contributions to Roth. If you have those magical ingredients, you may be able to build an enormous amount of Roth dollars for retirement.

Should I do a Mega Backdoor Roth?

I know what you’re thinking: forget about paying off high-interest debt, building an emergency fund, or contributing to a regular Roth IRA. I need to try out this Mega Backdoor Roth strategy now. Even if you do have the ability to build Roth dollars using the Mega Backdoor Roth strategy, it may not make sense to use it. For starters, there’s no reason to use this strategy if you can still contribute more money to a Roth IRA the old fashioned way or still have room left in your 401(k) salary deferral limit. There’s no advantage to building Mega Backdoor Roth dollars over Roth IRA or normal Roth 401(k) dollars, and executing the strategy is more complex. The Mega Backdoor Roth is part of Step 7 of the Financial Order of Operations for a reason. It is a maximization strategy and something to think about after your other financial ducks are in a row.

Even if you have the ability to use the Mega Backdoor Roth strategy and find yourself in Step 7 of the FOO, it still may not make sense for you. The average salary in the US is just over $60,000, which means if you max-out a Roth IRA, HSA, and 401(k), you would be contributing over half of your gross income into retirement accounts. That is a lot to ask for most Americans, to put it mildly, but also means it may not be necessary for most to maximize a 401(k), much less worry about advanced strategies like the Mega Backdoor Roth. If you have questions about how much you may need to invest for retirement, and what your retirement “number” is, check out our Know Your Number course.

The short answer to whether or not you should use the Mega Backdoor Roth strategy is “maybe.” If you aren’t sure, use the flowchart below to help you determine whether or not this strategy is right for you.

Can I do a Mega Backdoor Roth on my own?

So you’ve decided it makes sense for you to use the Mega Backdoor Roth strategy. Is this something you should attempt on your own or does it require the help of a professional? It is possible to attempt this strategy by yourself, but that doesn’t necessarily mean it is a great idea. The Mega Backdoor Roth is a complex strategy and, like the “normal” Backdoor Roth, there is a potential for unexpected tax consequences if something is not done correctly. Common pitfalls include not making sure your employer plan is set up correctly, not rolling your rollover balance quickly, or not knowing documentation requirements. If you have any doubts about your ability to effectively implement this strategy, or would feel better getting the help of a professional who has done it many times before, it may be worth reaching out to an experienced tax professional and/or a fee-only financial advisor.

For retirement savers that have already maximized their Roth IRA, HSA, 401(k), and other tax-advantaged retirement vehicles, the Mega Backdoor Roth strategy offers an incredible avenue to build even more tax-free dollars for retirement. However, this is a strategy that is best suited for high-income earners and Financial Mutants. Most Americans will never need to think about using the Mega Backdoor Roth strategy, and that’s fine! It is complex and not for the faint of heart, but the rewards can be tremendous.

Have questions about Roth IRAs and how Backdoor Roths work? Check out our Roth IRA Guide.

Can I make a backdoor Roth IRA contribution?

How do you know if you can or even need to make a backdoor Roth contribution? The first step is knowing the Roth income phaseouts. For 2023, they are $138,000 to $153,000 for single tax filers and $218,000 to $228,000 for married couples filing jointly. If you know you are going to be below the income limits next year, that’s great! You can just contribute to a Roth IRA normally and don’t need to worry about backdoor Roth contributions.

If you aren’t sure whether or not income limits will affect your ability to max out your Roth IRA, you have a few different options. The first, and what many people in this situation do, is wait to contribute until they are sure they will be under the limit (you have until April 15th of the following year to max out your Roth IRA). But you don’t need to wait; if you are able to use the backdoor Roth strategy, you can max out earlier in the year, regardless of whether you end up below or above the income phaseout.

If you know you will be above the income limit to contribute, you will need to use the backdoor Roth conversion strategy to build Roth IRA dollars. If you have pre-tax IRAs, SEP IRAs, or SIMPLE IRAs, this strategy may not work for you. This is due to the pro-rata rule, which could cause a portion of your pre-tax IRA assets to become taxable when converting assets to a Roth IRA.

If you have pre-tax IRA assets but still want to build Roth IRA dollars, it could be worth considering rolling pre-tax IRA dollars into an employer-sponsored plan, such as a 401(k). 401(k) assets are not factored into pro-rata calculations, so this would allow you to proceed with the Roth conversion. However, make sure you know the pros and cons of both holding those pre-tax dollars in an IRA and moving them to your employer plan before you consider rolling any assets over. Employer-sponsored plans have some ERISA protections that IRAs do not, but investment options may be more limited and expensive.

How do I do it?

To recap, if you are considering making a backdoor Roth contribution, you:

• Are above the income phaseout or might be above the income phaseout.
• Have no pre-tax IRA assets that would cause you to fall victim to the pro-rata rule.

There are no income limits on non-deductible IRA contributions, which is what makes the backdoor Roth possible. If you know you can make a backdoor Roth contribution, all you need to do is 1) Make a non-deductible IRA contribution, then 2) Convert those dollars to a Roth IRA. That’s it! There are several pitfalls to watch out for, though. Be careful investing non-deductible contributions, since non-deductible IRA earnings are taxable. Any growth that occurs before you convert the assets to a Roth IRA will be taxed. You will also want to be careful of transaction and account fees. Custodians may charge an account closing fee if you are not careful with the funding and conversion from the traditional IRA.

The transaction may confuse both your tax preparer and the IRS as they process your tax return. A requirement of this planning strategy is completing Form 8606, “Nondeductible IRAs,” with your annual federal tax return. It is not uncommon for tax preparers to complete the form inaccurately, which can lead to an unnecessary overpayment of taxes (erroneously reporting the conversion as income) and potential tax notices from the IRS.

What if I can’t do it?

If you are over the income limit and have pre-tax IRA assets that aren’t going anywhere, the backdoor Roth conversion strategy may not work for you. Even if you can’t build Roth IRA dollars, you can still build tax-free retirement dollars. There’s no income limit for making Roth 401(k) contributions or HSA contributions. If your employer offers a Roth option in your employer-sponsored plan, you can build more Roth dollars (up to $22,500 in a 401(k) in 2023, not including the catch-up for those 50+, and even more if your employer plan allows for mega backdoor Roth conversions).

HSAs don’t have an income limit, although you do need to be enrolled in a high-deductible health plan (HDHP) in order to make contributions. You may be able to make contributions through an employer plan, if they have one, or you may need to open your own HSA. Contributing through an employer plan is preferable since you will receive an additional FICA tax break on contributions. For 2023, HSA contribution limits are $3,850 for individuals and $7,750 for families (and a $1,000 additional catch-up contribution for those 55 and older).

I need some help!

Not everyone is confident in their ability to execute more advanced financial strategies on their own, and that’s okay! Backdoor Roth conversions can have unintended tax consequences if something goes wrong, so enlisting the services of a professional may give you additional peace of mind. Helping with backdoor Roth contributions is just one of the many things a fee-only financial advisor can do for you. Feel free to learn more about our advisory services or submit a “Work With Us” form if you are interested in taking the relationship to the next level.

You’re not going to believe we’re giving away this advice for free! We’re so excited to share these untold secrets and help you take your finances to the next level.

WARNING: These ideas are advanced. While they may be exactly what you need to achieve financial abundance, each step involves complex rules and the IRS. You may not want to try these without a professional.

If these strategies sound like your next step, let us guide you to success! It may be time to take our relationship to the next level as part of the Abound Wealth family.

Here’s what you’ll learn in today’s episode:

Advanced Charitable Giving

• How to use Charitable Gift Funds like a pro
• How to give a larger gift to charity and get a larger tax deduction
• What a “QCD” is and why every non-profit, church, and person over 70 needs to know about it

HSA Fund and Hold

• 3 Ways to Use an HSA (and how most people miss best one)
• The powerful HSA strategy only 4% of people are taking advantage of
• What happens to your HSA if you pass away

Roth Conversions

• How to get the tax advantage of a Roth IRA in spite of the income limit
• The one “catch” to Roth Conversions
• A flow chart that lets you know if Roth Conversions are right for you

Mega Roth Conversions

• How to contribute $50,000 a year to a Roth IRA (We know it sounds crazy!)

Resources and Research Cited in this Episode

• IRS Bulletin (Covering HSA rules)
• Health Savings Account Balances, Contributions, Distributions, and Other Vital Statistics, 2017: Statistics From the EBRI HSA Database

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