The MEGA Backdoor Roth: How to Save An Extra $43,500 Each Year

Roth IRAs are a favorite among retirement savers who want predictable retirement income. While contributions to a Roth IRA are made after tax, withdrawals are completely tax-free, regardless of how much investment profit has been made in the account.

For 2023, individuals can contribute as much as $6,500 to a Roth IRA, or as much as $7,500 if the account holder is 50 years old or older.

There are some potential drawbacks. If you earn too much money, you might not be able to contribute to a Roth IRA at all. And even if you can contribute, is $6,500 in retirement savings per year going to be enough? For many Americans, the answer is no.

Fortunately, there is a strategy called the backdoor Roth IRA that allows high-income individuals to contribute. And for people who need to save more than the IRS allows in an IRA, you might be interested in the mega backdoor Roth strategy. If it’s available to you, it could be an incredible tool you can use to build a massive retirement nest egg.

Roth IRA income limits

First, some background information. Roth IRAs are intended to give low- to moderate-income Americans a way to create tax-free retirement income. So, unfortunately for higher earners, Roth IRAs are income restricted.

For 2023, taxpayers who file as single must have income of less than $153,000 and for married couples filing jointly, the income threshold is $228,000.¹ So if you earn more than those levels, you cannot contribute to a Roth IRA, directly.

Do you earn too much? Not to worry

Notice the use of the word directly at the end of the last sentence. The good news for high earners is that there is a way to contribute money to a Roth IRA indirectly, which is informally known as the backdoor method, or a backdoor Roth IRA.

In a nutshell, a backdoor Roth IRA takes advantage of two important facts:

• While the ability to take a tax deduction for traditional IRA contributions is income-restricted for everyone who has an employer-sponsored retirement plan (and even individuals whose spouses do), anybody with earned income can contribute to a traditional IRA, regardless of how high their income is.
• Under the current law, a traditional IRA can be converted into a Roth IRA, regardless of the account owner’s income.

So, a backdoor Roth IRA involves contributing money to a traditional IRA and rolling the money into a Roth IRA. If you do this soon after contributing and don’t have any pre-tax traditional IRA funds, it can even have no adverse tax implications.

Here’s how it might work. Let’s say that you earn $300,000 per year and file a single tax return. You contribute $6,500 to a traditional IRA. You leave the money uninvested and just a few days later, you notify your broker that you want to roll the money into a Roth IRA, and directly transfer the funds into a new or existing Roth IRA.

It’s also worth noting that under current tax law, you can convert any amount from a traditional IRA to a Roth IRA, which is also technically a form of the backdoor Roth IRA. However, keep in mind that doing so will likely trigger a taxable event. For example, if you have $50,000 in pre-tax money in a traditional IRA and decide to convert the account to a Roth IRA, you will have an additional $50,000 in taxable income this year. For this reason, many people who want to convert an existing traditional IRA to a Roth do so a little bit at a time or in a year when their income drops to avoid a massive amount of taxable income in any given year.

The mega backdoor Roth IRA contribution limits

Let’s be honest. Setting aside $6,500 per year in a Roth IRA, even if you do so every year, may not be enough to build up a retirement nest egg all by itself.

The mega backdoor Roth IRA strategy takes things to the next level.

Let’s start with the issue of the annual IRA contribution limit. If you have a 401(k) or similar retirement plan at work, you might already know that the contribution limit to these types of accounts is much larger than the IRA limit. In fact, in 2023, participants under 50 can choose to defer as much as $22,500 of their compensation to their qualified retirement plan. Including all contribution sources, such as employer matching contributions, the total contribution limit is $66,000. And, if you are 50 or older, add $7,500 in catch-up contribution allowance to these figures.

For IRS purposes, the money that you choose to contribute from your paychecks to your 401(k) plan is considered a pre-tax contribution. Many plans also have Roth 401(k) options, and if offered, you can choose to have some of the $22,500 elective deferral limit placed into a Roth-style account.

However, consider the difference between the $22,500 elective deferral limit and $66,000 aggregate limit is $43,500. And most employer matching contributions don’t come anywhere close to $43,500.

One thing many 401(k) participants don’t realize is that they may be able to contribute beyond the $22,500 annual contribution limit in the form of after-tax contributions. Think of this as a similar concept to non-deductible traditional IRA contributions. You can still put money in the account and invest it on a tax-deferred basis, but you can’t deduct your contributions from your taxable income in the year they’re made. With many 401(k) and other retirement plans, participants can choose to make after-tax contributions all the way up to the aggregate limit.

Consider this simplified example. Let’s say that you are 45 years old and earn $200,000 per year. You max out your 401(k) in 2023 by contributing $22,500 out of your paychecks on a pre-tax basis. Your employer matches up to 5% of your salary, so they contribute another $10,000. Since the aggregate limit is $66,000, you can choose to make after-tax contributions of as much as $33,500. And what if there’s a way to take that after-tax $33,500 contribution and allow it to potentially grow tax-free forever?

Enter the mega backdoor Roth.

What is a mega backdoor Roth?

A mega backdoor IRA involves making after-tax contributions to your 401(k), and then converting the after-tax contributions to a Roth 401(k) – also known as an in-plan conversion. Some plans even allow participants to roll after-tax contributions into a Roth IRA.

Like with a traditional to Roth IRA conversion, you’ll have to pay taxes on any investment earnings included in the conversion (but not on the after-tax contributions you convert). In practice, this should be a rather minimal tax burden if you perform the conversion relatively soon after making the after-tax contributions.

Not all plans allow mega backdoor Roth strategies

One major caveat is that in order for a mega backdoor Roth strategy to be possible, your plan must have two specific features:

• The plan must allow after-tax contributions, as described earlier. While the IRS certainly allows this, up to the aggregate contribution limit, not all individual 401(k) plans do.
• The plan must have a Roth 401(k) option that allows for in-plan Roth conversions, and/or must allow withdrawals of your after-tax contributions while you are still employed (so you can roll them into a Roth IRA).

Next steps

The good news is that nearly 90% of 401(k) plans offer a Roth option for employees.²

On the other hand, just over 20% of 401(k) plans offer the ability to make after-tax contributions, so this is likely to be the most limiting factor.³ 

So, if you’re interested in the mega backdoor Roth strategy, the best course of action would be to contact your plan’s administrator to find out what is and is not allowed.