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A Roth IRA is one of the most popular retirement savings vehicles in America and for good reason. Unlike the traditional IRA or 401(k) plan, Roth vehicles are funded with after-tax dollars and investment growth is tax-free. When you put money into a traditional IRA, you’re taking a tax break now and agreeing to pay taxes later down the road in retirement. But with a Roth, you won’t owe any taxes on either your principal or investment gains when you take distributions in retirement.

Of course, Roth IRAs have income limits on who can participate. If you are a single filer with a Modified AGI of more than $140,000 or a joint filer with a Modified AGI of $208,000 in 2021, you aren’t eligible to make direct contributions to a Roth IRA. However, no matter your income, you are able to partially or fully convert other retirement accounts into a Roth IRA. This is known as a backdoor Roth IRA.

Roth IRAs can even go one step further. A mega backdoor Roth IRA is available to those who want to roll large amounts of their 401(k) into a Roth IRA. In fact, you can roll a significant sum of cash into a Roth IRA from your workplace 401(k) without paying taxes on it – but you need to follow rules and regulations precisely to avoid penalties and surprise tax bills.


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What is a Mega Backdoor Roth IRA Conversion?

In a normal backdoor Roth IRA conversion, a high income saver will take contributions made to a retirement account IRA and roll it over into a Roth IRA. These conversions are limited by the contributions limits to the pre-existing account. For example, if you contributed the maximum amount to your traditional IRA in 2019, 2020, and 2021 – $6,000 each year – then you would have $18,000 in principle available to convert (plus any earnings).

Moreover, a conversion from most retirement accounts to a Roth IRA will trigger a taxable event. Of course, rolling over funds from a traditional IRA or 401(k) to a Roth IRA means paying taxes now instead of later. If you roll $5,000 from your traditional IRA into a Roth IRA, you’ll owe taxes on that $5,000 sum and you can’t use retirement funds to meet your obligation because that triggers the 10% early withdrawal penalty.

A mega backdoor Roth IRA conversion allows high earners to utilize the extra space in their workplace 401(k) limit by converting after-tax contributions. A couple conditions must be present for this to be an option though – here’s what you’ll need to do.

How Does It Work?

A megadoor backdoor Roth IRA conversion takes advantage of the total contribution limit of the 401(k). Now, this isn’t the $19,500 limit on employee contributions. It’s the full limit of employee and employer contributions, which is $58,000 in 2021. Many people never meet this limit because their employers will only match a small percentage of their contributions. For example, if you max out your 401(k) and your employer chips in a 4% match on your contributions, you’ll still be far below the total annual limit at $27,300.

So how do you utilize the extra $30,700 in your annual 401(k) limit? You can execute a mega backdoor Roth IRA conversion. But here’s the key – your employer’s 401(k) program must allow after-tax contributions. Not all 401(k) plans allow contributions to be made this way, so you’ll need to check with your employer about your specific plan.

In our scenario above, we’ve got $30,700 to spare in total 401(k) contributions. To use a mega backdoor Roth, you would make an after-tax contribution of up to $30,700 to your workplace 401(k) and then use an in-service distribution to roll that amount into a Roth IRA. Unlike the usual backdoor Roth conversion, no taxes will be due on the rollover amount since the cash came from after-tax contributions to the 401(k).

Note that mega backdoor Roth IRA conversions are only available if you have a 401(k) at work that allows after-tax contributions. You don’t necessarily need to have in-service distributions (i.e. withdrawing money while you’re still employed by the plan provider), but without them, you’ll need to wait until you leave the job to utilize this strategy.

Who Can Benefit from a Mega Backdoor Roth?

The backdoor Roth IRA benefits high earners who can’t access a Roth IRA due to income restrictions. Likewise, a mega backdoor Roth IRA conversion benefits those single tax filers with a modified AGI over $140,000 or joint tax filers with a modified AGI over $208,000 who have contribution limits to spare in their workplace 401(k).

Let’s say you make $400,000 annually and want to accumulate capital in a Roth IRA as quickly as possible to avoid taxation. If you max out your 401(k) and your employer doesn’t make a contribution, you’ll have $38,500 left in total 401(k) contributions. As long as it’s permitted, you can make an after-tax contribution of $38,500 to your 401(k) and roll it over immediately into a Roth IRA. You can do this annually without needing to worry about taxes as long as you only roll over an amount equal to the after-tax contribution. If you roll over any investment gains from a traditional 401(k) to a Roth IRA, you’ll owe taxes on those gains.

Now let’s say in-service distributions are not permitted with your employer-sponsored plan. That’s okay! You can still use a mega backdoor Roth IRA when you leave your job. If you plan on taking a new career path and have money saved in a savings or taxable brokerage account, you can use those funds to make an after-tax contribution during your last year at your current employer and then roll that amount into a Roth IRA when you leave the job.

A mega backdoor Roth IRA conversion is a nice little trick for those lucky enough to have workplace 401(k)s that allow after-tax contributions. If you aren’t maxing out your retirement options, you won’t need to utilize this strategy though, just keep contributing until you hit the max. But if you’ve maxed out everything, make too much for a Roth IRA, and want to park a large lump sum in a Roth IRA (without paying taxes), a mega backdoor Roth IRA conversion could make a lot of sense.

Next Steps with Advanced Retirement Strategies

The long-term benefits of a Roth IRA can significantly improve your quality of life during retirement, stretching your savings to their full potential.

The team of retirement planners at Advanced Retirement Strategies in Bountiful, Utah has the expertise and qualifications to create mega backdoor Roth IRAs on behalf of clients – a maneuver that can create opportunities for a long and comfortable retirement.

The Certified Financial Planners® at Advanced Retirement Strategies, located in Davis County, Utah, specialize in helping diligent savers with $250,000 or more of investable assets (not counting your primary residence) prepare for and then transition into retirement.

We would love the opportunity to assist you. Just head to the get started page and set up a free 15-minute quick consult.

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