You may have heard of a film called the Meg – about an enormous shark in the ocean. Or maybe you’ve heard of Megatron – the transformer that is gigantic. Everyone knows of the Megamillions lottery! Mega is Greek for large but doesn’t come close to explaining how absolutely, undeniably, incredibly massive, monumental and colossal this concept could be for you! Mega Backdoor Roths could be the investment strategy that changes your life.
What is a Mega Backdoor Roth?
Individual Retirement Accounts (IRA) are one of the most popular tools to build a retirement fund. Traditional IRAs contribute pre-taxed dollars, your money grows tax-deferred, and then you are taxed when you withdraw it after retiring. Roth IRAs contribute after-taxed dollars so you are not taxed when you withdraw it after retiring. But what happens when your income level places a restriction on your use of a Roth IRA?
Thunderously entering the equation comes the Mega Backdoor Roth.
Each year the IRS adjusts eligibility for contribution based on inflation. So all the high-income earners are ineligible to participate in the usual way. Thankfully, the Mega Backdoor Roth gives you a way into both a Roth IRA and a Roth 401 (k). In the 2024 tax year, individuals that earn $161,000 or more, or married-filing-jointly taxpayers earning $240,000 or more, can’t contribute directly into a Roth IRA. Mega Backdoor Roth becomes a useful strategy to potentially accumulate an extra $46,000 in an indirect process.
How Does a Mega Backdoor Roth Work?
How does the Mega Backdoor Roth work? Simply, it takes two steps. First, you make the pre-taxed contribution to your 401(k). Second, you do a conversion to a Roth IRA. The trick here is there are no limits on income or conversions. There is a risk of a tax bill to be aware of when using pretax money (investment earnings or deducted contributions) – so be sure to understand all the tax implications and consequences as well as specific features of your retirement plan before employing this strategy.
Here is the math for the aforementioned $46,000 potential stockpile. The most any saver can contribute to their pre-tax 401 (k) is $23,000 if you are under the age of 50. If you are over the age of 50 you can contribute up to $30,500. Any saver can put an additional $46,000 of after-tax contribution that is not employer matched. Your total contribution can be $69,000 or $76,500 if you are over 50 years old. If your employer matches half your contribution ($11,500) then the maximum you can contribute is $34,500. Keep in mind that when you make a withdrawal during retirement, any earnings will be taxed at ordinary rates.
Now you’re ready to roll into a Mega Backdoor Roth. Converting your 401 (k) into either Roth IRA or Roth 401 (k) will have taxes taken from earnings – essentially being double taxed – but still allowing you to use the Roth. There are some moving parts and your employer can offer in-service distributions which allows you to move money around while you’re working at that company. There are even occasionally options of auto-conversion which is a mega offer all by itself. If they don’t allow this, you’ll have to delay the Mega Backdoor Roth until after you leave your job.
Is a Mega Backdoor Roth For You?
There are some things to keep in mind when deciding whether or not to use the Mega Backdoor Roth strategy. You’ll need to consider your current tax rate against your potential tax rate when you retire. You’ll also need to take into account how the conversion itself will impact your taxes that year. Once you’ve worked out any potential obstacles, the goal is to get as much money into a Roth as soon as possible to get as much tax-free growth as soon as possible and start dreaming about your future. A Mega Backdoor Roth is an amazing way to save for retirement after you’ve maxed out your 401 (k) and are making more than can be put directly into a Roth.
