Mega Backdoor Roths: How They Work

If you like the idea of a Roth, then you’re going to love the supersize version, known as a mega backdoor Roth.

If fortune smiles on you, this strategy could allow you to stash an extra $43,500 into a Roth IRA or Roth 401(k) in 2023, then roll it into a mega backdoor Roth. But that “if” is big. You could even call it mega.

First, some background and a caveat

• Roth and traditional IRAs: With Roth IRAs, you put in money after paying income tax on it, and then those dollars grow tax-free. But income rules restrict who can contribute to a Roth, and there’s a maximum IRA contribution limit of $6,500 in 2023 ($7,500 if age 50 and older). A traditional IRA gives you an immediate tax break on your contribution, your money grows tax-deferred and you pay income tax when you pull out your money in retirement.

» Everything you need to know about Roth and traditional IRAs

• Backdoor Roth: A strategy for people whose income is too high to be eligible for regular Roth IRA contributions. You simply roll money from a traditional IRA to a Roth. There are no income or contribution limits — that is, anyone can convert any amount of money from a traditional to a Roth IRA. But you risk a hefty tax bill on the rollover if you have pretax money — either contributions you’ve deducted or investment earnings — sitting in any traditional IRAs, thanks to the IRS’ pro-rata rule.

» Read more about that rule in our backdoor Roth IRA guide.

• Mega backdoor Roth: This takes it to the next level, as we describe below. It’s for people who have a 401(k) plan at work; they can put up to $43,500 of post-tax dollars in 2023 into their 401(k) plan and then roll it into a mega backdoor Roth, which is either a Roth IRA or Roth 401(k). The caveat: Creating a mega backdoor Roth is complicated, with many moving parts and the potential to get hit with unexpected tax bills, so consult with a financial planner or tax pro before trying this at home.

» Are you on track for retirement? Run your numbers through our retirement calculator to see.

How a mega backdoor Roth works

The mega backdoor Roth allows you to save a maximum of $66,000 in your 401(k) in 2023. How does this add up? The regular 401(k) contribution for 2023 is $22,500 ($30,000 for those 50 and older). You can put an additional $43,500 of after-tax dollars into your 401(k) account, assuming you don't get an employer match.

If you do get an employer match, you'll need to deduct your employer contributions from the $43,500. Here's is where it gets good – the mega backdoor Roth enables you to take the after-tax dollars you contribute and roll them into a Roth IRA. If you have a Roth 401(k) at work (and the plan allows for the mega option as described below), generally you can choose whether the final destination of your mega contributions is the Roth 401(k) or a Roth IRA. If your employer offers only a traditional 401(k), then your mega contributions would end up in a Roth IRA.

Here’s a quick summary of what you need to have in place for the ideal mega backdoor Roth strategy:

• A 401(k) plan that allows “after-tax contributions." After-tax contributions are a separate bucket of money from your traditional 401(k) and Roth 401(k) contributions. The dollars you put into an after-tax bucket are post-tax, so you've already paid taxes on them.

• In-service distributions. Your employer has to offer either in-service distributions to a Roth IRA — that is, you can take money out of the 401(k) plan while you’re still working at the company — or lets you move money from the after-tax portion of your plan into the Roth 401(k) part of the plan. If you’re not sure, ask your human resources department or plan administrator.

• Spare cash. You’ve got money left over to save, even after maxing out your regular 401(k) and Roth IRA contributions.

Here’s more detail on each of those bullet points:

Your 401(k) plan allows after-tax contributions

This is pretty straightforward: Either your employer plan allows after-tax contributions or it doesn’t.

If it does, here’s how to figure out the maximum amount you’re allowed to put into the after-tax portion of the plan:

• If your 401(k) plan allows for after-tax contributions, the maximum that you and your employer combined can put into your 401(k) is $66,000, or $73,500 for individuals 50 and older in 2023. For example, let's say you earn $200,000 annually and you contributed the pre-tax limit of $22,500 in 2023. Your employer also matched your contributions by 6% of your salary, adding $12,000 to your contributions. That brings your total pre-tax contributions for that year to $34,500. Because the total limit is $66,000, you can still contribute an additional $31,500 in after-tax dollars.

Your 401(k) lets you move your after-tax money

If your plan doesn’t allow in-service withdrawals to a Roth IRA or in-plan rollovers to a Roth 401(k), then your opportunity to do the mega backdoor Roth is delayed until you leave your job. If that’s the case, you might want to reconsider this strategy.

Ideally, executing the mega backdoor Roth means throwing all of your after-tax savings into your after-tax bucket (once you’ve maxed out your regular 401(k) contribution limit). Then, you’re almost immediately getting your money out of that bucket and into either a Roth IRA or Roth 401(k) before it starts accruing investment earnings. That’s because if you leave your after-tax contributions in the after-tax bucket, which is tax-deferred bucket, you’re going to eventually owe tax on those earnings. But once that money is in a Roth, it grows tax-free.

The point is to get as much money into the Roth as soon as possible to get as much tax-free growth as soon as possible. If your after-tax contributions accumulate investment earnings, the IRS has said it’s OK to split up that money, by rolling your after-tax contributions into a Roth IRA and the investment earnings into a traditional IRA. ^[0]

You’ve got money left over for savings

A mega backdoor Roth IRA is a sweet way to get a lot of money into a Roth IRA, but it’s really for folks who have a lot of money to put aside for savings. In general, it makes sense to first max out a regular or Roth 401(k) and a Roth IRA, if you’re eligible. Here’s why:

• With a regular 401(k), you get an upfront tax break — your taxable income is reduced in the year you make your contributions, and you defer taxes on your investment earnings until you make a withdrawal.

• If you opt for the Roth 401(k), you contribute money that you’ve already paid taxes on. Your tax break is delayed, but your money grows tax-free and you get tax-free income in retirement.

• If you’re below the income limits for a Roth IRA, it’s easier to simply contribute directly than to jump through all the hoops required for the mega backdoor Roth IRA. If you’re above the Roth IRA income limits, then a backdoor Roth — the non-mega kind — is also an option.

» Get started: Learn how to open a Roth IRA

If you’ve maxed out your 401(k) and a Roth IRA and you still have money to save this year, that’s when you’d consider a mega backdoor Roth.

Note: On rare occasions, a 401(k) plan may be forced to return your contribution to you. This generally happens only if you're among the highest paid workers at your company. That's because IRS nondiscrimination tests require that retirement plans don't offer a substantially bigger benefit to high-income employees than rank-and-file workers. If the highest paid workers are saving at a much higher rate than other workers, the plan may be forced to return some of that money.

Can’t do a mega backdoor Roth? That’s OK

If you’re unable to do a mega backdoor Roth, don’t lose any sleep over it. Seriously, no need for FOMO here. The mega backdoor strategy is just one of a handful of ways to enjoy the beauty of the Roth treatment, where your money earns investment returns that you’ll never owe taxes on.

• If you’re under the income limits, you can contribute directly to a Roth IRA.

• If you’re over the income limits, you can get in with a backdoor Roth.

• If your employer offers a Roth 401(k), you can contribute to that.

And don’t forget that if you’re saving and investing for retirement in any type of tax-advantaged account, you’re already ahead of the game. Kudos to you.