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A Roth IRA is a great way for savers and investors to grow wealth. The advantages include tax-free growth on money withdrawn after age 59 ½, assuming the account has been open for at least five years.
But high earners often can’t contribute to a Roth IRA. If your modified adjusted gross income (MAGI) is more than $153,000 in tax year 2023 ($228,000 if married, filing jointly), you can’t contribute to a Roth IRA at all.
This situation gave rise to the backdoor Roth and the mega backdoor Roth. They sound similar, but there are many differences between the two strategies. If you’re a high earner, one of them might be worth pursuing.
What is a backdoor Roth IRA?
A backdoor Roth IRA is fairly straightforward. If you make too much to contribute to a Roth IRA, you contribute to a traditional IRA instead. While you can only contribute up to $6,500 to an IRA in 2023 ($7,500 for those 50 and over), there is no specific conversion limit.
Suppose you’ve been contributing to a traditional IRA for years. You could theoretically convert several years of contribution at once, moving them from traditional to Roth. However, if you have pre-tax money in your traditional IRA, you may not be able to move it into a Roth account. This is due to the IRS’s pro-rata rule. And even if this doesn’t apply, the conversion could be taxable.
What is a mega backdoor Roth?
The backdoor Roth is a good way to grow wealth without paying taxes on earnings, but the pro-rata rule makes it infeasible for some. In that case, the mega backdoor Roth might be a viable alternative.
The mega backdoor Roth works a little differently. With this strategy, you usually contribute the maximum amount to a 401(k), which is $22,500 in 2023 ($30,000 for those 50 and over). Then, you contribute an additional $43,500 in after-tax dollars to your 401(k), assuming no employer match. Finally, you convert the money to a mega backdoor Roth, which can be either a Roth IRA or Roth 401(k), if your plan allows.
The reason for the $43,500 limit is this plus either $22,500 or $30,000 puts you at the maximum total contribution for the year. You must deduct that from the $43,500 if your employer offers matching contributions.
To pursue this strategy, your employer’s plan must allow after-tax contributions to their 401(k). It must also allow either in-service distributions or let you move money from an after-tax part of your plan to the Roth 401(k) part of your plan.
While this strategy is more complex than the backdoor Roth, it can be worth it for those who earn a lot — and whose employers’ plans have the characteristics necessary to enable the mega backdoor Roth.
Mega backdoor Roth vs backdoor Roth IRA
Both strategies can give your savings a boost, but each has pros and cons:
Backdoor Roth pros
- Get around income limits: A backdoor Roth allows you to contribute to a Roth IRA, even if your income would normally preclude you from doing so.
- Tax benefits: Money in a Roth IRA can be withdrawn tax-free in retirement, assuming the account has been open for five years.
- No required minimum distributions (RMDs): There are no RMDs for Roth IRAs, so you can withdraw the money whenever you want.
Backdoor Roth cons
- Tax consequences: There could be state, local or federal taxes that apply to backdoor Roth conversions.
- Higher income brackets: Because backdoor Roth conversions mean moving money from a pre-tax bucket to an after-tax bucket, it could move you into a higher income tax bracket.
- Five-year rule: Money must generally sit in a Roth IRA for at least five years before you can withdraw it penalty- and tax-free.
Mega backdoor Roth pros
- Larger contributions: This strategy lets you contribute much more than normal into a Roth IRA (up to $43,500 in 2023).
- Tax-free growth and withdrawals: Once the money is in the Roth account, it can be withdrawn tax-free in retirement.
- Minimizes taxes: If you roll funds into a Roth plan soon after the contribution, you can minimize the taxes you would otherwise pay on gains.
Mega backdoor Roth cons
- Limited availability: To access this strategy, your employer’s plan must allow after-tax contributions to a 401(k), plus either in-service distributions or conversions.
- Tax implications: You may still owe taxes on the money you convert from a traditional 401(k) to a Roth account.
- Five-year rule: Much like the backdoor Roth, money generally must sit in a Roth account for at least five years before you can withdraw it penalty- and tax-free.
Bottom line
The backdoor Roth and the mega backdoor Roth are both viable strategies for getting around the typical income limits of a Roth IRA. The backdoor Roth IRA is best for converting money from a traditional account to a Roth. Meanwhile, the mega backdoor Roth is most suitable for high earners who want to contribute more than the typical contribution limit. Consider working with a financial advisor before committing to one or the other.
FAQs
A Mega Backdoor Roth is an enhanced version of the traditional Backdoor Roth IRA. The Mega Backdoor Roth involves converting additional after-tax contributions made to a 401(k) to either a Roth 401(k) within your 401(k) account or to your Roth IRA.
What are the disadvantages of mega backdoor Roth? ›
Mega backdoor Roth cons
Tax implications: You may still owe taxes on the money you convert from a traditional 401(k) to a Roth account. Five-year rule: Much like the backdoor Roth, money generally must sit in a Roth account for at least five years before you can withdraw it penalty- and tax-free.
Is the backdoor Roth going away in 2024? ›
Yes. Backdoor Roth IRAs are still allowed in 2024. However, there has been talk of eliminating the backdoor Roth in recent years. And the future is, of course, difficult to predict.
Is Mega Backdoor Roth going away? ›
Is the mega backdoor Roth going away? Right now, the mega backdoor Roth is not going away as long as your employer plan allows it. That's good news! But it's not permanent news – there could be legislation on the way that eliminates the option to make after-tax contributions.
What is the downside of backdoor Roth? ›
Cons: All or part of a backdoor Roth IRA conversion could be a taxable event. You may have to pay federal, state, and local taxes on converted earnings and deductible contributions. Conversions could kick you into a higher tax bracket for the year.
Is Mega Backdoor Roth better than Backdoor Roth? ›
A mega backdoor Roth takes a backdoor Roth to the next level and is specifically for people with a 401(k) plan at work. They can put up to $46,000 of post-tax dollars in 2024 into their 401(k) plan and then roll it into a mega backdoor Roth, which is either a Roth IRA or Roth 401(k).
What is the 5 year rule for Mega Backdoor Roth? ›
The 5-year rule applies to being able to withdraw earnings from a Roth account tax-free and penalty-free after age 59.5. For Roth Solo 401k accounts, the 5-year clock starts separately for each 401k plan, including when rolling over from a previous employer's Roth 401k to a new Roth Solo 401k.
Will backdoor Roth be banned? ›
No, the backdoor Roth is not considered illegal. The IRS does not classify the backdoor Roth as a form of tax evasion but could best be described as a form of tax avoidance. If you have any misgivings about this financial maneuver in a specific situation, you can consult a more experienced tax professional.
When to avoid a backdoor Roth IRA? ›
A backdoor Roth IRA can be a worthwhile investment strategy, especially for high-income earners who exceed the income limits for contributing directly to a Roth IRA. It may not be a promising idea if: Your federal income tax bracket is 32% or higher. You need to withdraw money in five years or less.
Do you get taxed twice on Backdoor Roth? ›
To be clear, no converted funds would get double-taxed, but some circ*mstances can result in a taxable transaction. That's where the rules get more complicated. (And that's why it's a good idea to consult with a financial advisor when deciding whether a backdoor Roth makes sense for you.)
Is the backdoor Roth allowed in 2024? Yes, even though the Build Back Better Act in 2004 was drawn up to end backdoor Roth IRAs by 2020, this financial strategy remains in place for now. It is unknown, however, whether any future legislation will remove the backdoor Roth.
What is a super backdoor Roth? ›
A mega backdoor Roth refers to a strategy that can potentially allow some people who would be ineligible to contribute to a Roth account, based on their income or contribution limits, to transfer certain types of 401(k) contributions into a Roth—including a Roth IRA and/or Roth 401(k).
What are the new Roth rules for 2024? ›
The Roth IRA contribution limit for 2024 is $7,000 for those under 50, and an additional $1,000 catch up contribution for those 50 and older. Source: "401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000," Internal Revenue Service, November 1, 2023.
How does the rich man's Roth work? ›
Despite the nickname, the “Rich Person's Roth” isn't a retirement account at all. Instead, it's a cash value life insurance policy that offers tax-free earnings on investments as well as tax-free withdrawals.
Do I need to report backdoor Roth on taxes? ›
Backdoor Roth IRAs can be great for doctors and other high-income earners planning for retirement. However, they can be tricky. Therefore, it is essential to report them properly on your tax return to avoid unnecessary taxes. Be sure to consult your CPA if you have specific questions regarding your situation.
Can you undo a backdoor Roth? ›
No do-overs: Once your conversion's complete, it can't be reversed. Tax bill: The amount you convert is taxable in the year you convert. So you need to plan for taxes. Selling investments: Most traditional IRA investments can convert to a Roth IRA without being sold.
Is mega backdoor Roth taxed twice? ›
Say you are over the income limit for Roth contributions, so you make a traditional contribution with no tax deduction and then do a backdoor Roth. Is that conversion taxable? If so, you would be paying tax on that money twice since you paid tax on that income already.
How do I take advantage of mega backdoor Roth? ›
Put very simply, the mega backdoor Roth strategy entails 2 steps: (1) making after-tax contributions to your 401(k) or other workplace retirement plan, and (2) then doing a conversion either to a Roth IRA or Roth 401(k). (Note that not all plans allow these steps; more details on that below.)
What are the limits on mega backdoor Roth? ›
Mega backdoor Roth IRA contribution limit
For 2024, total 401(k) contributions (pre-tax, after-tax, employer matching contributions, and any other non-elective employer contributions) are capped at $69,000, up from $66,000 for 2023. If you're 50 or older, the limit is $76,500, up from $73,500 in 2023.
