It’s almost always advantageous to max out your retirement accounts. Doing so in a Roth account allows your investment to grow tax-free. However, contribution limits restrict the total funds you can add to a Roth IRA every year.
Fortunately, there is an investing technique that, depending on your financial situation, may help you add an outrageous amount to your Roth IRA. In fact, if you qualify, a mega backdoor Roth IRA could add an additional $39,000 into your Roth IRA account, providing a serious boost to your retirement savings. Yes, you read that right: this isn’t just a friendly, neighborhood “backdoor Roth IRA” all your friends have told you about, this is a mega backdoor Roth IRA.
Read on to learn exactly why “mega” is the most appropriate term for this retirement account loophole.
What is a Roth IRA (or Roth 401k)?
A Roth IRA (or Roth 401k) is a special retirement account where all funds can grow tax-free. All contributions made to a Roth account are done with after-tax dollars, meaning, unlike a traditional IRA, the contributions are not tax-deductible. However, all after-tax contributions grow at a tax-free rate such that when the funds are withdrawn at the age of retirement, they are tax-free. However, there are certain income limits that make Roth IRAs not available to everyone.
Roth IRA vs. Traditional IRA
|Roth IRA||Traditional IRA|
|Contribution Limit (2024)||$7,000 if under 50-years old, $8,000 if age 50 or older||$7,000 if under 50-years old, $8,000 if age 50 or older|
|Income limits (2024)||$146,000 for single filers and $230,000 for those married and filing jointly||N/A|
|Contributions made with…||After-tax dollars||Pre-tax dollars|
|Taxes at the time of withdrawal||Tax-free withdrawals||Contributions are tax-deductible, but earnings are taxed at the time of withdrawal|
|Required Minimum Distributions (RMDs)||None||72 years old|
|Early withdrawals||Contributions can be withdrawn without penalties after 5 years; 10% penalty on early withdrawal on earnings||10% penalty on any early withdrawals|
What is a backdoor Roth IRA and a mega backdoor Roth IRA?
The income limits of a Roth IRA make it not an option for high-income earners who are phased out contributing to this type of retirement plan. However, high-income earners can still get the benefits of a Roth through what is known as a backdoor Roth IRA.
A standard backdoor Roth IRA allows you to rollover capital within a traditional IRA into a Roth IRA by paying taxes you would normally pay in a rollover. This is limited to $7,000 for the 2024 tax year. The standard backdoor Roth IRA method can be done along with maxing out your 401k plan from your employer, which is an additional $23,000 for 2024 (plus any matching funds your employer adds).
For big savers that want to save more than the IRA + 401k IRS maximum ($7,000 + $23,000) into their retirement, they can implement one neat trick!
Enter the mega Backdoor Roth IRA– this tax loophole is available to anyone who can open a traditional IRA, which does not restrict contributions based on income limits.
With a mega backdoor Roth IRA, you can convert up to $69,000 per year (in 2024) from your 401k into a Roth IRA or Roth SDIRA. The $69,000 limit comes from the IRS too, it is composed of the employee ($23,000) contribution limit plus the employer ($46,000) matching limit of a 401(k). Once you implement the mega backdoor Roth IRA strategy, your investment grows tax-free, and is withdrawable tax-free when you retire.
How to qualify
There are some important qualifiers to consider when attempting to use the mega backdoor Roth IRA. Without these qualifiers, you won’t be able to implement the mega backdoor strategy:
- Use of 401k – If your employer offers a 401k plan, you must use it. Alternatively, if you are self-employed you can use a solo 401k plan instead.
- Max out 401k contributions – Not only do you need to contribute to your 401k, you must max out your contributions first ($23,000 in 2024) before being able to take advantage of the mega backdoor Roth. If you don’t reach your 401k contribution limit, you can’t take advantage of the mega backdoor Roth.
- After-tax contributions – Your 401k plan must allow for after-tax contributions, which will be rolled over into a Roth IRA. If your employer’s plan doesn’t support after-tax contributions, you’re out of luck.
- In-service withdrawals – You must be able to withdraw funds from your 401k while still employed at your current position. If this isn’t an option, you will have to wait until you leave your current employer to use the mega backdoor strategy. (The withdrawal, which would be the entire $69,000, is rolled over into a Roth IRA.)
How it works
- Max out contributions to your 401k plan ($23,000 for 2024)
- Add after-tax contributions to your 401k up to the IRS $69,000 allowable limit (remember this total includes any matching funds from your employer)
- Immediately take an in-service withdrawal of your contributions
- Rollover the contributions to a Roth IRA or Roth SDIRA plan
- Keep any pre-tax contributions in your 401k account so as not to incur any penalties
- Alternatively, you can rollover the pre-tax contributions to the Roth IRA as well and pay taxes on it now, so your money can then grow tax-free
Remember, it’s important to complete the Roth rollover as soon as possible after making the after-tax contribution. This is because any returns on these funds will be taxed at the time of the conversion. If you do accrue earnings on your after-tax contributions, you will be forced to pay taxes on the earning at the time of the rollover.
The important part of the mega backdoor Roth strategy is being able to contribute after-tax dollars after you max out the employee limit of $23,000. The extra $46,000 is the limit set aside for the employer. While your employer will likely match some funds, they very likely will never reach this maximum (unless you have an awesome employer). This is why you have to contribute to it after-tax to reap the benefits of the full limit.
Let’s use a real-world example to show how this process works:
Imagine you max out your 401k contributions at $23,000 and your employer provides you with $5,000 in matching funds to your retirement account. This leaves you with $41,000 in capital that you can still contribute in after-tax dollars if desired:
$69,000 limit on 401k contributions – $23,000 employee contribution – $5,000 employer contribution = $41,000
With this in mind, you can now contribute an additional $41,000 in after-tax contributions to your 401k retirement account.
Once you have contributed up to the additional $41,000 after-tax limit, you can immediately take an in-service withdrawal and rollover your entire 401k contributions to a Roth IRA account where the funds grow tax-free into retirement.
Saving $69,000 into your retirement in a single year is impressive and certainly deserving of the name “mega.”
Because contributions may change from year to year, be sure to check with the IRS on the specific limits for the tax year. You can view 2023 contribution limits here and the full range of 2024 contribution limits here.
Why consider a mega backdoor?
As previously mentioned, Roth IRA contributions are limited to only $7,000 per year and have income-based limitations too. For the 2024 tax year, these limits are $146,000 for single filers and $230,000 for those married and filing jointly. So if you make more than this, you can’t contribute directly to a Roth IRA.
For those that earn more than these income limits, contributing to a Roth IRA in the traditional way is not possible. This is where the mega backdoor comes into play. With this technique, high-income earners can still achieve tax-free earnings in a Roth IRA. And even for those that are able to contribute to a Roth, there are still contribution limits that curtail how much capital can be added to a Roth IRA in any given year.
Additionally, those that want to invest in alternative assets like gold, silver, and other precious metals might want to consider using the mega backdoor investment structure. A mega backdoor helps to maximize the amount of capital that can be contributed to a tax-advantageous, Roth Self-Directed Individual Retirement Account (Roth SDIRA) which gives its owners more control over the assets within their retirement account.
If you’ve already completed a mega backdoor Roth IRA, a Birch Gold Group representative can walk you through how to rollover your Roth account into a Roth SDIRA to give you more precious metals investing options.