A Mega Backdoor Roth is a strategy to put away as much Roth money as you can in one given year. If you’re age 50 or older, this could exceed over $70,000!
Regrettably, it’s not as simple as making one call to your financial advisor or your HR Department, it will require some strategy and planning with your tax professional at the table.
Moreover, your age, income, employment, and marital status, as well as your self-employment income will all factor into the masterful equation that will blow your mind! (O.k…that was a little much, but we geeks think the “Mega Backdoor Roth” is pretty cool.)
What exactly is the “Mega Roth”?
There are several definitions floating around regarding this topic or strategy, and some may even say a lot of confusion. Without getting into the “weeds” and trying to explain what other people are saying, here is my simple definition:
A Mega Backdoor Roth is a combination of using multiple Roth structures and strategies (401ks, IRAs, conversions, non-deductible contributions, and after-tax contributions) to defer as much as possible in Roth money in a given year. Essentially, it’s not (1) one Mega Backdoor Roth, but a bundle of Roths to get the maximum value. Combining this package of Roth money with the strategy of ‘self-directing’ into real estate, precious metals, crypto, small business, etc… the results can be incredible!
When does it make sense to use the Mega Backdoor Roth?
Admittedly, I realize I’m a little opinionated on this topic and know some financial or tax advisors won’t agree with my approach to the Mega Backdoor Roth. However, I like to see my clients take a holistic approach to their wealth building, tax planning, and asset protection, thus I suggest they check off several items on their “strategy checklist” before they embark on the Mega Backdoor Roth.
Have you already completed or considered all of the following this year?
- Participated in your 401k at your day job up to the ‘matching amount’ (if applicable)
- Funded your:
- Roth or Backdoor Roth IRA up to $6,000 or $7,000?
- Health Savings Account – HSA (individual or family) $3,600 or $7,200?
- Spouse’s Roth or Backdoor Roth IRA (if applicable)?
- Children’s Roth IRAs (if applicable)?
- Parents Roth IRA (if applicable)?
- Kid’s Education Savings Accounts – ESA up to $2,000 per child (if applicable)?
- Purchased a rental property interest (not in a REIT or PPM)
Don’t get me wrong, the Mega Backdoor Roth is amazing, but I would suggest you don’t even think about it unless you’ve seriously considered the other strategies above AND have an extra 50k+ to set aside for savings without the need for a current tax deduction.
Steps to Fund this Mega Backdoor Roth
First, keep in mind the true Mega Backdoor Roth is actually a combination of both a 401k AND an individual Roth IRA. In fact, you may end up using two (2) 401ks if you have a side-hustle and a day job.
Next, the number will actually vary depending on your age and possible matching with a day job, solo-401k, or even a safe-harbor 401k in your own small business.
Finally, you must be enrolled in an employer-sponsored traditional 401(k) plan that permits after-tax contributions and in-service withdrawals. But if you have your own small business, you will be able to adopt the provisions you want in your 401k and won’t be dependent on an ‘employer’.
Step 1. Make a regular backdoor Roth IRA conversion
Depending on your age, you can make a contribution of either $6,000 or $7,000 into an individual Roth. Even if you make too much for a Roth IRA, you can make a non-deductible contribution to a traditional IRA that you then convert to a Roth. (*Make sure you do not have other pre-tax dollars in any kind of IRA, or SEP before going down this path. Those funds need to be converted first).
Step 2. Contribute to a Roth 401(k)
Next, in order to build that “Mega Backdoor Roth”, max out your annual contributions to your Roth 401k. Depending on your age this will either be a maximum of $19,500 or $26,000. (*Again, keep in mind a wise matching strategy and using your own Solo 401k if you have self-employment income).
Step 3. Make an After-Tax Employee Contribution
This is where things get a little dicey and this step in the strategy depends on your employer’s 401k plan. In 2021, an individual and employer can contribute up to $58,000 into the employee’s 401k account, thus the ‘math’ involves subtracting what ‘you’ the employee contributed, and any match, from the $58,000, and this determines the amount of ‘after-tax’ contribution.
EXAMPLE. Your 401(k) employee contribution limit in 2021 is $19,500, or $26,000 if you’re 50 or older. Next, an employer can contribute enough to bring your total contribution to $58,000, or $64,500 if you are 50 or older. Assuming your employer doesn’t make any contributions, the maximum you can contribute in after-tax contributions is $38,500 (or $45,000 for people 50 or older) in 2021.
Step 4. Use the In-Service Withdrawal Provision
The in-service withdrawal provision is a necessary part of the Mega Backdoor Roth process. An employee/you makes the after-tax contribution, then immediately takes an in-service withdrawal before the contributions generate returns that would be taxable during a rollover to a Roth. The “withdrawal” is essentially transferred to a Roth IRA as a ‘conversion’. No tax is due, but of course, you didn’t receive a deduction either with the contribution in the first place.
In sum, if you’ve checked everything else off your list, have the extra income, and a 401(k) plan that makes a Mega Backdoor Roth viable, you’re in a great position to save big-time for retirement and enjoy the luxury the benefits of tax-free Roth distributions and avoiding required minimum distributions (RMDs).
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the PodCasts “The Main Street Business Podcast” and “The Directed IRA Podcast”, and the author of “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”, as well as several other well-known books. He is also the CFO of Directed IRA Trust Company, and a senior partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP, and the accounting firm K&E CPAs, LLP.