How Mega Backdoor Roth Conversions Work

The mega backdoor Roth is a complex strategy for getting around tax rules that preclude high-income earners from accessing the benefits of a Roth account. It’s called mega because it allows much higher contributions than common backdoor Roth IRA conversions. While the mega Roth backdoor is currently allowed, it could be eliminated under the Build Back Better bill.

What is a mega backdoor Roth?

A mega backdoor Roth conversion uses a loophole that allows high-income earners to roll over funds from traditional IRAs and retirement plans into a Roth account, either a Roth IRA or Roth 401(k). Once the money is in a Roth, distributions taken in retirement—including earnings on original contributions—are tax free. 

Knowing how to open the mega backdoor requires a firm grasp of Roth conversion rules and what makes the mega type distinctive from other backdoor methods. 

Basic Roth IRA rules

. Roth IRAs were originally intended to encourage middle-income earners to save for retirement. The following rules apply:

• Roth IRA savers can make annual after-tax contributions of up to $6,000 annually ($7,000 for individuals over 50). Only after-tax funds can be contributed to a Roth. 
• There are no required minimum distributions, and when money is withdrawn, there are no taxes due. Roth IRA funds can be passed on to a beneficiary after death, too. 
• High-income earners, however, face IRS income limits that bar access to a Roth IRA. The IRS defines high income as more than $144,000 a year for single filers and $214,000 for those filing jointly. 

The basic backdoor conversion strategy.

Thebackdoor to Roth IRAs cracked open in 2010, when the IRS lifted income restrictions on doing conversions between retirement accounts. The following changes were adopted:

• High-income earners were still barred from making contributions, but now they could make qualified non-deductible (after-tax) contributions to a traditional IRA, which they could immediately convert to a Roth IRA.  
• One could roll over any amount from other IRAs. However, pre-tax contributions and earnings would be subject to taxation upon conversion. The IRS uses a pro-rata formula to determine what portion is subject to taxation. Assets in 401(k) and 403(b) plans are exempt from this pro-rata rule. 

‍The mega backdoor uses a different key to get in—401(k) plans. Some 401(k) plans allow employees to add after-tax contributions. The individual can roll over those funds into a Roth IRA or Roth 401(k)—that’s a lot more money than can be contributed directly to an IRA. Keep in mind, not all 401(k) plans permit this.

How a mega backdoor Roth conversion works

The mega backdoor Roth 2022 conversion strategy typically uses a 401(k) plan as the starting point. But first, savers must verify if they even qualify to open the mega backdoor. Qualifications include:

• You have an employer 401(k) or Roth 401(k) plan

  . Or if self-employed, you have a Solo 401(k) plan.

• The 401(k) permits after-tax contributions

  . Not all 401(k) plans allow them. 

• The 401(k) permits in-service distributions of after-tax contributions

  . In-service means withdrawals are allowed while the saver is employed rather than retired. Not all plans permit this. 

How much can you convert in a mega backdoor Roth? 

The ultimate limit one can save in a workplace 401(k) for 2022 is $61,000 or $67,500 for over age 50. How much of that can be an after-tax contribution? This number varies based on an individual’s situation. Here’s how to determine it:

• Start with the elective deferral limit of $20,500 in 2022 ($27,000 including catch-up contributions for over age 50). 
• Then add any employer matches or nonelective contributions. 
• Subtract this from the $61,000 or $67,500 total limit. The balance is the amount an individual can contribute with after-tax dollars. 

The mega backdoor process

Let’s assume an individual already has a Roth IRA or Roth 401(k). They would then need to do the following steps: 

1. Max out the employee contribution amount to a qualified 401(k), 403(b), 457, or Solo 401(k) plan

   . The limit would be pretax contributions of $20,500 (or $27,000 for those over 50 years old).  

2. Make after-tax contributions to the retirement plan

   . There are limits on how much you can contribute, depending on what the 401(k) allows and whether the employer matches contributions. 

3. Request an immediate in-service withdrawal of the after-tax contribution

   . The 401(k) plan administrator would facilitate this. The IRS permits savers to split the withdrawal, sending only the after-tax contributions to the Roth IRA, while sending the investment earnings to a traditional IRA on a tax-deferred basis.  

4. Roll over the money into a Roth IRA or Roth 401(k)

   . Once the money is in a Roth, it can grow tax-free. 

Alternatives to mega backdoor Roth IRA

The mega backdoor Roth isn’t for everyone. Several conditions must be met to make it happen. If those conditions don’t apply, there are other Roth strategies to consider. 

• A high-income earner might qualify to go through the Roth front door and make direct after-tax contributions to a Roth IRA. 
• If the retirement plan forbids in-service withdrawals or in-plan rollovers, an individual might be able to use the mega backdoor after leaving their job. 
• A high earner who doesn’t have a retirement plan that allows after-tax contributions or in-service withdrawals, might consider a regular backdoor Roth IRA conversion instead. 
• If a saver’s employer offers a Roth 401(k), individuals can make direct contributions to that, up to the allowable limits. 

The bottom line

Mega Roth backdoor conversions are harder to navigate than regular backdoor IRA conversions from IRAs or other retirement accounts. If the individual investor is a high earner with a retirement plan that allows after-tax contributions and in-service withdrawals and has enough extra cash to supersize the contributions, then the mega Roth could be worth exploring.

FYI: Try Titan’s free Roth IRA Calculator to project how much your Roth IRA will give you in retirement.