Roth retirement accounts like a Roth IRA and Roth 401k are extremely tax-advantaged. You get tax-free compounding and you don't have to pay any taxes when you withdraw from your nest egg in retirement (no matter how crazy your gains). There are people who've turned a few thousand dollars into millions inside Roth accounts. And they didn't have to pay the IRS a dime of it.
Because it’s so tax-advantaged, the IRS doesn’t just let you put away an unlimited amount into a Roth retirement plan. They set strict contribution limits each year.
Roth account contribution limits for 2022:
Additionally, the Roth IRA also has an income restriction. If your income is over $144,000 for the year, you’re not allowed to contribute at all.
Since the restrictions are placed around CONTRIBUTIONS, we can use a different way to put the money in: CONVERSIONS.
There are no income restrictions with conversions and no limit on how much you can convert into an account.
Basically, we're going to go find a retirement account that has no income restriction and has the highest possible contribution limit set by the IRS. We're going to maximize that account, and then we're going to immediately convert it into our Roth IRA or Roth 401k.
The after-tax 401k is the perfect vehicle for this. It's different from a traditional 401k or a Roth 401k, and it has a much higher contribution limit at $61,000 ($67,500 if you’re over 50).
Since we can’t CONTRIBUTE more than $6,000 into a Roth IRA or Roth 401k, we’ll contribute $61,000 into the after-tax account, and then CONVERT it all immediately into a Roth account.
Instead of putting away $6,000 into a Roth IRA, or $20,500 into a regular 401k, we can put up to $61,000 into either of those accounts using the mega backdoor Roth strategy.
That's over 10x the contribution limit of a Roth IRA and nearly 3x the limit of a regular 401k.
The concept of a mega backdoor Roth is complicating the first time around. But once you get an understanding of how it works, it's actually quite simple.
Let's say that you're under 50 years old. This year, to max out your 401k employee contributions, you'll need to put in $20,500.
Your employer's matching contribution is 6%.
$20,500 x 0.06 = $1,230.
The contribution limit of an after-tax account is $61,000 for 2022. Minus your employee 401k contributions and your employer match from this number.
$61,000 - [$20,500 employee contributions + $1,230 employer match] = $39,270.
That's $39,270 more that you could put into your after-tax account, which would then get immediately converted into your Roth IRA or Roth 401k account.
The mega backdoor Roth strategy is useful for anyone with a regular 401k plan at their work. However, whether you're able to do this or not depends on if your company plan allows it. Not every company offers 401k plans that support the mega backdoor Roth strategy.
For the mega backdoor Roth to work, your company's 401k plan must offer two features:
Some well-known companies that offer the mega backdoor Roth IRA are Google, Facebook, Amazon, Apple, Microsoft, LinkedIn, Uber, and Yahoo.
After you contribute to your after-tax account, the Roth conversions can be done in two ways:
Some company plans only allow in-plan conversions into a Roth 401k, and some company plans only allow in-service distribution rollover into a Roth IRA. If they offer both options, it's up to you to decide which account you want to maximize.
While in-plan conversions into a Roth 401k are simpler to do, rolling the funds into a Roth IRA is the preferred choice.
Note that both types of conversions are not taxable events since you already funded the account with after-tax income.
If your company plan isn't set up to offer the mega backdoor Roth, you still have another viable option: The backdoor Roth IRA.
With a Backdoor Roth IRA strategy, high income earners who originally were not eligible for a Roth IRA can contribute to a traditional IRA first, and then roll over the funds into a Roth IRA.
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