What Is a Mega Backdoor Roth?
To understand the mega backdoor Roth, we’ll first review the basics of traditional and Roth IRAs. A traditional IRA allows investors to put $ 6,000 of pretax money into an account that grows tax-deferred. The Roth IRA is a similar account with a $ 6,000 max contribution, but investors fund it with after-tax dollars.
Because there are income restrictions to investing in the Roth IRA, not everyone qualifies. However, anyone who contributes to a traditional IRA can convert that IRA into a Roth, even if they do not meet the Roth IRA income limits. This is called a backdoor Roth conversion because it allows those who might not otherwise be eligible for a Roth to take advantage of tax-deductible contributions.
The mega backdoor Roth works like the backdoor Roth, except investors fund it with non-deductible (after-tax) contributions into a traditional 401 (k) plan. In 2022, investors are allowed to convert up to $ 40,500 of after-tax traditional 401 (k) contributions. By using the after-tax contributions made to the 401 (k), there is no tax consequence for the conversion.
Mega Backdoor Roth IRA
The mega backdoor Roth IRA is a good strategy to get more money growing tax-free, but it does have rules. Investors must be contributing to an eligible 401 (k) or 403 (b) plan where they are making after-tax contributions. Not every plan allows this, so investors need to talk to their plan’s administrator to see if it is possible to set up.
Once investors make the after-tax contributions, they’ll want to make an immediate in-service withdrawal. While most plans do allow for in-service withdrawals, not every plan does. Investors will want to check with their plan’s administrator about the process. Investors want to make the withdrawal immediately after the contribution because they do not want to have the contributions grow and generate a taxable event.
According to the IRS, when the money is pulled out, it must distribute after-tax funds alongside the earnings made on them. Investors aren’t allowed just to pull out the after-tax contributions.
Tip: Doing an in-service distribution into a rollover allows investors access to individual stocks and not just mutual funds and ETFs.
Mega Backdoor Roth 401 (k)
The mega backdoor Roth 401 (k) works similarly to the mega backdoor Roth IRA. The difference is that the employer’s plan allows the participant to open a Roth 401 (k). This allows the after-tax contributions to be made directly to the 401 (k) plan. The benefit is that it bypasses the need to distribute funds equally. Participants can directly apply contributions to the conversion.
Mega Backdoor Roth 403 (b)
A mega backdoor Roth 403 (b) conversion works the same as the mega backdoor Roth 401 (k) conversion. The after-tax contributions to the 403 (b) can be converted into a Roth 403 (b) plan directly. Investors may find 403 (b) plans do not always allow for after-tax contributions to the plan. Investors should check with their plan’s administrator regarding the rules.
How a Mega Backdoor Roth Strategy Works
The mega backdoor Roth strategy works because:
Taxes already paid: Investors fund the account with after-tax dollars.
Growth is tax-free: By converting the funds into a Roth structure, the money grows tax-free rather than tax-deferred
Allows for greater contributions: The 2022 maximum mega Backdoor Roth conversion is $ 40,500
Takes advantage of income loophole: Let’s investors who do not otherwise meet the income caps to contribute to a Roth, get the tax-free growth of the Roth
Mega Backdoor Roth Conversion Limits
Mega Backdoor Roth Tax Reporting
In order to take advantage of the tax benefits, investors need to report the mega backdoor Roth IRA conversion properly. When doing this conversion, there are two forms to look out for: Form 1099-R and Form 5498. The Form 1099-R will tell investors how much was taken out of a retirement account. The form alone designates a distribution that would be taxable if investors do not put the funds into another qualified plan.
When investors convert the funds and fund the Roth IRA, a Form 5498 is sent. This records the amount that was placed into the Roth IRA. To avoid any taxable event, the 1099-R and Form 5498 should match.
Benefits of a Mega Roth
The benefits of a mega Roth IRA are:
No tax consequence: Investors already paid taxes since it is funded with after-tax money.
Bigger Roth contribution: Allows more than $ 6,000 per year to be contributed to a Roth IRA.
Opens Roth up to those who otherwise are ineligible: Roth IRAs have strict income guidelines that the backdoor Roth gets around.
The mega backdoor Roth is a savings strategy that allows investors to save large amounts of money in a tax-free growth vehicle. Investors need to pay attention to the rules to ensure that they do not accidentally create a taxable event.
Is a mega backdoor Roth worth it?
A mega backdoor Roth IRA is well worth the effort for those who have the money to save. Having money grow tax-free means it will have greater buying power when withdrawn down the road. However, Roth accounts cannot be funded with deductible contributions. Seek advice from a financial professional to find out which is best for you.
Who is eligible to do a super Roth?
Anyone is eligible for a super Roth. While Roth IRAs have income limits and guidelines, there are no restrictions on who can convert a traditional retirement account into a Roth. This opens the door to many investors who otherwise could not take advantage of Roth IRAs.
Can you do a mega backdoor Roth withdrawal without incurring penalties?
Once the money is in the Roth account, you can take it out. However, there are penalties for investors taking funds out prior to holding the account for five years or until age 59 ½.