The Mega Backdoor Roth is ultimately built for those that have a large amount of cash that they want to put away towards retirement. Before we talk about the Mega Backdoor Roth, lets cover some ground work. Lets compare a traditional IRA vs a Roth IRA.

• Traditional IRA: Allows you to make tax-deductible contributions with earnings growing tax-deferred. Once you hit retirement and start to make withdrawals, they will be taxable.
• Roth IRA: You receive no tax benefit when contributing but it offers tax-free growth and tax-free withdrawals in retirement.

For 2024, the contribution limit for both Traditional and Roth IRAs is $7,000, or $8,000 if you are age 50 or older. With that being said, the ability to contribute to a Roth IRA starts to phase out once you hit income of $146k (Single) or $230k (Married) in 2024. This is where backdoor strategy would come into play.

How Does the Backdoor Roth IRA work?

A backdoor Roth IRA comes into play if you are hitting those income limits but still want to contribute to a Roth IRA. 

• Step 1: Make Non-Deductible IRA Contribution
• Step 2: On Day 2, Convert to Roth IRA
• Potential Issue: If you already have other Traditional IRA (pre-tax) money, there will be pro rata rules that mean some of the conversion will be taxable. You will want to talk to your accountant and financial advisor about this. This is some planning opportunities here that we discuss in TaxElm.

What Is a ‘Mega Backdoor’ Roth?

A "Mega Backdoor" Roth is a powerful retirement savings strategy that allows high-income earners to contribute significantly more to their Roth than the standard limits. This strategy leverages after-tax contributions to a 401(k) plan and subsequent in-plan Roth conversions or rollovers to a Roth IRA. The term "mega" refers to the substantial amount of money that can be funneled into a Roth IRA using this method, far exceeding the usual contribution limits.

Typically we will see this specifically with solo business owners (no outside employees) via a Solo 401k. You also need to ensure that your Solo 401k plan document allows for these type of after-tax contributions. If you have outside employees you will want to talk to your plan organizer about your situation. There may also be an alternative non-qualified option that can accomplish something similar. Luckily our retirement specialist partner can help with all of these items.

Key Benefits of Building a Mega Backdoor Roth

1. Tax-Free Growth: Once the funds are in a Roth, they grow tax-free. This means you won't pay taxes on the investment gains, which can significantly boost your retirement savings over time.
2. Tax-Free Withdrawals: You pay no tax on withdrawals from a Roth account during retirement.
3. Higher Contribution Limits: By using the Mega Backdoor Roth strategy, you can contribute up to $69,000 (for 2024) to your 401(k), including after-tax contributions, which can then be converted to Roth.

Breaking Down Limiting Beliefs for Lower Income Brackets

Many people in lower income brackets believe that strategies like the Mega Backdoor Roth are only for the wealthy. However, this isn't entirely true. While the strategy is particularly beneficial for high earners, anyone with access to a 401(k) plan that allows after-tax contributions can take advantage of it. Even if you can't max out the contributions, any amount you can contribute will benefit from tax-free growth in a Roth.

With that being said, before you go the mega route we'd recommend you do a backdoor on just a regular IRA first.

Why a Mega Backdoor Roth is So Effective

The Mega Backdoor Roth is effective because it maximizes the tax advantages of a Roth IRA while allowing for significantly higher contributions. This combination of high contribution limits and tax-free growth can supercharge your retirement savings. Lets look at the amounts you can put away.

• Phase 1: Max Out Individual Roth IRA (2024: $7,000)
  
  • Note: If you have a higher income that phases you out of the Roth IRA, do a backdoor.
• Phase 2: Max Out EmployEE Portion of Roth 401k (2024: $23,000)
• Phase 3: Max Out After-Tax Employee Traditional Contributions (2024: $46,000)
  • Note: If you have an employer match, you would reduce the $46k by that.
• Phase 4: Convert After-Tax Employee Traditional Contributions to Roth on Day 2
• Potential Max: Individual Roth IRA ($7k) + EmployEE Roth ($23k) + After-Tax Employee Traditional Contributions Converted ($46k) = $76k

Some key things to remember is that if you are over 50, all of these numbers are higher.  It's also important to note that if $76k into a Roth is not enough for you, there are even more advanced options that we discuss with-in TaxElm and can get you in front of our partner for those.

How to Create a Million-Dollar Mega Backdoor Roth

• Step 1: Maximize Your 401(k) Contributions
  • Understand Contribution Limits: For 2024, the total 401(k) contribution limit is $69,000, which includes employee contributions, employer matches, and after-tax contributions.
  • Make After-Tax Contributions: Check if your 401(k) plan allows after-tax contributions. If it does, contribute up to the plan limit after maxing out your pre-tax and Roth 401(k) contributions.
• Step 2: Utilize the Backdoor Roth
  • Convert After-Tax Contributions: Once you've made after-tax contributions to your 401(k), you can convert these funds to Roth. This can be done either through an in-plan Roth conversion or by rolling over the funds to a Roth IRA.
  • Pay Taxes on Earnings: When converting, you'll need to pay taxes on any earnings from the after-tax contributions. However, the principal amount (the after-tax contributions) can be converted tax-free. If you convert the next day there should be zero (or minimal) earnings.
• Step 3: Repeat Annually
  • Consistent Contributions: Make it a habit to maximize your 401(k) contributions each year and convert the after-tax portion to Roth. Over time, this strategy can help you build a substantial tax-free retirement fund.

Real-Life Example: John is a high income business owner and wants to put as much away towards retirement as possible. He utilizes the Mega Backdoor Roth strategy and contributes the maximum of $69,000 for 7.5 years. At a return rate of 12%, it'll take just 7.5 years to hit $1MM. No remember, since this is in a Roth account, the earnings and tax free and withdrawals during retirement are also tax free.

By following these steps, even beginners can start building a million-dollar Mega Backdoor Roth. The key is to understand the rules, maximize contributions, and consistently convert after-tax funds to Roth.

And if you want to build this strategy and more, click the link below to learn more about TaxElm, our full-scale service software that gives you full access to tax experts ready to help you on your journey.