Mega Backdoor Roth - 2020 Update
I’ve talked before about the Backdoor Roth. I’ve also covered the Mega Backdoor Roth, which is basically the Backdoor Roth on steroids. If you’ve been reading my stuff for years this article will look familiar as I originally wrote about it in 2017. However, I wanted to update the numbers for you.
Before I jump into the details, please note this is designed for people who have maxed out contributions to their retirement accounts but would like to put more away. Also, your 401k plan has to be set up properly to allow it to happen. Finally, I am going to stay high level with this as I could spend several thousand words spelling it out in detail and I try to keep my stuff short. You could always visit whitecoatinvestor as they have a great information on it. Let’s dig into the details.
Here is the basic breakdown. You have maxed out your annual 401k contributions but would like to save more. Your income may restrict you from doing a traditional Roth IRA contribution and/or you really want to sock more away for retirement. Fortunately, your employer is forward-thinking (like how I work my firm name in here) and they have designed a 401k plan that permits after-tax, non-Roth contributions. You may now be able to follow this strategy which has the ability to allow couples to contribute another $75,000 annually toward their Roth IRAs, which will never be taxed again. Not too shabby.
There are some key steps you need to follow to execute the Mega strategy.
- First, max out all your other retirement savings accounts. This includes your 401k, regular IRA contributions, and your HSA.
- Step 2 - if you still have money to contribute reach out to your work retirement plan specialist and find out if you can make after-tax, non-Roth contributions; whether you can do an in-service withdrawal; and if the after-tax contributions can be kept in a separate sub-account.
- Assuming all this is good, you can now plan your Mega strategy. You must take into consideration how much of a contribution is made by your employer. The total that can go into your 401k for 2020 is $57,000 and this includes the $19,500 employee contribution. Assuming your employer makes no contribution you can then contribute another $37,500 (difference between $19,500 employee and $57,000 maximum) after-tax to the plan. If your employer makes a contribution and the total amount between your two contributions is less than $57,000 you can contribute the difference. For example, you contribute $19,500 and they match this with a $12,500 employer contribution. You still have $25,000 you can contribute after-tax to hit the $57,000 plan max.
- Step 4 can really be broken down into sub-steps. The first is if your plan allows an in-service withdrawal. If so, you can immediately take your Mega (your after-tax, non-Roth) contribution and roll it into a Roth IRA. You want to roll this as fast as possible to avoid any gains while the money is invested and before it is in a Roth because the gains will be taxed upon rollover. If done quickly the tax impact should be minor. The second is if the in-service option does not exist you have to wait until you are no longer employed with that company. Here you can then roll the money over, however, you have to pay extra attention to any gains made while the Mega money was invested. This is where you definitely want to engage your CFP® and CPA to determine the tax impact of the rollover.
Again, this is a very high-level overview of this strategy. I would say if you have maxed out your 401k contribution and want to save more it is time to find out if this strategy makes sense for you. As always, feel free to reach out if you have more questions. There are specific steps that have to be done properly, but once you do them it is definitely worth the effort.