Roth accounts are extremely powerful. They give you the ability to put after-tax dollars away and never pay tax on those dollars again.
Most know this, but... what most do not know is that you can get a total of $76,000 into Roth accounts a year.
Here's how:
So let me reiterate the power of Roth:
Sounds amazing, right? It is.
You have the ability to get Roth dollars in 3 ways:
If you utilized all 3, this could result in you getting $76,000 into Roth this year. $7,000 from Backdoor Roth IRA, $23,000 from Roth 401(k), and $46,000 from Mega backdoor Roth 401(k).
I won’t spend much time in this post talking about backdoor Roths or Roth 401(k)s as I have written plenty on those (most recent backdoor Roth one is below).
What we will go through is how to do the Mega Backdoor Roth 401(k).
Note: You need to either be a business owner and have a Solo 401(k) or have a 401(k) with an after-tax option to do this.
Anyways… let’s get into it and start with how you do this if you are an employee.
Step 1: Verify this is an option for you
For this to work, you need to have both an after-tax 401(k) and in service withdrawals. This means you have the ability to convert the dollars to a Roth 401(k) or a Roth IRA. Either will workI. f you do have this option, move to step 2.
Note: Not all 401(k)s allow thisI would say less than half do.
You may have to reach out to your HR team to do this. If so, here is some language to send them.
"Hey name, I read recently that there is a strategy called the Mega Backdoor Roth. I would love to do this, but I am not sure we have the ability. Does our 401(k) have an after-tax option? If so, does it have the ability to roll those dollars to a Roth account? It seems very impactful, but I need to make sure its a possibility first."
This is what it would look like inside your 401(k).
Step 2: Figure out how much you can do
The total amount that can go into a 401(k) per year is $69,000 if you are under 50. $23,000 can go directly into Roth or Traditional side. Then you have an employer match. Let’s say that is $7,000, this means you have $69,000 - $23,000 - $7,000 = $39,000 of room left to do the Mega Backdoor Roth. You also have to take a look at what you can afford obviously.
Step 3: Max out your 401(k)
Contribute the max $23,000 to your 401(k).Many who have the funds will choose to do a traditional 401(k) as they are in the highest tax bracketsOnce they exhaust all their pre-tax options they then choose to go to a Roth account. Never taxed again is better than taxed at long term capital gains rates.
Step 4: Make after-tax 401(k) contributions
Start making after-tax contributions up to the dollar amount you have left or whatever you can afford. Remember the annual limit to a 401(k) is $69,000 for 2024.
Step 5: Convert to Roth
This is the key step. Many people forget to do this and you do not want to be one of them. The growth on an after-tax 401(k) is taxed at your income rate. You do not want to have to deal with that. Make sure to convert this to a Roth 401(k) or Roth IRA. Some plans have the ability to automate this, while others require you to call the plan provider to get it done. Just make sure to do it and get the money over to Roth and then invest it.
Now let’s talk about it for business owners. If you are a business owner, you have the ability to guarantee this is an option.
How?
You setup a 401(k) or solo 401(k) that allows for this. All the rest of the steps are the same. It is an awesome benefit.
Let’s look at the impact of doing this. I have some clients in their early 30’s taking advantage of this and doing $7k each to their backdoor Roths ($14k total) and their spouse does $23k pre-tax, with a $46k mega backdoor Roth. That is $60k a year in Roth dollars invested.
Let's say they do this for the next 10 years from 30-40 and then never save into Roth again. By the time they are 65, they would have almost $4.5 million dollars in Roth assuming a 7% rate of return. This is insanely impactful.
This is definitely a strategy worth considering for my high income folks out there. If you need help setting this up, feel free to reach out.
Financial Advisor