Maximizing contributions to tax-advantaged accounts can be a key aspect of sound retirement planning. One lesser known yet powerful option available in some 401(k) plans is the Mega Backdoor Roth IRA. This strategy was made viable by IRS Notice 2014-54, which clarified the rules allowing individuals to roll over after-tax 401(k) contributions into a Roth IRA separately from pre-tax amounts. If your plan allows it, utilizing this strategy can significantly enhance your retirement savings.
The Potential Benefits of the Mega Backdoor Roth IRA
1. Substantial Tax Savings: The primary advantage is the potential for significant tax-free growth. By converting after-tax 401(k) contributions to a Roth IRA, you can shield a considerable portion of your retirement savings from future taxes.
2. Increased Savings Capacity: For high earners, the standard Roth IRA contribution limit of $7,000, or including a $1,000 catch-up for those age 50 and older of $8,000, may seem restrictive. Your income level may also preclude you from contributing to a Roth IRA at all. However, the Mega Backdoor Roth IRA allows you to set aside Roth funds well beyond the typical limits, irrespective of income.
3. Retirement Flexibility: Roth IRAs do not have required minimum distributions (RMDs) during the original owner’s lifetime. This provides more control over withdrawals, better management of your tax bracket in retirement, and the ability to leave the account to heirs for continued tax-free growth.
Example of the Mega Backdoor Roth IRA in Action
Consider a high-income earner aged 55, with a 401(k) plan that permits after-tax contributions and in-service distributions. For 2024, the total 401(k) contribution limit is $76,500, including catch-up and employer contributions.
Contributions:
- Employee pre-tax contributions: $23,000
- Employee catch-up contributions (age 50+): $7,500
- Employer match: $6,000
- After-tax contributions: $40,000 (Total contributions: $76,500)
The individual then executes an in-service distribution to convert the $40,000 in after-tax contributions to a Roth IRA. Keep in mind that any earnings on the $40,000 in after-tax contributions would be subject to taxes upon conversion. If your plan allows it, it may be best to convert the after-tax contributions to a Roth IRA frequently before earnings begin to accrue. Once converted, these funds will grow tax-free, which can provide a significant boost to retirement savings.
Not Available in All Plans
It’s important to note that not all 401(k) plans offer the Mega Backdoor Roth IRA option. Key requirements include:
· After-Tax Contribution Option: The plan must allow after-tax contributions beyond the usual pre-tax and Roth 401(k) contributions.
· In-Service Distributions: The plan must permit in-service distributions or in-plan Roth conversions to move after-tax contributions into a Roth account. If not allowed, the after-tax contributions can be rolled over into a Roth IRA upon separation of service or retirement.
Before pursuing this strategy, consult with your plan administrator to confirm whether your 401(k) plan supports these features. If so, you may be able to save a significantly greater amount of tax-advantaged funds. For personalized advice and to confirm if the Mega Backdoor Roth IRA is appropriate for you, please contact our team at Albitz/Miloe & Associates, Inc.
