More Bang for Their Buck: Why Your Clients Need to Know About the “Mega Backdoor Roth”
As a trusted advisor, you’re always looking for innovative ways to help your clients save more for retirement. If they’ve maxed out their regular 401(k) and IRA contributions, you might want to introduce them to a little-known but powerful strategy: the “Mega Backdoor Roth”.
So, what exactly is a Mega Backdoor Roth?
It’s a way to contribute after-tax dollars to a 401(k) and then roll those funds into a Roth IRA or convert them to a Roth 401(k). The beauty of this strategy is that Roth accounts allow for tax-free growth and tax-free withdrawals in retirement.
For high-income clients who might not qualify for regular Roth IRA contributions due to income limits, this is a fantastic workaround. They can save more for retirement and let their money grow tax-free — a win-win!
Here’s how it works:
- Make after-tax contributions: Your client’s 401(k) plan may allow after-tax contributions beyond the typical pre-tax or Roth 401(k) limits ($22,500 or $30,000 if they’re over 50).
- Convert or roll over: Once those after-tax contributions are made, the client can either convert them to a Roth 401(k) within the plan or roll them into a Roth IRA — where their funds can continue growing tax-free.
- Maximizing contributions: The total contribution limit for a 401(k) plan in 2024 is $66,000 ($73,500 if over 50). After maxing out the standard contributions, the remaining space can be filled with after-tax dollars for the “Mega Backdoor Roth”.
Potential beneficiaries include:
- High-income clients: For those earning too much to qualify for a regular Roth IRA, this strategy opens a door to more tax-free savings.
- Those looking for tax-free income: Roth accounts have no required minimum distributions (RMDs) and allow for tax-free withdrawals in retirement.
- Clients with flexible 401(k) plans: If your client’s employer allows after-tax contributions and in-plan Roth conversions, they’re in an ideal position to take advantage.
Key things to keep in mind:
- Plan specifics: Not every 401(k) plan allows for after-tax contributions, so make sure your client checks with their employer first.
- Tax reporting: If handled improperly, tax reporting can get tricky. Be sure to clearly separate any earnings from the after-tax contributions before conversion.
- Long-term planning: Make sure this strategy fits your client’s broader financial goals, particularly when it comes to future retirement income and taxes.
Why the Mega Backdoor Roth matters:
This strategy allows high-income earners to do what seems impossible: contribute more to a Roth, avoid RMDs, and grow their savings tax-free. It’s an excellent tool for building wealth over time, and with the right guidance, your clients can take full advantage.
For more in-depth knowledge on the “Mega Backdoor Roth” strategy, check out these trusted sources:
- IRS: (Get a breakdown of contribution limits and rules) IRS Contribution Limits.
- NerdWallet: Mega Backdoor Roths and How They Work
- Investopedia: A Short Guide to the Mega Backdoor Roth