At The Money: The Mega Backdoor Roth

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• The Mega Backdoor Roth is an IRS-approved strategy allowing high earners to contribute significantly more than the standard $24,500 limit into a Roth structure within their 401(k), potentially up to $72,000 total contributions.  Copied to clipboard!
• The feasibility of implementing the Mega Backdoor Roth hinges on the employer's 401(k) plan design, specifically requiring both after-tax contribution allowance and a mechanism (in-plan Roth conversion or in-service distribution) to move those dollars to Roth status, often complicated by compliance testing.  Copied to clipboard!
• For self-employed individuals with solo or owner-only 401(k) plans, the Mega Backdoor Roth is highly advantageous because it bypasses the complex compliance testing that often prevents larger firms from adopting the feature.  Copied to clipboard!

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Introduction to Mega Backdoor Roth

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• Key Takeaway: The Mega Backdoor Roth allows contributions above the standard $24,500 limit up to $72,000 total in a tax-advantaged account.
• Summary: Tax-deferred portfolios are extremely popular, with nearly 75% of US households participating in some form of retirement savings. The Mega Backdoor Roth is the latest addition, enabling high earners to significantly boost their after-tax contributions within their 401(k). This strategy is essentially a high-limit version of the regular backdoor Roth IRA conversion technique.

Legitimacy and Plan Requirements

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• Key Takeaway: The Mega Backdoor Roth is completely legitimate under IRS rules, but its availability depends entirely on employer plan design.
• Summary: The strategy is not a loophole but is fully blessed by the IRS, though the term ‘backdoor’ can sound questionable. The employer, as the plan sponsor, must explicitly offer both after-tax contributions and a Roth conversion feature. Custodians are generally not involved in the decision to offer these features.

Employer Reluctance and Compliance Testing

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(00:06:50)

• Key Takeaway: Employers often avoid offering the Mega Backdoor Roth due to added complexity and compliance testing risks.
• Summary: The feature adds complexity to plan design, primarily by triggering additional compliance testing. If this testing fails, the overall strategy may not work effectively. The feature is most viable in companies where a broad base of employees, not just the top 20% of highly compensated earners, utilize the contributions.

Suitable Industries and Process

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• Key Takeaway: Professional services, tech companies, and any industry with a high percentage of earners over $150,000 are well-suited for this feature.
• Summary: The process requires the employer to update plan documents to allow after-tax contributions and a conversion method. The two conversion methods are in-planned Roth conversion (staying in the 401k) or an in-service distribution to an outside Roth IRA, with the in-planned conversion being more common and simpler. There is generally no additional cost to the employer, only minor administrative burden.

Self-Employed Application and Timing

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• Key Takeaway: Solo 401(k) plans are ideal for the Mega Backdoor Roth because they avoid compliance testing headaches.
• Summary: The Mega Backdoor Roth works perfectly for solo or owner-only 401(k) plans since there are no compliance tests required. Conversion timing depends on the provider; some allow only annual manual conversions, while others offer daily automatic Roth conversions, which is considered a game-changer. Employees generally need to activate the automatic Roth conversion feature if the provider supports it.

Risks and Liquidity Considerations

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• Key Takeaway: The primary risk is restricted liquidity, as in-plan Roth conversions are subject to age 59.5 withdrawal rules.
• Summary: If the in-plan Roth conversion is used, the money follows Roth 401(k) rules, meaning it generally cannot be accessed until age 59.5 or a distributable event. Taxable accounts may be better if present-day liquidity is a high priority. Importantly, Roth 401(k)s are now exempt from Required Minimum Withdrawals (RMDs) following the Secure 2.0 Act.