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With less than two months before the end of the year, there’s not much time left to cram more savings into your Roth 401(k) account at work using the Mega Backdoor Roth technique. So if you want to take advantage of this option, the time is now. For 2024, your total contribution limit to a 401(k) plan, including any employer-matching contributions, is $69,000, or $76,500 if you’re age 50 or older. That’s in contrast to the regular contribution limit for 401(k) plans in 2024 of $23,000, or $30,500 if you’re age 50 or older. Using the Mega Backdoor Roth strategy, you can save an additional $46,000 above the regular contribution limit, an increase of $2,500 from last year.
The Mega Backdoor Roth technique allows you to not only save more, but to have money grow tax-free. With the Mega Backdoor Roth, you can contribute above the regular contribution limit and also save that money as Roth 401(k), which in addition to growing tax-free, won’t be taxed when you take the money out in retirement. That’s different from regular pretax 401(k) contributions that aren’t taxed as they grow, but are taxed as ordinary income when you take the money out in retirement.
The amount of savings you should distribute between pretax account types (e.g., IRA, regular pretax 401[k]) and after-tax account types (e.g., Roth IRA, Roth 401[k], after-tax IRA), depends on many factors, including your current tax situation. Here’s more information about how to decide.
The Mega Backdoor Roth technique is popular with people who have high income, have already contributed the maximum regular amount to their 401(k) plan, and are looking for an additional way to save. These high-income earners also probably aren’t able to contribute to a Roth IRA account because of income limits, and a Roth 401(k) is one of the few ways to get money into Roth-type accounts.
It’s important to know that Mega Backdoor Roth is financial slang—you won’t see it described this way on your company’s 401(k) website—and not every company’s 401(k) plan has the features needed to allow you to use it. To determine if it’s an option for you, you’ll want to look on the company’s 401(k) website for these three features:
Roth 401(k)—the plan must allow the Roth 401(k) savings type.
After-tax contributions—the plan must allow you to make after-tax contributions, in addition to the regular pretax contributions that you’re more familiar with.
In-plan Roth conversion—the plan must allow you to convert your after-tax contributions to Roth 401(k) savings inside of the plan, preferably automatically.
Not all 401(k) plans offer this set of features. Leading tech companies offering these features include Apple, Cisco, Google, Intel, Meta, Microsoft, PayPal, and ServiceNow. (If you’re unsure of whether your company plan offers the required features, we can help you figure this out.)
In-plan Roth conversion comes in two main forms: manual and automatic. The manual version requires you to go into the 401(k) website every pay period and manually convert your after-tax contributions to Roth 401(k). That can be a serious hassle, and most people won’t remember to do it. If you don’t convert the after-tax contributions to Roth 401(k) right away with each pay period, the after-tax contribution will grow in value (usually, if your investments are increasing in value), and when you convert to Roth 401(k), you will owe tax on this increase.
If your company’s 401(k) plan has automatic in-plan conversion, you’re in luck. With the automatic feature, your after-tax contributions are converted to Roth 401(k) automatically after each pay period, and you don’t need to do anything. If your 401(k) plan doesn’t have this feature, you should request it from your human resources or employee benefits team at work—these are pretty obscure features, and not all companies are aware of them or how useful they can be for employees.
While “Maxing the Mega” can be a good strategy for some people, it’s not for everyone. First, you need to have enough income and extra saving capacity to go beyond the regular contribution limits. If you’re not maxing out the regular contribution yet, you’re not ready for the Mega Backdoor Roth. Second, you won’t be able to access this money in most cases until you are 59½ years old. This is long-term savings for retirement. If you’re saving up money to buy a home or have another short-term savings goal, you should not direct your extra savings into Roth 401(k) because you won’t be able to get access to it to use for near-term financial needs. This money is locked up. It becomes illiquid for you.
Contributions to 401(k) plans must be made through paycheck deductions. With the high contribution limits using the Mega Backdoor Roth technique, it can take many paychecks to max out the contribution limit. It’s best to start early in the year. With the year-end approaching, if you’re trying to catch up and get as much as possible into the Mega Backdoor Roth this year, you may need to direct a large portion of your remaining paychecks into this strategy to hit the maximum for the year. To do that, you will need to increase your 401(k) contribution amount, perhaps substantially. In practice, that may mean dipping into your savings to cover living expenses because your paycheck will be a lot smaller. In effect, you’ll be transferring money from savings or brokerage accounts to your Roth 401(k) account. It’s a clever approach to boosting your tax-free savings, but again, it’s not for everybody.
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you’d like help understanding the Mega Backdoor Roth and whether it makes sense for you, schedule a complimentary consultation.
