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A step-by-step guide to the mega-backdoor Roth conversion

  • 4-min read

If Elastigirl from The Incredibles were a type of retirement account, she’d be a Roth IRA.

Two people talking with a mannequin dressform in between them, one wearing a black t-shit and beanie, the other wearing a suit, with the caption, “You feature the back door a lot, don’t you?”
World of Wonder / Giphy

If Elastigirl from The Incredibles were a type of retirement account, she’d be a Roth IRA. The accounts allow for maximum flexibility (as far as retirement plans go) and are one way Americans make retirement investments that grow tax-free.

One problem: The IRS limits Roth IRAs to taxpayers who earned less than $144,000 in 2022. But as with most tax laws, high earners have sniffed out a loophole.

If your employer allows in-service distributions and after-tax contributions in your 401(k) plan, you may be able to convert as much as $40,500 to a Roth IRA in 2022 using a mega-backdoor Roth conversion.

What’s the benefit of a mega-backdoor Roth conversion?

Since withdrawals from Roth IRAs are not taxed as income once you reach age 59 ½, these accounts are helpful for people who think their tax rates will be higher in retirement than they are now. The problem is that high earners are typically excluded from contributing to Roth IRAs. In 2022, the maximum modified adjusted gross income (MAGI) a single filer can have while contributing to a Roth is $144,000. For married couples, it’s $204,000.  

The mega-backdoor Roth conversion is a way for someone who makes more than that limit to not only contribute to a Roth but also contribute far more than the $20,500 contribution limit for 401(k) plans. 

The benefit of the Roth itself is that your investments can grow without tax hindrances. Instead of paying capital gains tax every time you sell a stock and income tax on the dividends you receive each year, that money stays in the account unmolested to keep growing until retirement. 

Of course, the same is true of traditional IRAs, so the tax rate difference is the key. If you have a lower tax rate now than you expect to have in the future, a Roth IRA is the way to go; otherwise, a traditional IRA makes more sense.

Steps to complete a mega-backdoor Roth conversion

Review your 401(k) plan

First, you’ll need to verify with your 401(k) provider that you can make after-tax contributions and in-service distributions. Not all providers allow one or both of these. It’s also wise to gauge the helpfulness of the service team and potentially your employer’s HR department because this is a complicated process that might require their assistance.  

Max out your 401(k)

You can only start making after-tax contributions—the kind you’d eventually use to fund your mega-backdoor Roth conversion—once you’ve maxed out your pre-tax and Roth contributions. The maximum total 401(k) contribution for 2022, including employee and employer contributions, is $61,000. As an employee, you can add up to $20,500 to your 401(k) between pre-tax and Roth. 

Say you contributed the maximum $20,500, and your employer contributed $10,000. That means you can make after-tax contributions of up to $30,500:

$61,000 (annual limit) – $20,500 (your contribution) – $10,000 (employer match) = $30,500 after-tax contributions  

Make an in-service distribution

After-tax contributions are often, by default, invested in the same assets as your other contributions. However, make sure you set up the account to leave them in cash for easy distributions. If the contributions are invested, you’ll owe tax on any earnings when you make the distribution.

After you request the in-service distribution, the provider will send you a check that you’ll need to deposit ASAP to avoid the wrath of the IRS. 

Transfer the distribution into a Roth IRA

You can set up the Roth IRA at just about any brokerage and transfer the money into it. There are forms and phone calls and satanic rituals (not literally) that you’ll need to make that we don’t have the space here to cover. 

Make sure you have a CPA or similar tax professional guiding you through the process. And take the time to work with them and determine whether or not the process is even worth it. 

Is it worth going through the mega-backdoor?

Deciding whether the mega-backdoor Roth conversion is worth it is highly dependent on your financial situation. 

The key to deciding between a Roth and traditional IRA is tax rate variance. If you make too much now to contribute to a Roth and need to contribute through the backdoor, you’re in one of the four top tax brackets. Will you still be in a high tax bracket come retirement? Your best prediction will probably come from talking with a tax pro…or a Magic 8-Ball.

Tax avoidance strategies like this one can get incredibly complicated. You could pull off the maneuver without much outlay or fuss if you have a reliable CPA who isn’t overly expensive. Despite federal legislation aiming to dilute and eventually eliminate the mega-backdoor Roth conversion, the strategy won’t be going away in 2022. So take your time and consider all the options for supersizing your retirement savings.