What to Know About Mega Backdoor Roth 401(k) Conversions

In this article you will learn what a mega backdoor Roth 401(k) conversion strategy is and how to best use it to your advantage.

What Is a Mega Backdoor Roth 401(k) Conversion?

A mega backdoor Roth 401(k) conversion is a strategy that allows high-income earners to make after-tax contributions to their 401(k) plan and then convert those contributions to Roth 401(k) assets, all while avoiding the contribution and income limits that normally apply to Roth IRA conversions.

This strategy can be a powerful tool for building tax-free retirement income, but it can be complex and is not suitable for everyone.

How Does a Mega Backdoor Roth 401(k) Conversion Work?

The mega backdoor Roth strategy takes advantage of a loophole in the tax code that allows 401(k) plan participants to make after-tax contributions to their plan up to the annual contribution limit.

Employees under the age of 50 may defer up to $20,500 of their salary into their company’s standard pretax or Roth (after-tax) 401(k) account ($27,000, if age 50 or older).

These after-tax contributions are not tax-deductible, but they can grow tax-deferred inside the 401(k) plan.

Once the after-tax contributions have been made, the participant can then convert them to Roth 401(k) assets by paying taxes on the amount converted at their marginal tax rate.

Since the after-tax contributions have already been taxed, there is no tax due on the conversion itself.

This effectively allows high-income earners to make Roth IRA conversions without being subject to the income limits that normally apply.

Who Can Benefit From a Mega Backdoor Roth 401(k) Conversion?

The mega backdoor Roth strategy can be a helpful tool for high-income earners who are looking to build tax-free retirement income.

However, it is important to note that this strategy is complex and not suitable for everyone.

Before considering a mega backdoor Roth conversion, be sure to consult with a tax and/or financial advisor to see if it is right for you.

Criticisms of the Mega Backdoor Roth 401(k) Conversion

The mega backdoor Roth strategy has come under criticism over the years for allegedly violating the intent of the Roth IRA rules.

Critics argue that the mega backdoor Roth is a way for high-income earners to circumvent the income limits that apply to Roth IRA conversions.

While there is some merit to this argument, it is important to remember that the mega backdoor Roth is a perfectly legal strategy.

For taxpayers who are looking to build tax-free retirement income, the mega backdoor Roth can be an effective tool if they plan with a tax or financial advisor.

Mega Backdoor Roth 401(k) Conversion – FAQs

How likely is it for mega backdoor Roth 401(k) conversions to be eliminated in the future?

Legislators from both parties in the US have sought to eliminate the mega backdoor Roth 401(k) conversion loophole in the tax code.

However, no concrete action has been taken to date and it remains to be seen if mega backdoor Roth conversions will be eliminated in the future.

What is the difference between a mega backdoor Roth and a regular Roth conversion?

A mega backdoor Roth 401(k) conversion is a strategy that allows high-income earners to make after-tax contributions to their 401(k) plan and then convert those contributions to Roth 401(k) assets, all while avoiding the contribution and income limits that normally apply to Roth IRA conversions.

A regular Roth conversion is a strategy that allows taxpayers to convert their pretax assets into Roth assets by paying taxes on the amount converted at their marginal tax rate.

What are the risks of a mega backdoor Roth conversion?

The biggest risk of a mega backdoor Roth conversion is that legislators could eliminate the loophole in the tax code that allows for this strategy.

If this were to happen, taxpayers who have already completed a mega backdoor Roth conversion may be subject to paying taxes on the amount converted, plus interest and penalties.

Another risk to consider is that mega backdoor Roth conversions can complicate your tax situation.

For this reason, it is important to consult with a tax advisor before completing a mega backdoor Roth conversion.

Summary – Mega Backdoor Roth 401(k) Conversion

A mega backdoor Roth 401(k) conversion is a strategy that allows high-income earners to make after-tax contributions to their 401(k) plan and then convert those contributions to Roth 401(k) assets, all while avoiding the contribution and income limits that normally apply to Roth IRA conversions.

The mega backdoor Roth strategy can be a helpful tool for high-income earners who are looking to build tax-free retirement income. However, it is important to note that this strategy is complex and not suitable for everyone.

News over the abuse of Roth accounts has attracted support for potential changes in the tax laws governing them, so this is also something to be mindful of.

Before considering a mega backdoor Roth conversion, be sure to consult with a financial and/or tax advisor to see if it is right for you.