Mega Backdoor Roth Strategy

Jarrett E. Hindrew, CFP®, ChFC®,CLU®, Financial Advisor

High-income investors may be overlooking a powerful savings and tax strategy that is available through their retirement savings plan. After-tax contributions to a 401(k) plan can be a valuable strategy to consider for individuals looking to save additional funds for retirement. One potential benefit of making after-tax contributions is the ability to perform a "mega backdoor Roth conversion." This strategy involves rolling over the after-tax contributions and their earnings into a Roth IRA, allowing for tax-free growth and withdrawals in retirement. However, not all 401(k) plans allow for this conversion, so it's essential to check with your plan administrator.

Here are some key points to understand about after-tax contributions to a 401(k):

1. Contribution Limits: The overall contribution limit for a 401(k) in 2024 is $23,000 for individuals under 50 years old and $30,500 for those aged 50 and above. However, this limit only applies to pre-tax and Roth contributions. After-tax contributions can be made on top of these limits.1

2. Employer Match: Keep in mind that employer matching contributions typically only apply to pre-tax or Roth 401(k) contributions. After-tax contributions may not be matched by your employer. Be sure to understand your employer's specific matching policy.2

3. Tax Treatment: After-tax contributions are made with money that has already been taxed, meaning the contributions themselves are not tax-deductible. However, the earnings on after-tax contributions grow tax-deferred until withdrawn.

4. In-Service Withdrawals: Some 401(k) plans allow for in-service withdrawals of after-tax contributions. This means you may be able to withdraw the after-tax contributions (not the earnings) and roll them over into a Roth IRA while leaving the pre-tax and employer match portions in the 401(k). Consult your plan administrator or review your plan documents to determine if this option is available.

5. Consult a Financial Advisor: Given the complexity and potential tax implications of after-tax contributions and the subsequent conversion to a Roth IRA, it is advisable to consult a financial advisor or tax professional who can provide personalized advice tailored to your specific situation.

Understanding the rules and potential benefits of after-tax contributions to a 401(k) can help you make informed decisions about your retirement savings strategy. Consult with your plan administrator or financial advisor to explore if this option is available and suitable based on your goals and objectives.