If you have a high income, you may feel the new $23,000 limit on 401(k) contributions and $7,000 limit on IRAs in 2024 isn't enough.
Well, you may be in luck. A little-known hack could allow you to save up to $46,000 more in a tax-advantaged retirement account in 2024. It's called the mega backdoor Roth.
Read on to learn how you can access this colossal retirement option and what it can do to supercharge your savings.
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What is the mega backdoor Roth?
If you're a high earner, you might be familiar with the backdoor Roth IRA. The mega backdoor is very similar in nature.
For those who don't know, the backdoor Roth IRA allows those making over the income limit to contribute directly to a Roth IRA to still get their money into a Roth account. It starts by making a non-deductible contribution to a traditional IRA. You then immediately convert those funds from a traditional IRA to a Roth IRA.
A mega backdoor Roth does the same thing, but it relies on using your 401(k).
There's a special rule in the IRS code that notes a total contribution limit for a 401(k) (or similar defined contribution retirement plan). That limit for 2024 is $69,000. Those 50 and older can include their $7,500 catch-up contribution limit, bumping the total to $76,500.
The total contribution limit is how much you contribute directly through tax-deferred payroll deductions, the matching contribution from your employer, and a third special type of contribution that may be available to you.
That third type of contribution is called (non-Roth) after-tax contributions. Not every plan allows you to make this type of contribution, so read your plan carefully or ask your HR department for details.
If you're eligible to make an after-tax contribution to your 401(k), you also need to be able to convert those funds to a Roth account. That could either be a Roth account within your current 401(k) plan with an "in-plan conversion" or a Roth IRA that you control separately.
The latter is ideal, as fees and investment choices are usually better with an IRA versus a 401(k), but it won't be available with every 401(k) plan. The plan must allow for in-service withdrawals in order to roll over funds from your 401(k) to a Roth IRA, so be sure to check. Even if that route is blocked, getting extra funds into a Roth 401(k) has a lot of advantages even if you have to pay some fees.
If your plan allows for it, you could be putting up to $84,500 total into retirement savings across your 401(k) and IRA contributions if you're 50 or older, or $76,000 if you're younger than 50.
The benefit of the mega backdoor Roth for high earners
The alternative to using the mega backdoor Roth is to save your money in a standard taxable brokerage account.
All things being equal, savings earmarked for retirement are better off in a Roth IRA than in a taxable brokerage account. That's because you can generally invest in the same securities in an IRA and you won't pay any fees on top of all the tax benefits afforded by a Roth account. Namely you won't pay any capital gains tax or taxes on your dividends, which can be a huge savings for a high earner. (If you have to leave your funds in a high-fee Roth 401(k) for a long time, though, fees could eat away at any tax savings over time.)
There are some downsides, though. Specifically, you won't be able to access your full account balance whenever you want. You can withdraw any amount of money you convert to a Roth account after waiting five years without penalty, but any earnings on that amount will be subject to penalty and taxes if you haven't yet reached age 59 1/2. What's more, withdrawing from a Roth 401(k) prorates the withdrawal between principal and earnings, so you can't avoid paying at least some penalty and taxes on your withdrawal unless you're able to convert it to a Roth IRA first.
Overall, though, the mega backdoor Roth, if available, allows you to reach retirement faster and have more to spend thanks to the tax savings it ultimately provides. If you're trying to save more for retirement, but find the regular contribution limits for the 401(k) and IRA to be too limiting, be sure to see if you can access the mega backdoor strategy.
