Investing in a Roth IRA is a great way to save for the future, as it will yield you tax-free income in retirement. But for high-income earners, there's a way to save even more than the $6,000 contribution limit for the 2020 and 2021 tax years (or $7,000 limit if you're over 50): a mega backdoor Roth IRA, a trick that could boost your annual Roth IRA contributions to well over $30,000 each year.

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What is a mega backdoor Roth IRA?

Roth IRA contributions are off-limits for high-income earners -- that's anyone with an annual income of $140,000 or more if filing taxes as single or head of household in 2021 (up from a $139,000 limit in 2020) or with an annual income of $208,000 or more if married filing jointly (up from $206,000 in 2020). Therefore, a backdoor Roth IRA offers a workaround: Earners may contribute money to a nondeductible traditional IRA and then convert it to a Roth IRA. A mega backdoor Roth IRA uses the same conversion technique, but could significantly lower or eliminate the tax liability on the conversion.

Here's a checklist to determine if a mega backdoor Roth IRA is possible for you:

  • You earn more than $140,000 (single or head of household) or $208,000 (married filing jointly) in 2021.
  • You max out your employer's annual 401(k) (or 403(b) or 457, or your solo 401(k)) pre-tax contribution limits of $19,500 (or $26,000 if you're over 50) in 2020 or 2021.
  • Optional, but you max out annual nondeductible traditional IRA contributions of $6,000 (or $7,000 if you're over 50) in 2020 or 2021.
  • Also optional, you can afford to make additional after-tax contributions over and above the $19,500 (or $26,000 if you're over 50) annual 401(k) limit.
  • Your employer's retirement plan allows for in-service withdrawals of these after-tax contributions, or you plan to leave your job in the near future or plan to make a rollover to a Roth IRA later.

How to create a mega backdoor Roth IRA

To invoke the powers of the mega backdoor Roth IRA, first consider maxing out your other retirement savings options. First, ensure you are contributing the maximum pre-tax $19,500 (or $26,000 if you're over 50) a year to your 401(k). Check with your company's HR department for help with this. Second, make the maximum nondeductible traditional IRA contribution of $6,000 (or $7,000 if you're over 50) to your traditional IRA account. Make sure you have a Roth IRA account opened as well. If you don't already have both, you can easily open either kind with most brokers.

Next, start making after-tax contributions to your 401(k) (and remember this is different from Roth 401(k) contributions!). Once you're ready, get in touch with your 401(k) provider to make an in-service distribution -- a fancy term for withdrawal -- of your after-tax contributions into your Roth IRA. Alternatively, if you're unable to make in-service distributions, you can still make after-tax contributions to your 401(k) and move those funds to your Roth IRA when you leave your job.

Mega backdoor Roth IRA contribution limit

As with all retirement savings, the amount you can contribute to a mega backdoor Roth IRA is capped each year. Calculating what you can contribute depends on maximum 401(k) contribution limits and whether your employer offers a matching contribution on your deposits. Here's how to calculate your mega backdoor Roth IRA contribution limit:

  • For 2021, total 401(k) contributions (pre-tax, after-tax, and employer matching contributions and any other nonelective employer contributions) are capped at $58,000 ($64,500 if you're over age 50) in 2021, up from $57,000 ($63,500 if you're over 50) in 2020. 
  • Subtract the $19,500 pre-tax contribution you make ($26,000 if you're over 50) from the annual max 401(k) contribution limit.
  • The resulting maximum mega backdoor Roth IRA contribution for 2021 is $38,500 (up from $37,500 in 2020) if your employer makes no 401(k) contributions on your behalf. 
  • If your employer does make matching 401(k) contributions, subtract that amount as well. For example, if you make $200,000 a year and your employer makes a 3% match, subtract the additional $6,000 in matching contribution ($200,000 x 0.03), leaving a maximum mega backdoor Roth IRA limit of $32,500 in 2021.

Mega backdoor Roth IRA taxes

With a normal backdoor Roth IRA, income taxes are owed on the amount of money converted to a Roth IRA to the extent that the traditional IRA holdings were initially deductible. Similarly, with a mega backdoor Roth IRA, your after-tax contributions are nontaxable. Only investment earnings on after-tax contributions are taxable at your current income tax rate at the time of the withdrawal for deposit to your Roth IRA.

There's a way to avoid those taxes, though. If you make frequent withdrawals of after-tax money (perhaps monthly or quarterly) or you leave your contributions in a money market fund, the earnings should be minimal. Also, if your investments don't yield any return over a given period (or have a tough stretch and lose money), there are no applicable taxes.

This can be tricky if you are making after-tax contributions and your employer doesn't allow for in-service withdrawals. You can still contribute after taxes and transfer the funds to a Roth IRA when you leave your job, but any earnings on after-tax investments could create a sizable tax bill. Consider investing those after-tax funds anyway and transferring the earnings to a traditional IRA instead to avoid the tax bill.

Should I use a mega backdoor Roth IRA?

You should stick with a regular backdoor Roth IRA conversion if your income level isn't high enough, you can't max out both your annual 401(k) and traditional IRA contributions, or your employer doesn't allow for in-service withdrawals. 

But if you meet the income and savings requirements, a mega backdoor Roth IRA is a great vehicle for diversifying your retirement income -- granting you both tax-deferred income (taxable at the time of withdrawal) on your pre-tax contributions and tax-free income on your after-tax contributions (if funds are transferred to a Roth IRA). Plus, a mega backdoor Roth IRA can avoid the taxable event that a normal backdoor Roth IRA conversion often creates.