What is the Mega Backdoor Roth IRA Contribution? How can it be a game-changer for some high-earning individuals who are already maxing out their 401k plans? If you’re investing the maximum you can a year, think of how quickly you can hit financial freedom. If you’re passionate about investing as much of your income as you can—this is the episode for you. I explain the step-by-step process of finding out if you qualify. Don’t miss it!
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Outline of This Episode
- [1:33] Dissecting the total compensation package
- [4:34] Executing a Mega Backdoor Roth IRA Contribution
- [6:55] Does your 401k plan allow non-Roth after-tax contributions?
- [9:46] Is there room under the ACP test to make additional contributions?
- [11:39] Calculating how much you can contribute
- [13:23] Does your plan allow for in-service distributions?
- [16:44] Are the non-Roth after-tax contributions moved to a separate account?
Mega Backdoor Roth 101
The first question you have to ask: Have I made the maximum salary deferral contribution of $19,500 into my 401k? If you’re 50 or older, have you contributed $26,000? If you haven’t maxed it out, you don’t qualify for the Mega Backdoor. You have to focus on maxing out your 401 contributions first.
Secondly, Does your 401k plan allow non-Roth after-tax contributions? The answer can be found in your summary plan description. Your employer is legally required to give this to you when you’re hired—and if you ask for it again. If you login to your 401k provider’s website, you’ll often find it under the “documents” tab. If you can’t find it, email your HR rep and ask for a copy.
If your plan doesn’t allow the non-Roth after-tax contribution—you can’t move forward. If it IS allowed, you can contribute above and beyond $19,500 (or $26,000). You CAN continue along this journey. The truth is that most plans don’t allow this, but it’s worth finding out.
Is there room under the ACP test to make additional contributions?
An ACP test is typically conducted each year to make sure the 401k plan doesn’t unfairly benefit a highly-compensated employee. It limits the amount that highly compensated employees can make. If you’ve maxed out your 401k, you’ll likely fall into that category. Ask your plan sponsor if you’re considered highly-compensated.
What happens if you don’t ask? When the ACP test is done at the end of the year—after you’ve made the contributions—the money you contributed can get sent back. But if the plan sponsor says you aren’t considered highly compensated, you can move forward.
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How to calculate how much you can contribute
How do you calculate how much you can contribute? Add all of the employee and employer contributions that have been made this year—unless you’re 50 or over. You do NOT count the extra $6,500 contribution. Once that’s added, subtract it from $57,000. Why?
In 2020 you can make up to $57,000 worth of retirement contributions inside of your plan. If you have more than one 401k, add up every plan you've contributed to. So you take $57,000 and subtract $19,500 and what your employer contributes you arrive at $31,500. That’s the amount you can contribute to the non-Roth after-tax portion of your IRA.
Does your plan allow for in-service distributions?
You can find the answer to this in your summary plan description as well. Generally speaking, to withdraw money from a retirement plan, you must either retire or leave that employer (unless you’re taking out a loan). But most plans allow an in-service distribution. So, while you’re still working for the employer, you can withdraw money.
Many plans that allow the non-Roth after-tax contribution allow for in-service distributions of that money. If your plan does not allow in-service distributions you can still make a Mega Backdoor Roth IRA distribution—but you will lose some of the tax benefits.
If you leave your employer, you can roll the whole portion into a Roth IRA. But any earnings on that portion will be taxed as income when you roll it over. If your 401k allows for a non-Roth after-tax contribution AND an in-service distribution then you can move on to the final step.
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Have you moved the non-Roth after-tax contributions to a separate account?
If your 401k allows for a non-Roth after-tax contribution AND an in-service distribution—are the non-Roth after-tax contributions moved to a separate account? If the answer is yes, you CAN do the Mega Backdoor Roth IRA contribution. Once the contribution goes in, you can immediately take that after-tax portion and roll it into a Roth IRA while working for your employer. It will grow tax-free for the rest of your life. That is a Mega Backdoor Roth IRA.
How do you manage the Mega Backdoor Roth contribution? Do you need a financial advisor? If you’re not paying attention, this could blow up in your face. How? I share my thoughts—and all the nitty-gritty details—in this episode.
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Podcast Disclaimer:
The Best In Wealth Podcast is hosted by Scott Wellens. Scott Wellens is the principal at Fortress Planning Group. Fortress Planning Group is a registered investment advisory firm regulated by the Securities Act of Wisconsin in accordance and compliance with securities laws and regulations. Fortress Planning Group does not render or offer to render personalized investment or tax advice through the Best In Wealth Podcast. The information provided is for informational purposes only and does not constitute financial, tax, investment or legal advice.
