Megabackdoor Roth: a Retirement Superpower

In the world of retirement planning, there are a few weapons that can help you build a tax-advantaged fortune. One of these hidden gems is the Megabackdoor Roth, a strategy that can supercharge your savings and leave you with a substantial nest egg. Let’s explore how it works, its benefits, and why it’s an absolute game-changer for those who understand its potential.

Traditional retirement accounts, such as 401(k)s and IRAs, offer tax-deferred growth, meaning you won’t pay taxes on the earnings until withdrawal. Roth contributions, on the other hand, offer tax-free growth and tax-free withdrawals.

In 2024, the contribution limits for 401(k)s and IRAs (both traditional and Roth) are:

• $23,000 for 401(k)s ($30,500 if over 50 years old)
• $7,000 for IRAs ($8,000 if over 50 years old)

It is a good chunk of change, but there’s a whole different bucket of tax-advantaged savings to be had.

The lesser-known 401(k) contribution limits

Every year, the IRS publishes contribution limits for retirement plans. Most news outlet will report it with a typical headline of “IRS raises 401(k) contribution limits to $23,000 for 2024”, but that’s not the whole story. They also publish a much larger number ($69,000 in 2024) which represents the total maximum contributions allowable from all buckets of potential contributions:

1. the “regular” bucket: where pre-tax and Roth contributions go and what 99% of people think of when they talk about their 401(k) contributions
2. the “employer match” bucket: where the employer deposits the contribution match, subject to their own rules and vesting schedule
3. the “after-tax” bucket: where the megabackdoor Roth magic will occur.

A real world example: Microsoft

Microsoft matches 50% of “regular” contributions. This means that an employee who takes advantage of the full regular bucket of $23,000 receives and additional $11,500 in match.

This leaves:

69,000 - (23,000 + 11,500) = $34,500 of after-tax contribution space.

Filling up the entire space

This is done by you contributing to a 401(k) plan that allows after-tax contributions. These contributions are made with after-tax dollars, just like a Roth IRA or Roth 401(k) contributions in the regular bucket.

The steps are:

1. contribute after-tax dollars to a 401(k) above and beyond the regular bucket
2. Make sure to designate the contributions as after-tax, so they’re not mixed with pre-tax or Roth contributions. This is crucial, as it will affect the tax treatment of the money in the future.
3. do a conversion of the after-tax contributions to Roth, either to a Roth 401(k) (staying in the plan), or an outside Roth IRA. All the big 401(k) providers now offer this conversion step as an automatic feature that occurs immediately after the contribution.

By following the process, a plan participant is able to squirrel away tens of thousands of dollars in a Roth vehicle, ensuring a comfortable retirement.