In 1989, Senator Bob Packwood of Oregon, and Senator William Roth of Delaware, proposed the idea of what they termed at the time, the “IRA Plus”. Their idea was to allow individuals to make contributions now, with no immediate tax savings (no benefit today), and then allow for tax free growth and tax-free withdrawals of the entire balance at and during retirement. As things tend to do in politics, it became a bargaining chip and finally, on a glorious day in 1997, President Clinton signed the Taxpayer Relief Act of 1997 with 100% Republican support and 82.2% Democrat support.

At Whitaker-Myers Wealth Managers, there are two things we are pretty passionate about: Dave Ramsey & Ramsey Solutions teachings and the Roth IRA. The Roth IRA, not only makes financial sense for most people but considering the out of control government spending we’ve seen recently, do you honestly think that tax rates and structures will be lower in the future, then they are today? As of July 1, 2021, the U.S. Treasury’s official figure for debt of the federal government is $28.5 trillion, which only three short years ago was about $19 trillion. This amounts to approximately $85,680 per person living in the US. Considering many US persons don’t even pay taxes, the debt per actual taxpayer is a staggering $183,000. The point of this article is not to discuss the merits or risk of government borrowing, as some would argue national debt is actually good, but to make the point, that amount of debt, needs to be serviced (interest) and taxes are the way it’s serviced. More interest owed equals more taxes needing to be paid… Hence the point of this article, the Mega Back-Door Roth.

Normal Roth Contribution Limits (2021)

$6,000 – Annual Roth IRA Contribution

$1,000 – Annual Roth IRA Catch-Up Contribution (if you’re 50 or older)

$19,500 – Roth 401(k) Contribution (assuming your employer allows it)

$6,500 – Roth 401(k) Catch-Up Contribution

$25,500 – Annual Roth contributions for those younger than 50

$33,000 – Annual Roth contributions for those older than 50

Of course, to be able to make the Roth 401(k) contributions, you must have access to a 401(k) with a Roth feature and, if you don’t, please have your employer contact Whitaker-Myers Wealth Managers 401(k) Group to discuss how to implement the Roth 401(k) at your place of employment. If you do have access to a 401(k) at your employer, it is possible that they allow after-tax contributions, after you max your 401(k) contributions for the year. The after-tax contributions are what creates the mega back-door Roth.

The mega back-door strategy relies on a little-known fact about 401(k) plans. The internal revenue service allows employees & employers to set aside up to $58,000 per year in a 401(k) account, and because of the $6,500 catch up contributions, it’s $64,500 for those 50 or older.

To get to the $58,000 annual 401(k) contribution limit the participant would have already made their $19,500 contribution into either the pre-tax, or Roth account, within the 401(k). They would now be able to contribute $38,500 through an after-tax contribution (this assumes no match and a match would decrease the amount eligible for the after-tax side). The strategy would then be to transfer the monies from the after-tax side of the 401(k) to their Roth 401(k) or Roth IRA soon after making them, therefore only requiring income taxes to be paid on the growth of the investment, from the time of the initial contribution to the conversion.

Client Example

Client A who makes approx. $250,000 in salary and bonus and receives a 5% 401(k) match from his employer, decides he would like to contribute the $58,000 into his Roth IRA through the mega backdoor strategy. Client A makes his normal $19,500 contribution from January 1st – April 30th and now he’s ready to make the after-tax contribution for the remainder of the year, which would be the $58,000 - $12,500 (employer match) - $19,500 (maximum employee contribution) = $26,000. From May 1st – December 31st , he maxes the after-tax side of his 401(k) plan. Then on January 2nd of the following year, he and his financial advisor call his 401(k) provider and have them roll over his after-tax contributions of $26,000, which has earned $1,000 (assumed) in market growth over the last 8 months. The $26,000 would not be taxable, because it was an after tax, hence already taxed, contribution, but the $1,000 in growth has never been taxed, therefore it would need to be taxed at his current income tax rate, perhaps 24% federally, therefore costing him around $240 in taxes, to complete his mega back door Roth IRA.

401(k) Plan Adoption

To be able to complete the mega back door Roth, you’ll need to determine if your plan allows for it. Additionally, you’ll want to ask if your 401(k) plan allows participants to roll their after-tax savings over to a Roth IRA or convert this money to a Roth 401(k), while you’re still employed. If you’re over 59 ½, most plans will allow you to roll over your 401(k) savings, both pre-tax and Roth, to an IRA, even if you continue to work for the company and contribute to the 401(k) plan.

Today, Vanguard Group says that about 40% of 4.7 million participants in its 401(k) plans have access to after-tax savings, hence would be eligible for the mega back door Roth. Currently, only 10% of those participants have made such a contribution. On the other hand, Fidelity, who is the largest retirement plan provider in the US, says more than 90% of its 19.5 million participants in its 401(k) plans are eligible to make after-tax contributions. Additionally, about three quarters of 401(k) plans that Fidelity administers offer a Roth 401(k) option.

Your Whitaker-Myers Wealth Managers Financial Advisor would be more than happy to discuss the mega back door strategy with you to determine, if it makes sense for your unique personal situation and to help investigate whether your companies retirement plan allows such a benefit.