Mega Backdoor Roth: The Retirement Scheme You Should Know

The Backdoor Roth enables savers to convert a pre-tax retirement account (e.g., 401K or traditional IRA) into a Roth account and avoid paying taxes on the same funds upfront. The problem with this strategy is that it’s only available to those who meet specific criteria: You must have a private company or non-governmental organization employer, have no other significant sources of income besides your retirement savings, and be able to commit to at least 5 years of continuous employment with the same employer. To increase people’s ability to take advantage of the back door conversion, the Mega Backdoor Roth does not require those who qualify to commit to the same employer for 5 years. Moreover, you can consider this strategy if you can’t meet any of these criteria but still want to convert some of your retirement funds into a Roth account. Here’s what you should know about the Mega Backdoor Roth.

1. What is a Mega Backdoor Roth?

A mega backdoor Roth is a strategy that allows you to convert a traditional IRA or 401(k) account into a Roth IRA. Converting from a traditional IRA or 401(k) to a Roth IRA has a big upfront tax bill, usually about 10 percent of the amount converted. But after that, all future withdrawals are tax-free. Converting a traditional IRA or 401(k) to a Roth IRA is especially beneficial for younger people in a lower tax bracket but who expect to be in a higher bracket later in life.

The Mega Backdoor Roth is a strategy that lets you convert a portion of your pre-tax retirement funds into a Roth account without meeting any of the traditional criteria associated with the regular backdoor Roth. This is because the regular backdoor Roth only applies to those with a W-2 job. On the other hand, the Mega Backdoor Roth does not require you to have a W-2 job, though you’ll have to pay taxes on the funds you convert.

2. How does the Mega Backdoor Roth work?

The Mega Backdoor Roth works exactly like the regular backdoor Roth. However, you don’t need to have a W-2 job to qualify. Instead, you can use funds from your traditional IRA or 401K to make a nondeductible contribution (i.e., funds that you have already paid taxes on) to a Roth IRA. You have up to 60 days after the start of the new year to make the contribution. You’ll have to report the funds as income, but you don't need to pay taxes since you’ve already paid them. You can then withdraw them tax-free after age 59. You can contribute a maximum of $19,000, or $36,000 for married couples, for the 2019 tax year. Anything over $19,000 is taxable.

3. How much can I contribute to a Mega Backdoor Roth?

A Mega Backdoor Roth contribution is a helpful way to save for retirement if you earn too much to make traditional IRA contributions or if you don’t have access to a workplace retirement plan. Mega Backdoor Roth IRAs offer several advantages over traditional IRAs. First, there are no income restrictions — anyone can contribute. Second, there is no required withdrawal date. And third, there is no 10 percent early withdrawal penalty.

4. How to Convert Your IRA to a Roth IRA

You’ll first need to open a Roth IRA account to execute the Mega Backdoor Roth strategy. You can open a Roth IRA through many different brokers, including TD Ameritrade, E-Trade, Charles Schwab, Fidelity, Vanguard, and others. If you don’t already have a Roth IRA account, you can open a new account online in a matter of minutes. Next, you’ll have to open a Traditional IRA or a 401K account. You can do this online as well. Make sure to fund your Roth IRA account first before transferring funds from your Traditional IRA or 401K to your Roth IRA account. You can also use a trustee-to-trustee transfer to avoid the hassle of mailing paperwork. Once the funds are in your Roth IRA account, you can start withdrawing them at any time after 59. Keep in mind that you’ll pay taxes on the funds when you make a withdrawal.

5. Benefits of the Mega Back Door Roth

Unlike the standard IRA, the Mega Back Door Roth IRA allows you to contribute up to $19,000 per year. In addition, unlike the standard IRA, the Mega Back Door Roth IRA gives you a tax break upfront. With the Mega Back Door Roth IRA, you won’t have to pay taxes again when you withdraw funds in retirement.

The Mega Back Door Roth IRA also allows you to withdraw funds without paying taxes or penalties if you become disabled or if you’re over 59 1/2 years old. In order to open a Mega Back Door Roth IRA, you must have earned income. As with all IRAs, you can’t contribute to the Mega Back Door Roth IRA if you’re above the maximum income level. In 2019, that was $132,000 if you’re single or $194,000 if you’re married.

The Mega Backdoor Roth strategy also allows you to diversify your retirement savings, reduce your tax burden, and increase the amount you save for retirement.

6. Limitations of the Mega Backdoor Roth

Although the Mega Backdoor Roth is a great strategy, it’s important to remember that this strategy involves paying taxes upfront. You have to factor in taxes you’ll have to pay upfront when determining how much you can contribute to a Roth IRA. Moreover, there’s always a chance that you’ll have to pay more taxes on the funds you withdraw after 59 if Congress passes tax legislation.

7. The Catch: You Must Pay Taxes Upfront

A huge advantage of the Mega Backdoor Roth is that it doesn’t require you to commit to 5 years of continuous employment with the same employer. However, the flip side of this advantage is that you must pay taxes on the funds you contribute to your Roth IRA. 

8. Is a Backdoor Roth worth it?

While a backdoor Roth might benefit some, it’s important to note that it isn’t the best option for everyone. Certain groups of people should avoid a backdoor Roth, including people with a high income and those in a high tax bracket. If you’re in a high tax bracket, you will probably pay a higher rate on your earnings than if you had taken the same amount of money as taxable income.

Self-employed people may also want to avoid a backdoor Roth, as you’ll likely be in a high tax bracket. People likely to be in a high tax bracket should consider other ways to contribute to their retirement accounts, such as making regular contributions.

The Mega Backdoor Roth strategy is definitely worth it for two reasons. First, you effectively save yourself a ton of money. Remember, you’ve already paid taxes on the funds you contribute to your Roth IRA. Second, a Roth IRA is one of the best retirement savings accounts out there. With the Mega Backdoor Roth, you can put more money away for your golden years.

Summing up

The IRS continues to release new retirement schemes to help you save for your golden years. The latest is the Mega Backdoor Roth, which is a more advantageous version of the backdoor Roth IRA. The Mega Backdoor Roth allows you to convert a portion of your pre-tax retirement funds into a Roth account without meeting any traditional criteria associated with the regular backdoor Roth. Suppose you want to save more for your retirement but don’t have enough money to do so. In that case, you can use the Mega Backdoor Roth strategy to convert a portion of your pre-tax retirement funds into a Roth account without meeting any of the traditional criteria associated with the regular backdoor Roth.