Megabackdoor Roth

Motivation

The motivation for a megabackdoor Roth is to take advantage of the full 401k limit defined by the IRS. It is comprised of the employee contribution limit of $22,500 limit, which can be Traditional (pre-tax) or Roth. This is the limit most people are familiar with. If you are over the age of 55, this limit is $30,000.

However, the total 401k limit is actually $66,000, or $73,500 for those over 55! The additional difference is made up by your employer match (if you have one!) and "after-tax" 401k contributions. After-tax is what we will be leveraging to perform megabackdoor Roth conversions. It is a way of unlocking the full limit.

After-tax contributions are like Roth contributions in that you pay income taxes on the contribution amount at the time the contribution occurs. However, unlike Roth, there is no tax advantage to after-tax contributions without performing a conversion. A conversion is a change of the tax treatment of contributions. In the case of a megabackdoor Roth, that conversion is from after-tax treatment to Roth. This is a taxable event!  

Thankfully, you already paid taxes on the contribution amount, so the taxable event is generally not impactful. The only taxable income on the conversion that occurs is on the gains that may have occurred in the time that it was classified as after-tax. Many 401k providers have made these conversions as close to instantaneous as possible, meaning each conversion is not taxable.

After a conversion has taken place, the converted principal is now entirely classified as Roth, meaning you'll never pay a dime in income taxes on that balance again!* * under current tax law

Note: Some employers artificially limit after tax maximums. for instance, my employer limits it to account for the maximum possible employer match.