By Venessa Wong

Mega-backdoor Roth strategy lets high earners boost their retirement savings

Open enrollment season is here, and as people plan their budgets for 2025, some lucky high-earners might consider boosting their retirement savings using a rare but increasingly popular strategy for their sponsored 401(k)s by the employer.

The “mega-backdoor Roth” – a three-part strategy that allows employees to direct more of their paychecks into workplace retirement accounts than the usual limit – will allow workers to put up to 70 $000 in their 401(k) in 2025. (k) Contributions are not tied to open enrollment. “I think (this period) is a good marker for people to evaluate how they are saving,” Matthew Fleming, financial planner and senior wealth advisor. at Vanguard, told MarketWatch.

The mega-backdoor Roth remains a rare feature in 401(k) plans, but Jorie Johnson, a financial advisor at Financial Futures in New Jersey, said more than 30 percent of her clients now have 401(k) plans. companies that offer this option. , up significantly compared to just a few years ago. About half of his clients with access to this strategy use it to save extra money for retirement, even if they don’t cap it at $70,000.

“We’re seeing more and more 401(k) companies offering it because more and more people are asking for it,” Johnson told MarketWatch. “It’s not difficult for a company to add it” because most large payroll systems are able to handle it, she added, so “it’s so easy for HR to offer as an advantage.

Here’s how the strategy works:

1) Employees are maximizing allowable contributions to their company 401(k) – which the IRS recently announced would amount to $23,500 for 2025, with workers ages 50 and older receiving an additional $7,500 in catch-up contributions.

2) They direct an extra portion of their paychecks to their 401(k) as after-tax contributions.

3) They immediately convert these after-tax contributions to Roth status (which some plans let you do automatically), so they can grow tax-free and eventually be withdrawn tax-free in retirement.

Related: The IRS Just Set 401(k) Limits for 2025 — Here’s How Much You Can Save

It’s a way for high-income people – who make too much money to be able to increase their retirement contributions through a regular Roth IRA (which is an individual account, not a company plan) – to save up to $70,000 in their employer-sponsored 401. (k) next year, or $77,500 for people over 50. This is indeed a “mega” amount.

“It’s really nice to get tax-free growth on that money,” Fleming said.

Who can afford the mega-backdoor Roth?

Although increasingly popular, the use of this strategy remains rare for several reasons. On the employer side, only a small portion of 401(k) plans offer all the mechanisms necessary to create a mega-backdoor Roth: a Roth option, the ability to make after-tax contributions, and the ability to convert those dollars into a Roth . At Fidelity, only 10% of 401(k) plans can achieve all three, noted Mike Shamrell, vice president of thought leadership at Fidelity. “It’s not very widespread,” Shamrell told MarketWatch.

On the employee side, most Americans simply don’t earn enough to contribute the maximum $23,500 to their 401(k). “It’s not like you’re doing anything wrong; it’s just the norm for many American workers,” Shamrell said. As a reminder, the median income for all American households was $80,610 in 2023 and $119,400 for married couples, according to the Census Bureau.

See also: Avoid the 401(k) and IRA ‘tax time bomb’ by going all-in on Roths, expert says

Those who are able to max out their 401(k) can choose to invest additional retirement dollars in a traditional or Roth IRA. However, there is a $7,000 annual contribution limit on IRAs in 2025, and people who earn more than $165,000 as a single filer and $246,000 as joint filers in 2025 cannot save in a Roth IRA. This is where the mega-backdoor Roth strategy can come in handy.

Financial Futures’ Johnson said that for clients who want to save more for retirement, “I recommend doing the mega-backdoor Roth,” while those with short-term goals might be better served by others means.

Interested savers should consider whether there “might be competing priorities or wealth goals” that could benefit from investing these after-tax dollars “in a more accessible manner” than a retirement account, a said Fleming of Vanguard. He also noted that people with very high net worth should think about the tax implications of increasing their estate for beneficiaries through retirement accounts, and whether that money “could be better used to help fund different types of trust vehicles”.

How to Set Up a Mega Backdoor Roth

People who have done their math and are interested in the mega-backdoor Roth strategy can call their 401(k) plan provider and ask if their plan offers it. Another way to characterize it is “after-tax contributions that can be converted to a Roth.”

If you’re eligible, the plan provider would set the deduction on each paycheck coming into the 401(k) to reach the $23,500 maximum for 2025.

You will then also decide how much of your salary you want to put into the 401(k) as after-tax contributions. Remember that the sum of all your contributions and your employer’s match next year cannot exceed $70,000. For example, if you contributed the maximum $23,500 and your employer match was an additional $10,000, you could make up to $36,500 in after-tax contributions to your 401(k).

Johnson said some of his clients who can’t afford to save more from their regular paychecks have set up their bonuses to fund big backdoor Roth plans.

The provider could then set up the after-tax contributions to automatically convert to a Roth (as an “in-plan conversion”) when they are deposited, so that you don’t pay tax on the earnings. Fleming said that generally, these after-tax dollars are invested in whatever the rest of the 401(k) is invested in — but “there’s not a uniform set of rules,” so people will have to ask their providers how their specific plan works. and act accordingly. For example, at Fidelity, some plans may allow users to choose a specific allocation for Roth sources.

Other plans, instead of making conversions within the plan, execute the mega-backdoor Roth strategy by removing these after-tax contributions from the plan in the form of a Roth IRA rollover, Fleming noted. “You need to talk to the plan provider to understand what options are available,” he said.

People with accounts with Vanguard can track their money by logging into their 401(k) and viewing the source details, which show the amount of pre-tax contributions, Roth contributions and – for people using the Roth strategy of mega-backdoor – after -tax assessments, Fleming said.

The mega-backdoor Roth is not simple and “every situation is unique,” ​​Shamrell said. “Seeking advice from a tax professional is the best way to help you understand the potential tax impacts of your strategy.”

-Venessa Wong

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  11/23/24 1043ET
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