Is a Mega Backdoor Roth IRA Right For You?

Christine Benz: I want to touch on what’s called the mega backdoor Roth IRA, and I’m hoping you can talk about who should consider that.

Ed Slott: That’s from a company plan where you can actually load up on the aftertax money in a 401(k), let’s say, in a separate 401(k) aftertax account, and convert just that to your Roth IRA and pay no tax. Yes, it can be done. You can bank lots of big money, but for most people, it doesn’t work—especially in big companies, maybe if you’re a smaller company and you have fewer employees—because you have to satisfy discrimination rules and testing rules. And the people that tend to want to do it are the high-income people at the company. The big executives want to do that, but they may not be able to—I’m giving you the reader’s digest version of the compensation tests—and it may be that they don’t qualify because not enough lower-income employees are doing it. It’s how many people are doing it. And remember, you have to have the disposable income to do it. A lot of the lower-paid employees can’t do it, so they don’t. And that only leaves the higher-paid people, so they fail the discrimination or the compensation tests.

Benz: And in any case, it sounds like maxing out the 401(k) up until the basic limits should be job one for most employees.

Slott: Oh, yeah, to get the matching and so forth. But the backdoor Roth is still alive, and it’s a great technique for lots of people. I’ll tell you one they miss. I found this every tax season. You have somebody who wants to do that. Let’s say, especially a lot of our viewers, you could have a married couple where one spouse is working and the other one is already retired. You can do the backdoor Roth for the nonworking spouse as long as you have enough income. Most people miss out on that.

So, for example, using the 2024 amounts, which are $7,000 and $1,000, or $8,000, you could put away for 2024—I know people right now might be working on their 2023, but just to give you an example—you could double that even if the nonworking spouse has no earnings as long as there’s enough earnings that you’ve made. And you could double that and put $16,000 away for both spouses. And to me, that’s a freebie. You’re just taking from one pocket taxable money and putting in tax-free for both spouses. Many people don’t realize that they have that ability.