Could a Mega Backdoor Roth Enhance Your Tax-Free Retirement Savings?

Roth IRAs are a favored tool for retirement savings, offering the benefit of tax-free qualified withdrawals after age 59½, and in some cases even earlier. For many individuals, the advantages of Roth IRAs often outweigh those of traditional IRAs and qualified retirement plans. However, high earners face significant challenges in accessing Roth IRAs due to strict income limits.

For 2024, you cannot contribute to a Roth IRA if your modified adjusted gross income (MAGI) exceeds:

• $161,000 if you’re single
• $240,000 if you’re married and file jointly

While this can be a roadblock for many high-income earners, those with access to a 401(k) may still unlock Roth benefits, regardless of their income.

Here are three ways 401(k) plans can enable high earners to enjoy the perks of Roth savings:

1. Roth 401(k) Contributions: Unlike Roth IRAs, Roth 401(k) contributions have no income eligibility limits. While these contributions are not tax-deductible, qualified distributions are entirely tax-free. Moreover, the contribution limits for Roth 401(k)s are significantly higher than Roth IRAs, set at $23,000 for 2024, with additional catch-up contributions for those aged 50 and older.
2. In-Plan Roth Conversions: Many 401(k) plans now allow in-plan conversions, enabling participants to convert non-Roth amounts (e.g., pre-tax contributions) into Roth amounts. This conversion triggers taxable income but positions the funds for future tax-free growth.
3. Mega Backdoor Roth Strategy: For eligible participants, the Mega Backdoor Roth allows for substantial additional contributions to a Roth account within a 401(k) plan.

A Mega Backdoor Roth hinges on the flexibility of your 401(k) plan. If your plan permits certain types of after-tax contributions, you could use this strategy to maximize Roth savings. Here’s how it works:

• After-Tax Contributions: Some 401(k) plans allow after-tax contributions beyond the standard salary deferrals and employer matches. These after-tax contributions are distinct from Roth contributions since any earnings on them are taxable upon withdrawal.
• Immediate Conversion to Roth: If the plan supports Roth in-plan conversions, you can immediately convert these after-tax contributions into a Roth account within the plan. Because the conversion happens before the funds earn any taxable income, no taxes are due on the conversion itself.

The total contribution limit for 401(k) plans in 2024 is $69,000, which includes:

• Salary deferrals
• Employer contributions
• After-tax contributions

For example, if you contribute $23,000 and your employer adds $7,000, you could make up to $39,000 in additional after-tax contributions.

While the Mega Backdoor Roth offers immense benefits, there are a few plan requirements:

• Your 401(k) must allow Roth contributions, in-plan conversions, and after-tax contributions.
• After-tax contributions are subject to non-discrimination testing, which can limit contributions for highly compensated employees (those earning over $150,000 in 2023). However, certain 401(k) plans may be exempt from this testing.

For high-income earners unable to contribute directly to a Roth IRA, the Mega Backdoor Roth offers a powerful way to build tax-free retirement savings. By leveraging the flexibility of 401(k) plans, you can overcome income limits and maximize your retirement strategy. If your plan supports this strategy, a Mega Backdoor Roth could be the key to unlocking significant long-term tax advantages.

The details in performing a Mega Backdoor Roth can be complex, so you should consult with your Oppenheimer Financial Professional and tax advisor for guidance in your situation. Click here to find one in your area.