The Mega-Back-Door Roth 401 (k). Oh, how the government likes to look like they are helping us create our own financial security in the face of a very small social safety net for our country’s ill and elderly.
And you know who else loves it? That’s right, the financial news industry!
Every time the government “improves” our ability to save for retirement, the advertising sales folk at MSNBC, Bloomberg, MarketWatch, et al, rub their hands with glee.
More confusion for investors means more content to sell. Bawah-ha-ha-ha-ha!
But enough of my cynicism! What is the Mega Back Door Roth 401k and should you be using it?
A Mega Backdoor Roth 401(k) is a way for high earners to put more money into a Roth account than normal limits allow. Most people can only put a set amount into a Roth IRA each year. But some 401(k) plans let you add extra money after taxes (beyond your normal contributions). Then, you move that extra money into a Roth account. Once it’s there, it can grow tax-free.
How it works
- You max out your normal 401(k) contributions.
- You add extra money after taxes into your 401(k).
- You move that extra money into a Roth account (either inside the plan or into a Roth IRA) right away.
- That money grows tax-free going forward.
Pros
- More tax-free growth: Your investments can grow and be withdrawn later without taxes.
- Higher savings limit: You can invest much more than standard retirement limits.
- Great for high earners: Especially helpful if you make too much to contribute directly to a Roth IRA.
- Flexibility later: Roth money is often easier to use in retirement without worrying about taxes.
- Better for heirs: Roth money is better for the next generation to inherit than tax-deferred accounts.
Cons
- Not all plans allow it: Your 401(k) must support after-tax contributions and
- More complex: There are extra steps, and mistakes can lead to taxes.
- Less take-home pay now: You’re saving a lot, which means less money to spend today.
- Tax already paid: You don’t get a tax break upfront like with traditional 401(k) contributions.
- Money is tied up until age 59 ½: What if you want to retire in your early 50s and you’ve tied up all your money in accounts that penalize you for taking money out prior to age 59 ½?
Who typically uses this?
A likely investor is someone who:
- Earns a very high income
- Already maxes out their 401(k)
- Has extra cash to save
- Wants more tax-free income in retirement
Although the Mega Backdoor Roth is a powerful tool, it’s NOT for everyone. Don’t get caught up in FOMO or financial media hype.
Talk to your advisor before acting on the advice of a magazine columnist or financial guru with silicone injected all over her face. Oops, there is that cynicism again.
