Mega Backdoor Roth IRA

Mega-sized Retirement Savings

When we fight our best rate fight, we want the highest possible sustained turn rate.  When we fight our best retirement savings fight, we want the highest possible savings rate.  For most of us that looks something like:

  • $6,000 in a Traditional or Roth IRA, and/or
  • Up to $19,500 in the Traditional or Roth TSP / 401(k)

If retirement savings rate was BFM, then most of us would be getting 6° per second, and some might be getting 25.5° per second (6 + 19.5).  But is it possible to get 64° per second?  Yes… but probably not while you’re on active duty.

Ops Limits Review

Recall that the current IRS limits for retirement account contributions are as follows for those under age 50:

  • $6,000 into an IRA (Traditional or Roth)
  • $19,500 employee contribution into TSP/401(k) (Traditional and/or Roth)
  • $58,000 total contributions into TSP/401(k)

Let’s focus on that $58K number.  Sometimes referred to by its IRS name, the 415(c) limit is the total amount that can go into the TSP/401(k) in a year.  $58K is a pretty high number for retirement savings in a given year and it could be composed of:

  • $19,500 of employee contributions and $38,500 of employer contributions (which are always tax-deferred)

Or

  • Any mix of employee and employer contributions that doesn’t exceed the 415(c) limit

So, if it’s possible to max out the $58K contribution number, why don’t more of us do it?

Paths to $58K

Let’s imagine a dual-income family where one spouse is active duty and the other is an airline pilot with a 401(k).  The active duty spouse has some serious limits on their TSP contributions:

  • $19,500 employee contributions
  • $7,436 employer contributions (hypothetical maximum 5% match if under the Blended Retirement System for a 26-year O-6… which is a very hypothetical retirement saver…)

In a non-deployed year, the active duty spouse can only get about $26,936 into the TSP.

The airline pilot spouse probably gets a 16% profit sharing non-elective contribution directly into their 401(k).  So, let’s assume that the airline salary is $200K.  The contributions might look like:

  • $19,500 of employee contributions
  • $32,000 of employer contributions

The hefty airline 401(k) match nearly gets the account to the $58K limit.  At a salary of about $240K, the 415(c) bell rings and over that, the automatic employer 16% contribution starts to crowd out the employee’s contributions.  First-world problems to be sure, but we’re trying to max perform our retirement savings rate here…

Enter the Mega

The previous examples are the customary paths to maxing out employer-sponsored retirement accounts.  However, in each case, a large chunk of the contributions are tax-deferred Traditional dollars even if the employee made Roth contributions.  This is because employer contributions are always tax-deferred to the employee so that the employer can deduct them in the tax year they’re paid.

If you (or your spouse) are self-employed with a Solo 401(k), or you work for a company that has a versatile 401(k) you can get to $58K without such an outsized profit share or salary using a “Mega Backdoor Roth IRA.”

The Mega Backdoor Roth IRA is a bit of financial slang to describe the process where you use a 401(k)’s enhanced features to contribute additional non-deductible dollars beyond the $19,500 employee limit, then immediately convert those additional contributions into Roth dollars, either inside the 401(k) or by rolling over those dollars over to your Roth RIA.

Before you log on to the TSP or your 401(k) to give this a spin, here’s the bad news.  The TSP doesn’t allow this and most 401(k)s don’t either.  There are two key plan features that the plan must offer:

  • Additional after-tax contributions
  • In-service Roth conversions or withdrawals

Additional after-tax contributions allow you to inject dollars past the $19,500 employee limit.  If your employer doesn’t offer matching dollars, then in theory, you can contribute $38,500 of additional after-tax dollars regardless of whether the first $19,500 was Traditional or Roth.

In-service Roth conversions allow you to recharacterize dollars as Roth while keeping them inside the plan.  Post-conversion, those dollars remain “after-tax” and their earnings grown and distribute tax-free in most cases.  If you had just contributed these additional after-tax dollars, then there should not be a taxable event for this conversion.

If the plan doesn’t allow in-service conversions, but does allow withdrawals, you can achieve the same effect by rolling over (direct between institutions, please) those dollars into your Roth IRA.  You just paid tax on the money as you earned it, but now it grows tax-free, potentially until 10 years after the later of you and your spouse’s deaths.

Presto—instead of getting $6,000 into your Roth IRA through the backdoor, you get that $6K plus potentially $19.5K of employee Roth 401(k) contributions, plus up to $38.5K of additional after-tax contributions that you immediately convert to Roth dollars for a total of up to $64K of Roth contributions (in 2021, under age 50).

Cleared to Rejoin

Why discuss Mega Backdoor Roth IRAs if you can’t do them in the TSP?  Simply-put: times have changed.  Many of us have working spouses that out-earn us.   Some of us moonlight on the side in real estate or other consulting.  Finally, we won’t be in uniform forever.

If extra retirement savings dollars were scarce while serving your country, knowing about tactics like the Backdoor Roth IRA and Mega Backdoor Roth IRA can help you play catch-up when it’s time to push up the throttles on retirement.  As always, there a lot of devilish details about Mega Backdoor Roth IRAs, but if you’re the type that likes to max-perform anything that can be max-performed, you may want to look into this strategy.

Fight’s On!

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