Biden’s failed (or delayed?) Build Back Better plan had lofty ambitions, one of which was to close loopholes in order to raise tax revenue.
One of those loopholes that BBB went after is the “Mega Backdoor Roth”, an oft overlooked strategy to grow retirement savings tax-free.
It goes something like this:
1. Max out your traditional “pre-tax” 401(k) allotment ($20,500 for 2022).
2. Contribute an additional sum of money to your 401k in the form of “after-tax” contributions [I didn’t realize this until recently, but after one one has maxed out their traditional pre-tax 401(k) allotments, the IRS allows after-tax contributions up to a maximum of $61,000 in total contributions, inclusive of your pre-tax contributions and money your company contributes. These additional funds come in to your account “after-tax”, so they don’t come with the same tax benefit as traditional contributions].
3. Work with with your 401(k) administrator to trigger “in service withdrawals” to a Roth account — or in other words automatically move your “post tax” 401(k) allotment into a Roth IRA or Roth 401(k) after each contribution.
By doing all of the above, you can move up to $40,500 of additional funds (assuming no company contributions) into a Roth account, which grows tax free, and generally won’t trigger taxes when you withdraw funds in retirement. Sure, you’re paying taxes on the money before you invest it, but if you’ve got a lot of years of savings ahead of you, not having to pay tax on the appreciation is a big perk.
Is this fancy maneuver for everyone? Probably not.
First of all, you need to work at a company that allows post-tax 401(k) contributions. Not all do.
Second of all, you need to be in a position to save more than the $20,500 already allocated to your traditional pre-tax 401(k). That’s a lot of retirement savings.
And third of all, your plan administrator needs to allow for “in service” withdrawals into a Roth IRA or 401(k). This is a critical element of the strategy, as it’s this step that enables the money to grow tax free. Without it, it’s not clear to me there’s much benefit to investing post-tax funds into your 401(k).
While not an authoritative source, levels.fyi reports a number of large firms that allow for the above sequence of events.
If you’re fortunate enough to have the means to save, and work at a company that supports it, 2022 may be the year to give the Mega Backdoor a try. It’s likely only a matter of time before congress successfully shuts it on you.
NOTE: I’ve had a few questions already about the difference between the Backdoor and Mega Backdoor strategies. They are different! And the Mega Backdoor is more tax advantaged in my opinion! Learn more here: https://www.buckbybuck.com/blog/mega-vs-regular-backdoor-roth-whats-the-difference
Disclaimer: I’m not a financial advisor nor a tax attorney. This stuff is complicated. Make sure you read up and consult a professional.