Mega Backdoor Roth Solo 401k and Roth IRA

Learn what it is, how it works and whether it is advantageous for your situation!

Rachel Nabers avatar
Written by Rachel Nabers
Updated over a week ago

Investors love to contribute and use Roth funds because of their tax-free growth. The trouble is you're typically limited in how much you can contribute to a Roth IRA. Contributions to Roth IRA have a ceiling of $7,000 per year.  The Solo 401k Roth limits are much higher at $23,000 but still - what if you could get more after-tax dollars to grow tax free? Enter the Mega Backdoor Roth IRA using the Solo 401k plan.

What is it?

 The mega backdoor Roth Solo 401k allows you to contribute more after-tax dollars than you would in a normal Roth IRA. By contributing money into the Solo 401k plan, you can convert those dollars to Roth funds. Once the funds are converted you can roll the Roth funds into a Roth IRA. The result is that you can eventually take the funds out of the Roth IRA without tax penalty.

The IRS recognizes the Mega Backdoor Roth as a legitimate strategy. In 2014 they released guidance on documenting after-tax contributions. The strategy grew out of the original backdoor Roth IRA conversion where investors would take contributions to their 401k or traditional IRA, convert them to Roth (and pay the taxes) and then roll those Roth funds into a Roth IRA. This is an especially valuable strategy for high-earners who don't qualify to contribute directly to a Roth IRA or those who want to get more savings and assets into a Roth IRA structure.

Disclaimer: This is a complex strategy that requires meticulous calculation and excellent documentation. The Nabers Group Solo 401k plan allows for all elements of the mega backdoor Roth. However, we recommend you get help from your CPA or tax advisor before executing this strategy  to ensure it's done properly.

How does it work?

The mega backdoor Roth strategy is a way to get even more money into your Roth Solo 401k or your Roth IRA.

To exercise a Mega Backdoor Roth, the plan documents must contain:

  1. Employee elective deferral Roth contributions

  2. In-plan Roth conversions

  3. After-tax employer contributions

Your Nabers Group Solo 401k contains all the elements needed for a mega backdoor Roth Solo 401k option.

Decide how much you'd like to get into the Roth structure through the mega backdoor Solo 401k strategy. Then, allocate how much will be a Roth contribution (if any) and how much will be a voluntary after-tax contribution. Roth 401k contributions can roll into a Roth IRA almost any time. Voluntary after-tax contributions are converted to Roth funds once they are in the plan.

Converting after-tax contributions to Roth is not a taxable event as the funds are already after-tax. Rather, you are re-classifying the voluntary after-tax contributions to Roth funds.

IMPORTANT: Keep in mind that once you convert/re-classify your voluntary after-tax contributions to Roth funds, they must follow the rules for Roth distributions in order to be qualified. Once you convert after-tax funds to Roth, they cannot be turned back!

After you have contributed Roth or after-tax dollars to your Solo 401k plan, and the after-tax contributions are converted to be Roth funds, those funds can then roll into a Roth IRA. The result? Instead of making $7,000 in Roth IRA contributions, you can make up to $66,500 in mega backdoor Roth IRA contributions. That's a ten-fold difference in Roth IRA funds!

 

What are the steps?

  1. Decide how much you plan to convert to Roth using this strategy, including Roth contributions and voluntary after-tax contributions

  2. Determine where you want the funds to eventually land (your Roth Solo 401k or your Roth IRA?)

  3. Make your contributions (deposit funds into your Solo 401k trust bank account)

  4. Convert voluntary after-tax contributions to Roth 401k funds or complete an in service distribution out to your Roth IRA.

    1. If you roll out to your Roth IRA then you may lose your ability to self direct your funds.

    2. Remember, once funds are Roth IRA funds, they are forever Roth IRA funds. Roth IRA funds cannot roll into a Roth 401k.

  5. Complete a 1099-R to document the conversion. No taxes are due on converting voluntary after-tax contributions to Roth

Who is this for?

This strategy is a great fit for a Solopreneur wanting to maximize Roth funds (Roth 401k or Roth IRA).

Remember, if you're a sole proprietor or single-member LLC, this income is the business revenue subtracting expenses. Use your W2 income if your business is an S-Corp/C-Corp or LLC with S-corp taxation status.

Logistics:

  1. Voluntary after-tax contributions are not the same as Roth contributions. While both are "after-tax" money, the Roth funds have their own rules and regulations around when they can be distributed from the plan

  2. Open three bank accounts for your Solo 401k:

    1. Traditional (pre-tax) funds

    2. Roth funds

    3. After-tax funds.

    4. Label each account with a distinct nickname on your online banking portal to keep funds in their preferred "bucket"

  3. Open a separate bank account (or three) for your spouse for easier record-keeping. Once after-tax contributions are made into their separate accounts, you can do internal in-plan Roth conversion

  4. Have your CPA or tax advisor help with the 1099-R to document the in-plan Roth conversion of voluntary after-tax funds

  5. After tax contributions are just like pre-tax and Roth contributions which means they are calculated based on the earned income you receive in your business

  6. With the Nabers Group Solo 401k plan, your voluntary after-tax contributions may be up to 100% of your net earnings from your business

The mega backdoor Roth strategy can be a powerful tool for growing your Roth funds. When executed properly, you can position yourself for tax-free distributions from your retirement plan. This is an excellent aggressive wealth tool because you will pay less in taxes in the long-run. However, always work with your tax advisor to ensure proper reporting and filing of forms documenting the conversion of Roth funds.

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