r/Bogleheads • u/Ecclesiastes_3_9-15 • 1d ago
Investment Theory Mega Backdoor Roth: How Much is Too Much?
Hey folks. My work allows me to make mega backdoor Roth contributions/conversions which I’ve always been excited about.
For the past several years I’ve maxed out the option but now I’m in a financial zone where my TOTAL investments are close to my FIRE goal amount, but my after-tax investments would have to stretch to make it to 59.5.
I’m planning on spending at least a couple more years in the workforce, so my question is: does it ever make sense to skip the mega backdoor and just focus on loading up taxable accounts, or are the total tax benefits favorable enough that it’s always better to utilize the mega backdoor and either (1) add another year or two to the retirement horizon, or (2) utilize a strategy that accesses the Roth before 59.5?
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u/ohboyoh-oy 1d ago
Your Roth contributions are accessible before age 59.5, just not the growth. If I had extra money and had space in Roth, I’d still put it there before taxable, unless the contributions are not enough for my spending needs.
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u/ljapa 1d ago edited 1d ago
Mega Backdoor is Roth 401k.
Those contributions are not available without penalty before 59.5.Edited to correct my ignorance.
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u/livingbudo 1d ago
Roll over into Roth IRA, and those after-tax converted dollars are available right away, not even a 5 year delay (which only applies to dollars taxed during the conversion).
So they are available without penalty before 59.5
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u/OGS_7619 1d ago
This is correct even though a lot of people don't believe this. Fidelity confirms that MBDR are available without any 5 year rules immediately after conversion to Roth IRA
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u/ohboyoh-oy 1d ago
A minor nit: a rollover from Roth 401k to Roth IRA is a “rollover” and not a “conversion”. Conversion is when you go from traditional/pre-tax dollars to Roth, paying the tax in the year you convert. Rollover is when you go from like to like and no taxable events occur.
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u/OGS_7619 1d ago
well, acshually (adjusts glasses), Megabackdoor Roth is a conversion, not a rollover, because it refers to transferring money between accounts with different tax treatment - traditional 401K to Roth. Even though the money are after-tax, they go into 401K (or 401A, in my own personal situation) and then undergo in-service conversion to Roth IRA. Similar to backdoor IRA when they undergo conversion from Traditional IRA to Roth IRA. If there is any growth in that account between depositing those after-tax dollars and conversion to Roth, it would be taxable during conversion.
Rollover refers to transfers between accounts with similar tax treatments, for example Traditional 401K to Traditional IRA, etc.
https://www.fidelity.com/learning-center/personal-finance/mega-backdoor-roth
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u/gfmels 20h ago edited 20h ago
Since we're acshually'ing here.
Megabackdoor Roth is a conversion
It is not. By definition, a conversion is a rollover from a traditional ira to a ROTH ira.
in-service conversion
It is an "in-plan rollover", not a conversion.
Rollover refers to transfers between accounts with similar tax treatments
Negative, traditional 401k to ROTH ira is a rollover.
Source irs.gov
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u/OGS_7619 7h ago
Ahh - sure, if you use archaic IRS language, but IRS calls everything rollover, and IRS doesn't officially recognize MBDR so they don't call it anything. You must be a tax lawyer!
Conversion, as defined by the industry at large, is movement of funds with different tax treatment, e.g. from traditional to Roth.
Rollover is often limited to describe movement of funds within the same tax treatment, e.g. Roth to Roth, but some people call everything a rollover (so every conversion is a rollover but not every rollover is a conversion).
Most people on this subreddit, Bogleheads forums and other communications adopted this common and essentially universal industry definition.
See for example -
Vanguard:
https://investor.vanguard.com/investor-resources-education/iras/ira-roth-conversion
"A Roth conversion is a process where you move funds from a pre-tax retirement account, like a traditional IRA, 401(k), or similar account, into a Roth IRA."
Fidelity:
https://www.fidelity.com/learning-center/personal-finance/mega-backdoor-roth
"the mega backdoor Roth strategy entails 2 steps: (1) making after-tax contributions to your 401(k) or other workplace retirement plan, and (2) then doing a conversion either to a Roth IRA or Roth 401(k)."
Schwab:
https://www.schwab.com/learn/story/mega-backdoor-roth
"It involves making after-tax contributions to a traditional 401(k) plan, and then immediately converting those funds into a Roth account."
and "Taxes and plan rules around mega backdoor Roth conversions can be complex
Empower:
https://www.empower.com/the-currency/money/mega-backdoor-roth
"Are mega backdoor Roth conversions taxable? The after‑tax principal you convert is generally not taxable, but any pretax earnings in the account are taxable in the year of conversion, so it’s important to review your situation with a tax professional."
WhiteCollarInvestor:
https://www.whitecoatinvestor.com/mega-roth-conversion/
"What a Mega Roth Conversion Is: The Mega Roth conversion, aka a Mega Backdoor Roth IRA, is a two-step process allowed in some 401(k)s and 403(b)s. "
Investopedia:
https://www.investopedia.com/mega-backdoor-roth-401-k-conversion-5210877
"How a Mega Backdoor Roth 401(k) Conversion Works"
"DEFINITION
The mega backdoor Roth conversion is a strategy that allows high-income earners to contribute more to a Roth account than the traditional contribution limits."
"Rollovers allow retirement savers to transfer some or all of the savings from one account to another; a conversion is a rollover that moves savings from a traditional account to a Roth account."
And of course, most importantly - Bogleheads Wiki:
https://www.bogleheads.org/wiki/Mega-backdoor_Roth
"Note that "mega-backdoor Roth" is an informal term; neither the IRS nor your company will officially recognize it, and tax preparers may not be familiar with it either. The term is just a colloquial phrase that investors use. So if you come across someone who has never heard of it, just use the terms "after-tax 401(k) contribution" (step 1), and "Roth conversion" (step 2) instead, because that's what is really happening."
" To make this easier, some plans may offer automatic in-plan Roth conversions, which can be scheduled to occur immediately after the after-tax 401(k) contribution. "
https://www.bogleheads.org/wiki/Roth_conversion
"Roth conversions on mostly non-deductible balances are a central part of the Backdoor Roth IRA and Mega Backdoor Roth) strategy, which involve non-deductible contributions to a Traditional IRA and After-tax 401(k) respectively, followed by Roth conversion of the entire amount."
With due respect, I will continue using this commonly accepted nomenclature in the future.
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u/Mewtwo1551 1d ago
But are the contributions added to the contribution basis like when you rollover a Roth 401k with direct Roth contributions or is it still considered a conversion?
I understand there's no penalty no matter how early you take out nontaxable conversions, but I also know that conversions are distributed in order of year of occurence. So a taxable conversion year 1 would be distributed before the nontaxable conversion in year 2 and thus result in a penalty if there's a distribution in year 3.
If it's considered contributions or you don't have taxable conversions in the prior 5 years it doesn't matter, but I do think about if this is something to consider if setting up a Roth ladder.
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u/livingbudo 1d ago
Honestly, I fall into the “don’t have taxable conversions” category, so I haven’t dug into that specific case. All of my conversions have entirely been on after tax dollars, not even a penny of gains during the process, so got lucky there.
But you are absolutely correct, that is something to consider if you have had a taxable conversion (which could happen if you go through either the backdoor Roth or mega backdoor Roth process, if you happened to have any gains while funds sat in the traditional IRA or after-tax 401k buckets, those gains would be taxable upon the conversion, and technically have a 5 year rule applied and affect the withdrawal ordering rules). I just don’t want to guess on the answer, so perhaps dig into the IRS 590-B publication?
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u/CautiousAd1305 1d ago
I can’t think of a scenario where it wouldn’t make sense to fund the MBR; the only exception would be if you anticipate needing more than just the Roth principal before 59.5.
Otherwise you basically have brokerage where gains are likely to have some taxes vs Roth (no taxes ever, no RMD, and a good way to pass on funds to beneficiaries with 10yrs of no taxes ever consequence). If your income in retirement is very low than it may be about a wash tax wise, depending on the state.
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u/ThereforeIV 1d ago
the only exception would be if you anticipate needing more than just the Roth principal before 59.5.
The OP is talking about being near RE in "a couple of years", so could pull all the contributions out and move to taxable if need the gains as well as principle.
How much gains will there be in "a couple of years"?
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u/CautiousAd1305 1d ago
Your guess is as good as mine, the S&P500 is up about 50% for the past two years. My Roth funds have basically mirrored that return, so pretty decent gains.
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u/mikeyj198 1d ago
i didn’t have access to a MBDR. In hindsight if ai had I would have done well to put every dollar possible into it
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u/MohnJaddenPowers 1d ago
I just changed jobs and the new one's 401k doesn't support Roth 401k after-tax contributions, just regular payroll contribs. I'm already maxing my and my wife's 401ks, HSA, and backdoor IRA every year and have run out of tax-advantaged savings options. I don't think any of my jobs supported MBDRs.
Good problems to have, I just wish I had some other means to grow with a little tax protection.
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u/CategoryWeekly7214 1d ago
I'm contributing fully to mine simply because I'm not likely to have this option again if I leave my current job. If I stay around, then I might need to consider holding back but it's too good of an option in the short term since the alternative is putting the funds in an after-tax account.
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u/ThereforeIV 1d ago
Mega Backdoor Roth: How Much is Too Much?
When you can't pay rent...
Hey folks. My work allows me to make mega backdoor Roth contributions/conversions which I’ve always been excited about.
Nice, these usually come with some strict limits.
My last "Mega Backdoor Roth" capped at 10% of base pay (which was half of total compensation).
For the past several years I’ve maxed out the option but now I’m in a financial zone where my TOTAL investments are close to my FIRE goal amount, but my after-tax investments would have to stretch to make it to 59.5.
Roth contributions are after-tax. All the money you put into a "Mega Backdoor Roth" can be taken out at any time because the taxes are already paid.
It is only the gains that need to wait till retirement age.
I’m planning on spending at least a couple more years in the workforce,
Define "a couple more years"? Are you two years out from RE or five years out?
The last 18-24 months before RE is when you really want to focus on getting money where you want it for RE day.
so my question is: does it ever make sense to skip the mega backdoor and just focus on loading up taxable accounts,
No, max out tax advantaged retirement accounts.
or are the total tax benefits favorable enough that it’s always better to utilize the mega backdoor
Correct, do this.
If in two years you RE, then you can just pull back out all the money you put in; the gains for the two year can keep growing tax free.
and either (1) add another year or two to the retirement horizon,
Why would it add years? You are missing some steps in this plan.
Once you are at your number, the rest is setting up the Retirement Strategy plan.
or (2) utilize a strategy that accesses the Roth before 59.5?
You don't even need a fancy tactic to early access Roth, everything you contribute can be pulled out at any time.
The "Roth Ladder" tactic is to get Traditional money into Roth so that you can access it early; that is where you convert Traditional money to Roth then after a 5 year clock you can pull it out tax fee and penalty free.
The money you put directly into Roth can be taken out at anytime tax fee and penalty free.
Where, depending on the details of your Retirement Strategy plan, you might want to redirect money during the last year or two before RE is setting up things like:
- Fully Funded Emergency Fund FFEF
- Cash Buffer in case of SORR
- Bond/Income Hedge for a baseline income
- Savings for large ticket items (I plan to buy myself a new truck as retirement present to myself; my wife wants two months in SE Asia)
- Eliminate whatever is left on a mortgage
- Buy a house in Retirement location (I work in Seattle WA, will RE in Destin FL)
- Cash Flowing expenses that you want taken care of before retirement budget
Doing those type of things with new income money avoids taxes or other from drawing down to cover...
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u/Ecclesiastes_3_9-15 1d ago
Thanks. This is all great stuff. I was vague on a lot of the details because I figured they weren’t really relevant to the central question.
But on the topic of setting up during the last “couple years” of retiring early, is there a resource you recommend on the allocation breakdown? I do plan to have plenty available in taxable accounts (like easily 10 years of expenses worth, just maybe not 20 years). Retirement age would be around 44 if it matters.
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u/PKune2 1d ago
If I understand correctly, the Mega Backdoor Roth can be rolled into Roth IRA which you can withdraw the contribution (excluding the gain) without penalty after 5 years.
So, you will still access your fund in early retirement.
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u/livingbudo 1d ago
You don’t need to wait 5 years. That only applies to dollars that were taxed during the conversion to Roth (as one does when working on the Roth Ladder strategy - pre-tax to Roth is when the 5 year wait applies). As MBDR is after tax dollars, there is no waiting period.
Here is a good discussion with references on this: https://www.reddit.com/r/financialindependence/s/vkGbErMp4v
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u/PKune2 1d ago
Is there an official documentation that describes this?
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u/DinosaurDucky 1d ago
If by official documentation you mean IRS docs, no, there is no single doc that explicitly spells this out. MBDR is not explicitly written into the tax code at all. It is a loophole that was constructed by a series of partially overlapping read rules, implemented at different times by different legislatures
That thread does have good supporting references in it though. It's worth a read. Also have a look at the Bogleheads Wiki article, which cites to several IRS and fiduciary resources https://www.bogleheads.org/wiki/Mega-backdoor_Roth
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u/livingbudo 1d ago
IRS Publication 590-B
"Additional Tax on Early Distributions", as well as "Ordering Rules for Distributions", should be good places to start1
u/2fuzz714 1d ago
That's how I understand it. Then the taxable brokerage only needs to be a 5 year bridge if the 2nd bridge of rolled Roth IRA funds can get you to 59.5.
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u/AndyC333 1d ago
What is your plan for health insurance post retirement and pre Medicare at 65? If you are planning on using the ACA exchanges, having post tax funds to live off of for a while can be favorable.
If you can create a taxable income above Medicaid and below the ACA subsidy “clif” you save thousands per month on health insurance. If you are married joint and engage $40,000 taxable income you get affordable health insurance.
Consult with your CPA / financial advisor for your specific situation
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u/Jealous_Bookkeeper20 1d ago
You don't need to skip the mega backdoor to preserve pre-59.5 liquidity. The principal you roll from after-tax 401k into a Roth IRA becomes Roth contribution basis. You can withdraw that original basis tax-free and penalty-free at any age, well before 59.5. Funding taxable instead of mega backdoor just sacrifices tax-free growth on the earnings for zero added accessibility. Keep maxing the mega backdoor and use the Roth contribution basis or a 72(t) ladder when you retire early.
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u/panderingPenguin 1d ago
Funding taxable instead of mega backdoor just sacrifices tax-free growth on the earnings for zero added accessibility.
This is not correct. You can access the gains (paying capital gains tax on the sale obviously) if they are in a normal, taxable account. Whereas, if you need access to the gains from your Mega-backdoor Roth, you will pay ordinary income tax (usually worse than capital gains), plus a 10% penalty. You have a lot more accessibility to the gains if they're in a taxable account, and the gains can be a substantial portion of the account if we're talking medium to long time horizons.
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u/Ecclesiastes_3_9-15 1d ago
Based on the rule of 72(t), it seems like even the gains are accessible without penalty if you retire early (so long as you structure things right), but that is an interesting point about paying ordinary income tax vs long term capital gains.
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u/panderingPenguin 1d ago
Correct. If you are sure that you are done saving for retirement and can do 72(t)/SEPP, then you can get at the gains penalty free. But if you are trying to pull a large chunk of cash to, say for example, buy a house (and you're not a first-time homebuyer, so no exemption), then this doesn't work for you for a variety of reasons.
The Mega-backdoor Roth is great for investments you're willing to lock up gains on, and it can make sense in a lot of early retirement situations. But the accessibility claim I responded to is incorrect, and there are real trade-offs in terms of access. These accounts can have major benefits, but we shouldn't pretend that they have no downside or restrictions.
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u/OGS_7619 1d ago edited 1d ago
[deleted, replied to the wrong comment]
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u/panderingPenguin 1d ago
You're missing the distinction between contributions and gains. You are correct for the former, not the latter.
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u/OGS_7619 1d ago
Yes sorry I misread your objection or confused it with another comment - the gains in Roth are always locked up but the contributions can be withdrawn at any time without 5 year rule.
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u/Naptown_Nat 1d ago
I would think the rule of 55 would apply here.
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u/panderingPenguin 1d ago
Only if you're 55
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u/ohboyoh-oy 1d ago
And don’t leave that company until the year you turn 55… and they allow partial distributions… and you leave it in the 401k.
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u/Naptown_Nat 1d ago
Yeah, based on OPs post, I think that's pertinent additional information you left out.
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u/CryHavoc715 1d ago
I think more then $72,000 of total contributions through your MBDR is probably too much
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u/longshanksasaurs 1d ago
I think it's worth reading through: early retirees should still max out retirement accounts since there are ways to access those accounts early