How Much Can a Participant Contribute to a Mega Backdoor Roth?
After-Tax contributions allow a participant to put up to $43,500 ($66,000 – $22,500 = $43,500) in 2023 into a Roth IRA, in addition to salary deferrals that can be either Pre-Tax or Roth. Below equation can be used to calculate how much a participant can contribute into his or her After-Tax portion in 2023:
$43,500 – Employer Match/NEC – Profit Sharing Contribution = After-Tax Contribution
How Does the Mega Backdoor Roth Work?
While it may sound simple, the Mega Backdoor Roth process can become complicated. After-Tax Contributions and In-Service Distributions must be built into the retirement plan document.
First, the participant would contribute up to the maximum allowed to the After-Tax Contributions bucket. Then, do an in-service withdrawal as a “rollover”. After-Tax Contributions can be rolled over to the Roth Deferral account within the plan, or to participant’s own Roth IRA. There are tax implications to consider when choosing between your Roth Deferral account and your Roth IRA. When it comes to withdrawal rules, Roth IRAs receive more favorable tax treatment than Roth Deferral accounts. Please consult with your tax advisor regarding the tax implications.
Things to Consider When Adding a Mega Backdoor Roth to Your 401(k) Plan
The most important factor to be aware is that Mega Backdoor Roth plans will likely fail Actual Contribution Percentage (ACP) Tests, if the plan has Non-Highly Compensated Employees (NHCEs). Even offering NHCEs employer contributions may not pass testing. Even if it does, the amount Highly-Compensated Employees (HCEs) can contribute to the After-Tax (Mega Backdoor Roth) portion may be limited.
If you are a small business owner looking to create a retirement plan with a Mega Backdoor Roth feature, we highly recommend hiring a Third-Party Administrator (TPA) to administer the plan, as they can assist with contribution and deferral testing.
The bottom line is that retirement plans with the Mega Backdoor Roth option are best-suited for businesses where every (or most) employees are highly-compensated, or self-employed individuals and small business owners with no other full-time employees. Self-employed individuals with an Individual/Solo 401(k) plan can easily add a Mega Backdoor Roth option since they are generally not subject to any non-discrimination testing.