On This Episode

In this episode, John and Nick explain the Mega Backdoor Roth strategy and how high-income savers may be able to contribute significantly more to Roth accounts through their workplace retirement plans. They break down the rules, requirements, and potential tax benefits, while highlighting who may benefit most from this advanced retirement planning strategy.

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Disclaimer: PFG Private Wealth Management, LLC is an SEC Registered Investment Advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. The topics and information discussed during this podcast are not intended to provide tax or legal advice. Investments involve risk, and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed on this podcast. Past performance is not indicative of future performance. Insurance products and services are offered and sold through individually licensed and appointed insurance agents.

 

Marc:

This week on Retirement Planning Redefined, part two of our conversation about the backdoor Roth IRA. This is the mega backdoor Roth. Let’s get into that conversation with John and Nick.

 

Hey, everybody. Welcome into the podcast. This is Retirement Planning Redefined with John and Nick from PFG Private Wealth. Find the guys online at pfgprivatewealth.com. That’s pfgprivatewealth.com. And it sounds like something, guys, out of a, I don’t know, out of a superhero story or something. It’s the mega backdoor Roth. And that’s the topic of the conversation this week. So we’re just going to dive right in because there’s a lot to cover anyway. So we’ll just jump in and get going.

 

I guess, Nick, if you want, why don’t you talk to us, give us a really, really short recap of what we talked about last week for those who may have not listened to that podcast. And then what’s to understand what to do if you want more than the IRA limits and just kind of set us up here a little bit for understanding the mega backdoor Roth.

 

Nick:

Sure. So just a quick recap on a Roth IRA and the benefits of it. So contributions typically are with after tax dollars. So income that has already been taxed. The account grows tax deferred, so you don’t receive a 1099 each year. And then the withdrawals are tax-free after 59 and a half. The Roth IRAs do not require required minimum distributions, which are nice. And they’re a great place to have more of your growth oriented assets because of the tax-free upside and the fact that you can leave a tax-free account to your beneficiaries.

 

Marc:

Gotcha. And I guess some confusion here, guys, and help me out to understand this a little bit, is that we’ve been thinking about the Roth. We typically just, I’ve been saying just the Roth, that’s the IRA. But because they have now created the Roth 401Ks, that adds a little confusion to the conversation as well. It’s always funny because the word contribution and contribution, excuse me, and conversion confuse people. So it just confused me right now. But also 401, the Roth 401k and then the Roth IRA is now confusing people as well too. So are we talking a little bit more about on this episode, that mega backdoor Roth being from the workplace plan? Is that what we’re looking at here?

 

John:

Yeah. So we’ll have to leave the IRA world and jump into the 401k plans where they have much larger contribution limits, which is where we get our superhero work.

 

Marc:

The mega term. Okay. Yeah.

 

John:

Exactly. We could do a lot more of what we discussed last week. So if you like the benefits Nick went over, this is a great way to really maximize those benefits.

 

Marc:

Okay. Well, let’s start with the limits. What are the limits? I guess again, we’re in the 401k plan now.

 

John:

Yeah. So for 2026, under the age of 50, standard contribution limit is 24,500. There is a catch-up, and for today’s purpose, we’ll just talk about the standard contribution. When you are talking catch-ups, just whatever we’re discussing, add the catch-up to it. But for today’s purpose, to keep it simple because we are going to do a deep dive into some of these numbers, let’s just assume standard contribution limit, which for this year, 24,500. And what a lot of people aren’t aware of because it typically doesn’t apply is your total limit to the 401k contributions. Now this is employee and employer is actually 72,000 for 2026, and that gets adjusted up every year similar to the standard contribution limits.

 

Marc:

Oh, okay. Wow, that is a big number.

 

John:

Yeah, it’s mega.

 

Marc:

Yeah, it’s mega. Yeah. So why would the IRS build a $72,000 ceiling if they cap the personal down so low? So I guess what’s the other 47,500?

 

John:

Yeah. So one of the things that we focus on is 401ks, which comes with employee benefits, perks, things like that. And some people hear the term matches quite a bit.

 

Marc:

Sure.

 

John:

Another one is profit sharings. So that $72,000 limit is basically the IRS saying, hey, the employee can do this amount, and if the employer’s going to give X amount of benefits, it really can’t go over this $72,000 threshold. So that’s pretty much what it is. The IRS basically said, hey, let’s put some limits to this so we can’t over commit to people or do … They want to be able to provide a benefit, but not go crazy with it. So that’s where we get the number.

 

Nick:

And to kind of summarize that, a away to think about it is that there are standard

limits for the employee contributions. And sometimes as an example, we’ve seen clients say, we’ve told them, especially new clients, like, “Oh, well, I’m maxing it out when you include the employer match.” And it’s like, no, those contributions are for your dollars. And then this overall maximum amount that John’s referring to is a combination of employee and employee dollars. So it’s like two separate tranches within the same year of the same plan.

 

John:

To confuse everyone a little bit more, part of that 72,000 is, if your plan allows it, and we’ll dive into this, is what they call the after tax contribution to a 401k. And I know we hit it last week, but that is something that goes into this feature, which is actually older than a Roth 401k, but it’s not used very often or not many people are very aware of it, but we’ll jump into it today.

 

Marc:

Okay. So the mega backdoor strategy is the employee kind of hacking, if you will, this potentially unused space. So can one of you guys maybe do a numbers example where it maybe will make a little bit more sense for folks?

 

Nick:

Sure. I’ll kind of break it down and give an example. So let’s say that there’s a 40-year-old and because they’re under age 50, their standard contribution into their retirement plan is going to be 24,500, so around two grand a month. In this case, their employer matches and the total amount of the match throughout the year is 10,500. So when you combine those two amounts, the total balance for the year, not including any gains or growth is going to be the total amount contributed is $35,000 for the year. So when we go back to that aggregate ceiling that John mentioned, the 72,000. So with our basic math, and if you’re not good at basic math, now we have AI that helps us.

 

Marc:

You got 37 grand basically, right?

 

Nick:

Yep. So 72 minus 35 is $37,000. That is the gap or kind of the unused space below the IRS guideline. So that’s the number that we can target should the plan allow it to build in or if you have … All this is dependent upon cash flow, of course, but if you have the cash flow to be able to save additional money into the plan.

 

Marc:

Gotcha. Okay. So that makes a little bit more sense, right? So you’ve got that space. It’s almost kind of like filling up your tax brackets before you move to the next tax bracket, if you want to think about it that way, not to add more confusion to it.

 

John:

Yeah. It’s like filling up your gas in your tank here. I got this gap here. Let me, with the rest of this, like we said, Nick said, I said, if the plan allows it, I can do some after tax contribution up to that ceiling.

 

Marc:

So all right, with the Roth 401k existing now, and those contribution numbers are higher, because part of the reason for this hybrid guys, when they made the Roth 401k is you get the income limits of a traditional 401k, but you get the Roth benefits of the Roth IRA. That’s why they kind of merged these two together because people often say, “Hey, I make too much money to use a Roth IRA.” But the Roth 401k is higher. Isn’t this just what this is, just a contribution to a 401k? It kind of feels like it.

 

John:

It’s not because the Roth 401k is a formal tax designation that falls under that

standard contribution limit, that 24,500.

 

Marc:

Okay. All right. Back to the standard 24. Okay. Yeah.

 

John:

Yeah. Yeah. So kind of think about it that way. It’s that, hey, your pre-tax 401k contribution and the Roth 401k contribution are subject to that standard contribution limit, which in 2026 it’s 24,500. And with the Roth 401k, it’s after tax money and growth is tax deferred and tax-free distribution. Where the after tax, and we talked about that in detail, it’s after tax contribution, but the growth is tax deferred, but the growth if pulled out will be taxed, the earnings on that. So again, kind of caveat to understand the difference between those two contribution types.

 

Marc:

Gotcha.

 

Nick:

Yeah. And in general, a lot of the podcasts that we do are focused on broader base impacts a lot of people. This is definitely a niche sort of strategy. There’s not a huge percent of the population that has, number one, the ability to do this in the plan, but also the cashflow to do it.

 

Marc:

Gotcha.

 

Nick:

But for those that do, it can be a massive, massive edge on what they’re trying to accomplish.

 

Marc:

Yeah. Well, especially with that aggregate number, right? So the rules, they’re not as genus or generous, I should say, I guess as they are.

 

John:

Yeah, exactly. They won’t let us take advantage of too much stuff. So basically it’s like, hey, again, if the plan allows it, you can do more contribution, but it will be taxed when it comes out of the earnings portion of that.

 

Marc:

Okay. So to clarify, if I got this right based on Nick’s example a second ago, that extra $37,000 gap, again, just to kind of recap, we had that we put in 24,500, the company did 10,500 for total of 35,000, 72 is the aggregate there. So left us with that $37,000 gap. So if I drop 37,000 of after tax into that gap, I’ll get hit for taxes on all the compound interest of that growth when I pull it out, correct?

 

John:

Correct. Yes.

 

Marc:

Gotcha. Okay.

 

John:

Yeah. Which is the difference with the Roth where everything’s tax-free.

 

Marc:

Yeah. So every dollar gets taxed.

 

John:

Every earning dollar gets taxed.

 

Marc:

Earning dollar. Okay. All right.

 

John:

Yeah.

 

Marc:

So this after tax contribution isn’t the destination, it’s just the first step, sounds like.

 

John:

Pretty much, yeah.

 

Marc:

Okay. All right. What else?

 

John:

So step two would be the actual conversion or the conversion or basically putting these funds into the Roth account, whether it’s a Roth 401k or Roth IRA and we’ll go over the two different ways you can do it. So that would be the next step is converting it or transferring it before there’s any gains similar to what we discussed last week. Once there’s gains in this after tax contribution and growth, now it’s subject to taxes. So you want to do an immediate conversion or transfer to either to a Roth style bucket. I want to give an example of not converting immediately, what happens in that situation. So let’s say you do an after tax contribution of $10,000 dollars and you forget to convert it. And that $10,000 now grows to $15,000. So you have $10,000 is your cost basis, what you put into it and $5,000 is gained. So if you do the conversion after you have that gain of $5,000, your taxable income goes up by the taxable gain amount, which is the 5 grand. So you’re taxable income goes up by 5 grand, so you want to make sure you do the conversion immediately to avoid that additional tax hit from happening.

 

 

Marc:

Gotcha.

 

John:

And then once it’s in that Roth bucket, basically everything is tax-free and tax-deferred, tax-free, and subject to the Roth rules.

 

Marc:

Yeah, the age rules and time rules, all that good stuff.

 

John:

Yeah.

 

Marc:

So John, can everyone do this?

 

John:

Yeah, so I’m going to give you the annoying answer of it depends, and it depends on if your 401 k has particular features to it. And one of those features are, does the 401 k allow for after tax non Roth 401 k contributions? Okay, so you have to check that, so that’d be a question to the plan administrator, HR, whoever handles it. So, if that is allowed, the next question is, can you do the conversion? And there’s two ways you can do the conversion with with these 401 k plans. Option one is you do an in-service rollover and you roll the funds out to your Roth IRA, and it converts once it rolls out to your Roth IRA. Okay. Option two is you do an in-plan 401 k Roth conversion, so all the money stays within the plan.

 

Marc:

Gotcha.

 

John:

Okay, let’s kind of review the in-service rollover strategy. So, while you’re working, you’re still employed, so that’s where the in-service comes into play. What you would do is call up the provider and say, “Hey, I’d like to roll out these after-tax contribution funds to my Roth IRA. Again, outside of the plan you’re rolling it out. So, when you do that, it creates the conversion when that happens. So, once it goes from the after-tax contribution in the 401 k goes to your Roth IRA. Now the funds grow as if it’s a Roth IRA.

 

Marc:

Now it’s Roth money, right? Okay,

 

John:

Correct. So that completes that transaction. So something to be aware of, and we talked about this last time when we talked about the back door Roth with the Roth IRA is the pro rata rule. When you do it this way, the pro rata rule applies. If you have pre-tax IRA, there’s not to confuse everyone even more, but there’s a formula involved. If you have pre-tax IRA money and you do the conversion this way, there is some type of formula. So, again, meet with the CPA, your financial advisor, if you’re going to do this type of strategy while you have a pre-tax individual retirement account, IRA balance, okay,

 

Marc:

Geat, yeah, great disclosure there to make, make note of. So, good point there, John. What if your plan doesn’t allow that?

 

John:

Yeah, so let’s say you, your plan doesn’t allow the in-service rollover, in-service withdrawal, whatever you want to call it, or you’re not eligible to do it because you know certain plans you have to be above the age 59 and a half to do that. So, okay, recapping, your plan isn’t – you’re not eligible to take advantage of the in-service withdrawal slash rollover in your plan. The next thing you want to look at is, okay, does my plan allow for in-plan Roth conversions? So, that would be where everything stays within the 401 k hub, and what you’re doing is you’re converting the after-tax dollars right into the Roth 401 k funds. Okay, so it’s pretty simple here. The money goes in after tax, and then you do the conversion within the plan, and now it shows up into your Roth 401 k balance. So, it doesn’t create a taxable event, then doesn’t create a taxable event, because well, let’s backtrack. If you do the conversion immediately before there’s any gains on the after-tax funds, it does not create a taxable event in that situation.

 

Marc:

Gotcha. Okay.

 

John:

All right. Okay. And something to note here, and I referenced the pro rata rule on if it goes to a Roth IRA within the 401 k, that pro rata rule does not apply. Okay, so that’s a nice benefit of keeping it within the plan, is you don’t have to worry about that formula if you have pre-tax balances.

 

Marc:

Gotcha. Okay, there’s a lot to digest, for sure.

 

John:

It is. And actually, some plans I was just working with someone, and their plan actually had basically automatic conversions, so it was a feature where daily any money that hit the after-tax account would automatically convert to the Roth 401 k, so it basically could put on autopilot and not worry about it.

 

Marc:

Yeah, so it sounds like obviously these plan-specific features can provide possible green lights to do this, but you got to check that stuff.

 

John:

Yeah, exactly. And then, and just to clarify that pro rata rule, because it is confusing is if you do an implant conversion again, this is all within the 401 k plan. So you convert from after tax in the 401 k to Roth in the 401 k, and let’s say you have a balance of $400,000 pre tax. The pro rata rule does not apply, you can convert it, not worry about, hey, how much do I have pre tax versus if you roll it out of the 401 k into a Roth IRA, the IRS will look into if you have any money in a pre-tax traditional IRA, and if you do, that’s when the formula kicks in. Okay, so just, you know, that’s an important caveat that I’ve seen people miss if they do conversions, and it’s just important to, you know, talk to somebody, and before you execute these strategies.

 

 

Marc:

Okay. Yeah. So obviously there’s a lot of nuance here, so there’s a lot of things you got to be aware of. So making sure specific plan features have the green light, I guess, is one of the major steps to consider on this, Nick, right?

 

John:

One thing that we missed here, which is separate from the IRAs. So not to confuse everyone even more, when you do a conversion within a plan, there is no pro rata rule like the IRA. So it doesn’t matter if you have 400,000 in your pre-tax 401 and you do a conversion, there’s none of that formula there so you can do it and have no issue.

 

Marc:

Gotcha. And so circling back, Nick, you mentioned earlier, you got to check with the company, I guess, to make sure, again, we’re talking about workplace plans here to make sure that they even have this green light to get this done.

 

Nick:

Yeah. Realistically, if somebody was trying to figure out the steps on navigating this, step one is contact your employer, HR department, and ask if the plan allows for non-Roth after tax contributions. That’s step one. And then you kind of cascade down to the other parts or reach out to us and we can help walk you through it because all the details might make you want to cry.

 

Marc:

Right. Okay. All right. So let’s say a ton of stuff here to think about, obviously a lot of stuff to process. So I guess, okay, here’s a big question then. So you walk through the rules, some of the mechanics of whether you can do it. I guess the question, John, is should you? Just because you can do something as the saying goes doesn’t mean you necessarily should.

 

John:

Yeah. So that really probably should be the starting point. So you don’t have to go ask all these questions, see if you’re eligible to come to find out, hey, I probably even shouldn’t do this strategy. So if it goes back to planning, of course, can you afford to put a total of up to 72,000 potentially away into a 401 plan? If you can afford it and not have to worry about expenses and things like that, then now you should start considering it because this is a pretty risky strategy because you are locking up a lot of money subjecting it to all those IRS rules and penalties and things like that.

 

And then the other thing is, do you need the balance of having some more Roth funds, which I would say most people do where it’s, do I need a good mix of pre-tax and after-tax stuff? Looking at tax brackets now versus in retirement and a lot of the other things that Nick has mentioned, he could probably jump in here and give a few more details of it.

 

Nick:

So I’ll give a couple other ideal candidates as an example. So let’s say that somebody is a person or a household, high-income earners, they’re maxing out their 401k contributions. They don’t have a lot of Roth money because their income is high enough where kids are grown, they’re taking a hit from a tax perspective if they’re not doing pre-tax contributions. And maybe they’re saving a big chunk of money every month or every year into a non-retirement account, but they’ve also built up a decent balance in that account. And so they’re looking for a way that they’re not going to give up the deduction that they’re getting up for their regular 401k contributions, but they want to develop some Roth funds and they make too much money. And so it’s like, okay, check, check, check, here’s a perfect place to do it. Another way, another circumstance that could make a whole lot of sense, inheritance.

 

So dependent upon the structure, if somebody inherits money from an IRA, from a non-spouse, they have 10 years to withdrawal and deplete that account. So as that money’s coming out, maybe they’re looking for a place to put money that can have some tax benefits for them longer term and they have more cashflow in those years of taking out those withdrawals, so that’s a place that they can put it. Or somebody’s double dipping on Social Security, they’re still working and they’re taking Social Security and they’re looking for a way to deploy some of that money and put it into an account, that’s another good opportunity.

 

Marc:

Gotcha.

 

Nick:

So those are all situations that could make a lot of sense and add a layer of strategy that somebody hadn’t considered.

 

Marc:

So it sounds like obviously basic Roth conversions, there’s some complexity there. You want to check with financial professional. The back door gets even more complicated. Then the mega backdoor gets even more complicated. So at the end of the day, to find out if this is the right strategy and fit for you, it’s all about having a plan and running some numbers and getting some math put together to see what makes the most sense. Is that fair, John?

 

John:

It is, because even if you’re a fit to be able to defer that amount of money, some of these rules really limit who can actually take advantage of it. Where we see it work quite a bit is solo 401k, someone owns their own company, it’s just them and their spouse and they have a solo 401. Well, they can go to the provider and customize their 401 to allow this.

 

High earners at large companies where, again, don’t want to get into the weeds of this, but there’s 401 testing rules where it really affects smaller companies. When it’s a large company, you don’t see the rules affect some of those high earners because in small companies, there’s testing and stuff like that. And again, it’s more confusing stuff, but smaller companies, it is harder to take advantage of that if you are considered what the 401k Department of Labor considers a high earner. So great strategy if you can afford to do it and you have the flexibility with the 401k to allow you to do it’s an excellent way to take advantage of the Roth benefits and maximize it.

 

Marc:

Gotcha. So at the end of the day, it comes down again to having a strategy that fits for your situation. So understanding if it’s right for you, do you qualify? How do you do it? Making sure it’s done properly is the important pieces of all of this. And that’s why we talk often about the fact that growing and accumulating money is a little easier for DIYers to do that. A lot of us can kind of, with the technology and the resources today, can build our wealth. But it’s the preservation and distribution stage, which is also known as retirement, that you certainly need some help with because the rules get very complicated. And sometimes when you pull one lever, it affects nine other things that you didn’t even realize. So that’s why you want to get that retirement plan redefined with John and Nick. Reach out to them at pfgprivatewealth.com. That’s pfgprivatewealth.com.

 

And with that, we’re going to do it for this week. So make sure you subscribe to us on Apple or Spotify so that you can check out new episodes when they come out. And of course, if you have questions around this, and you probably do, make sure you reach out to them and have a conversation. Guys, thanks for successfully blowing our brains out with this one because it’s a lot of stuff to take, but it’s important because a lot of these strategies out there don’t get talked about as often. So good stuff. Thanks for breaking it down, John.

 

John:

Yeah, no problem. And I enjoy some of these deep dives, so look forward to doing some more of them.

 

Marc:

Yeah, for sure. Nick, thank you, my friend, for jumping in as well and helping out. It’s definitely a lot to unpack for people. So I always appreciate you guys.

 

Nick:

Thanks, Marcus.

 

Marc:

And be sure to consult with your tax advisor. This can affect your federal tax rates and also state taxes if you have state income tax. We’ll see you next time here on Retirement Planning Redefined with John and Nick.