Mega Backdoor Roth | 401k or IRA
After-tax 401(k) Contributions --> Roth 401(K) (aka The Mega Backdoor) | Updated for 2024 limits
Audience: Anyone interested in better understanding after-tax 401(k) contributions as basis for facilitating a Mega Backdoor contribution into a Roth 401(k)
TL;DR:
The Mega Backdoor via the 401k is very simple to set-up and represents a great way to create value (via tax savings).
ACTION REQUIRED
Fidelity-managed 401k: Step-by-step process to set-up Mega Backdoor after-tax contributions
Other providers (Vanguard, etc.): Feel free to reach out to uspersonalfinance@gmail.com for options on getting educational guidance
101 Level
[Meta employees only] Company 401k Investment Options Walk-Thru
For other companies, feel free to reach out to uspersonalfinance@gmail.com for options on getting educational guidance
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ROI (return on investment, in present value terms) of ~$7,400 for a $27,500 after-tax 401k Mega Backdoor contribution. This calculation was made when FB limited after-tax 401(k) contributions to $27,500. With the new higher limit, the ROI will not materially change.
Assumptions:
* $27,500 annual contribution to the after-tax 401k (which is immediately/perpetually converted to a Roth 401k or Roth IRA)
* 7% rate of return
* 15% long term capital gains (LTCG) tax rate
* 30 year investment horizon
* 2% annual dividend yield
* 15% qualified dividend tax rate
Output:
* Arriving at an ROI (in present value terms) of $7.4k on the initial $27.5k after-tax 401k investment, representing a 27% ROI (attached is my build to these numbers with commentary/methodology)
KEY INFORMATION
$23k annual IRS Limit on Traditional and Roth 401(k) employee contributions (as of Tax Year 2024): After-tax 401(k) contributions converted into a Roth 401(k)/IRA (as part of a Mega Backdoor strategy) do not count towards the $23k annual IRS limit.
Instead, they're limited by the Facebook $34,500 limit on after-tax 401(k) contributions
Total IRS limit on all 401(k) contributions (as of Tax Year 2024): The sum of traditional/Roth 401(k) contributions, employer match and after-tax 401(k) contributions can not exceed $69,000
Should I leave my $$ in the Roth 401k or should I transfer it to a Roth IRA?
I would highly recommend leaving $$ in the Roth 401k. The only time I would recommend moving it to Roth IRA is if you believe you need to execute an early withdrawal.
The main advantage of leaving it in the Roth 401k is that it's COMPLETELY automated. I mean you literally don't have to raise a finger once you've toggled on the daily in-plan conversion.
As I've explained and provided instructions above, there IS an option to transfer the after-tax 401k to the Roth IRA. But it requires an online portal request. As a further deterrent, transferring to a non-Fidelity Roth IRA will potentially entail additional headaches (e.g. you have to phone-in the request, receive a check and then send in this check to your non-Fidelity broker).
In addition to these manual requests, there will be additional tax paperwork each year (i.e. a Form 1099-R, which is generated anytime you move funds out of a retirement account, which in this case would be your Roth 401k).
We have great investment options through our company 401(k), between full market indexes, target date funds and the brokerage link.
Moving $$ from the Roth 401k to the Roth IRA is NOT a taxable event.
The basis and earnings/growth simply transfer from the Roth 401k to the Roth IRA. The earnings/growth is NOT taxed at the time of rollover.
SEE ATTACHMENT - Form 1099-R from the Roth 401k will show you in Box 1 - "Gross Distribution" amount, which is the total rollover amount (basis + earnings/growth), and in Box 5 - "Employee contrib/desig Roth contrib" amount, which is just the basis.
SEE ATTACHMENT - Form 5498 from the Roth IRA will show you in Line 2 - "Rollover Contributions" amount, which is the total rollover amount (basis + earnings/growth).
Executing an early withdrawal as part of a FIRE plan
SEE ATTACHMENT - Form 1099-R from the Roth IRA will show you in Box 1 - "Gross Distribution" amount
SEE ATTACHMENT - Form 8606 is what you use to report the early withdrawal to the IRS
INTERNATIONAL CONSIDERATIONS
If you plan to relocate to another country, please be mindful of local tax laws. Roth protection against tax on capital gains may not apply the same way. The process of withdrawing from your Roth accounts may, in general, be more complex.
Before diving into advanced topics, there are several prerequisite priorities:
6-month rainy day fund
Higher-interest debt pay-down (i.e. all non-home debt, so mainly car, student and credit)
Any money tied in the near term to a home down payment, children's education and family health SHOULD NOT (in my humble opinion) be invested into a retirement account (401(k) or IRA, due to $$, for the most part, being locked up till retirement) or, more generally, into the stock market. This money is best suited to be parked in a high-yield savings account or CD. The stock market, historically, only provides stable return over medium terms and beyond. Any money invested in the stock market, you should plan to keep invested for at least 5 years (and, ideally, 10 years). During the 2008-09 crisis, the market required ~6 years to fully recover. See attached graphic!