Open enrollment season is upon us, and as people plan their budgets for 2025, some lucky high earners may want to consider funding their retirement using the rare but popular form of employer-sponsored 401(k)s.
The “mega-backdoor Roth” — a three-part plan that allows employees to direct more of their money into workplace retirement accounts over a set limit — allows employees to put up to $700,000 into their 401(k) in 2025. While 401(k) contributions are not required to open registering, “I think [this period] it’s a good sign for people to review how they’re saving,” Matthew Fleming, financial planner and senior economic advisor at Vanguard, told MarketWatch.
The mega-backdoor Roth remains a rare feature in 401(k) plans, but Jorie Johnson, a financial advisor at Financial Futures in New Jersey, said more than 30% of her clients now have company 401(k) plans that offer the option. , is up significantly from a few years ago. About half of his clients have access to a strategy that uses it to save some money for retirement, even if they’re not maxing out at $70,000.
“We’re seeing a lot of company 401(k) giving because a lot of people are asking for it,” Johnson told MarketWatch. “It’s not difficult for a company to add to it,” since most payroll systems can handle it, he added, so “it’s low-hanging fruit for HR to reward.”
1) Employees increase allowable contributions into their company 401(k) – which the IRS recently announced will be $250,000 in 2025, with employees age 50 and older getting an additional $750,000 in catch-up contributions.
2) They direct a portion of their paychecks to go into their 401(k). after tax contributions.
3) They then convert the after-tax contributions to a Roth position (which some plans allow you to do yourself), so they can grow tax-free and eventually withdraw tax-free in retirement.
It’s a way for high-net-worth individuals — who earn enough money to maximize their retirement contributions through a regular Roth IRA (which is an individual account, not a company plan) — to save up to $700 for their employer-sponsored 401. (k) next year, or $77,500 for those over age 50. That’s pretty “mega,” indeed.
“It’s really nice to get tax-free growth on this money,” said Fleming.
While growing in popularity, the use of this strategy remains limited for several reasons. On the employer side, only a small percentage of 401(k) plans offer all the means to make a mega-backdoor Roth: the Roth option, the ability to make after-tax contributions, and the ability to convert those dollars to a Roth. At Fidelity, only 10 percent of 401(k) plans can do all three, said Mike Shamrell, vice president of strategic leadership at Fidelity. “It’s not much,” Shamrell told MarketWatch.
In addition to working, most Americans simply do not earn enough to contribute up to $23,500 to their 401(k). “It’s not like you’re doing something wrong; that’s what most working Americans are used to,” said Shamrell. For context, the median income for all US households was $86,660 in 2023, and $119,400 for married couples, according to the Census Bureau.
See also: Dodge the 401(k) and IRA ‘ticking tax time bomb’ by going all-in Roths, an expert says.
Those who are able to max out their 401(k) can choose to put extra retirement dollars into a traditional or Roth IRA. However, there is a $7,000 annual contribution limit for IRAs in 2025, and people who earn more than $165,000 in individual income and $246,000 in combined income in 2025 cannot save in a Roth IRA. This is where the mega-backdoor Roth strategy can be used.
Johnson of Financial Futures said that for clients focused on saving more for retirement, “I recommend they do the mega-backdoor Roth,” while those with short-term goals may be better served by other means.
Enthusiastic savers should consider that “whether competing wealth goals or goals” can benefit from investing those after-tax dollars “in a more accessible way” than a retirement account, Vanguard’s Fleming said. He also said that high-net-worth individuals should consider tax-advancement of their estates for beneficiaries through retirement accounts, and that these dollars “could be better spent helping finance various types of vehicles.”
People who have done their math and are interested in the mega-backdoor Roth strategy can call their 401(k) plan provider and ask if their plan offers it. Another way to call it is “an after-tax contribution that can be converted to a Roth.”
If you qualify, the plan provider can make a deduction from each paycheck into the 401(k) to reach the $23,500 maximum by 2025.
You will also decide how much of your salary you want to go into the 401(k) as after tax contributions. Remember that the amount of everything your contributions and your employer’s match next year cannot exceed $70,000. For example, if you contributed the maximum $23,500 and your employer’s match was another $10,000, you can make up to $36,500 in after-tax contributions to your 401(k).
Johnson said some of his clients who can’t save more from their regular paychecks structure their bonuses to fund Roth plans.
The donor will be able to set up tax-advantaged contributions to automatically convert to a Roth (as an “in-plan conversion”) when they are deposited, so that you don’t pay taxes on any gains. Fleming said that in general, these tax dollars are put into any other 401(k) that is put into it – but “there is no uniform set of rules,” so people will ask their providers how their specific plan works. and act accordingly. For example, at Fidelity, some programs may allow users to choose specific distributions for Roth resources.
Some plans, instead of making in-plan changes, do the mega-backdoor Roth strategy by moving these after-tax contributions out of the plan as a Roth IRA rollover, Fleming said. “You need to talk to the plan provider to understand what options are available,” he said.
People with accounts at Vanguard can track their money by going into their 401(k) and looking at the source, which shows how much is in taxable income, Roth contributions and — for people who use the mega-backdoor Roth strategy — after. -tax contributions, Fleming said.
The mega-backdoor Roth is not straightforward and “every situation is different,” Shamrell said. “Seeking advice from a tax professional is the best way to help you understand the potential tax implications of your health care.”
