We recently discovered that Mr. BITA’s workplace allows us to invest in a mega backdoor roth. Wheeeeeee.
Mega what-now? The mega backdoor roth is the secret weapon in the financial independence arsenal. It isn’t that well known, it isn’t available to everyone, and it offers great tax benefits. This article will
- Explain how to determine if your 401k plan allows for the mega backdoor roth option and
- Show you a step-by-step example guide to actually doing such a conversion.
Also, I find that I just enjoy saying mega backdoor. It feels like I’m talking about something vaguely naughty every time I say it, so that is part of my motivation for writing this post.
So what is the mega backdoor roth?
The Mad Fientist does an excellent job of explaining what a mega backdoor roth is, and I’m not going to attempt to do better. Head over there to learn about this somewhat esoteric way to grow your stash.
Does your 401k plan allow you to make use of the mega backdoor?
If you call your plan administrator and ask about a mega backdoor, you are probably going to be subjected to an uncomfortable sit down with HR. Don’t. Instead, first log into your account and see if there seems to be an option for you to contribute your after-tax dollars to your 401k plan. This might look something like this:
If there is no way for you to contribute after-tax dollars, the chances that you can take advantage of the mega backdoor are slim.
Now that you have determined that you can contribute after tax dollars, stand up and do a brief celebratory jig. Then you should probably call your plan representative (this can either be someone from within your company who deals with payroll or benefits, or you could try calling the company that administers your 401k plan e.g. Vanguard or Fidelity). Here is what you ask them:
“If I contribute after-tax dollars to my 401k am I allowed to do an in-service rollover to a Roth IRA? And if so, how often am I allowed to perform a rollover?”
If in-service rollover gets no traction you could try the phrases in-plan conversion or in-plan withdrawal instead.
If the representative you are speaking to seems completely clueless (and if you are dealing with a call center), hang up and try again. You might get lucky the next time.
Why is the frequency of the rollover important?
Remember the Fientist’s cool graphics? If you can’t rollover often, you may have a stickier tax situation to deal with. The after tax money that you contribute to your 401k will grow, and you will owe tax on that growth. You may have to do fancy things with a tIRA account to deal with this and keep detailed records in an Excel sheet. The ideal plan will allow you to rollover every paycheck so that this is not a concern. The important thing though is to understand what your plan offers, so that you can plan for it and do the right thing.
You should also ask if you can do the rollover online or whether you need to call in to execute the transaction.
Ok, I have access to a mega backdoor (damn, it is _still_ funny), what next?
- Figure out how much you can afford to invest every paycheck.
- Log into your 401k plan and set up your after-tax contribution amount.
- Wait patiently for your next paycheck.
- While you wait, decide where you want to invest this money (the same fund as the rest of your 401k? Or something else?) and, if necessary, set that up correctly. This will depend on your overall asset allocation and your tax efficient fund placement strategy.
Changing the asset allocation for your after tax dollars
In Mr. BITA’s plan, by default, our after-tax contribution would get invested in the same fund(s) as our pre-tax contributions. If we wanted to change the asset allocation of our after tax dollars, we could accomplish that change on the website of Mr. BITA’s retirement plan provider, Vanguard.
We would start by choosing the ‘Change paycheck investment mix’ option.
Next we would specify that we want to change our allocations based on the source of the funds.
We are then shown all the possible sources of funds and we would choose ‘After-Tax’.
We see that by default 100% of our after tax money would go into the Target Retirement 2050 fund. If this was not what we wanted, we would choose Select New Fund and the percentage amount and divvy up our money however we like.
Everything is setup correctly. Now the waiting begins.
Finally, into the rabbit hole and through the mega backdoor
Oh happy day! The waiting is done, and good things come to those who wait. You get your next paycheck, note happily that it is smaller than usual, and now you are ready to meander through your mega backdoor and enter the land of additional tax advantaged savings. What follows is a sample step-by-step guide to the process. This guide is based on the website of Mr. BITA’s plan administrator (Vanguard). Obviously, if you are using a different website, the steps won’t look quite the same, but hopefully this will give you an idea what you should look for and how you can accomplish the rollover.
Step 1: Are you going to move your after-tax money to a Roth IRA ‘in plan’ or ‘out of plan’? As we didn’t already have a Roth IRA elsewhere, and we were happy with the fund offerings within Mr. BITA’s retirement plan, we chose the ‘Convert to Roth within your plan’ option. If we wanted to move the money to an out of plan Roth IRA we would have selected ‘Manage my loans and withdrawals’.
Step 2: Read and heed the myriad warnings, but don’t be intimidated by them.
Step 3: Select the source of your rollover, your after-tax contribution. Select the amount. Be sure not to rollover any profits that you may have made. Refer to my note above about the importance of the frequency of the rollover.
Step 4: Proceed to the confirmation screen, double check everything, and agree to proceed.
Step 5: Wait for the rollover to complete. For us, this took two business days.
Ta-da! You have mega-backdoored your savings. Rinse and repeat as often as your plan allows you to. Happy Savings!