Mega backdoor Roth conversions can boost tax-free growth — if you avoid these mistakes

Mega backdoor Roth conversions can significantly boost tax-free retirement savings — but this maneuver is not available for all investors and mistakes are common, experts say.

When investors make too much to save directly to a Roth individual retirement account, backdoor strategies can bypass the IRS income limits. A mega backdoor Roth conversion involves after-tax 401(k) contributions, which are shifted to Roth accounts.  

It is more generous than regular backdoor Roth conversions because after-tax contributions can exceed the yearly 401(k) deferral limit, which is $23,000 for investors under age 50. The full 401(k) limit is $69,000 for 2024, including employee deferrals, employer matches, profit sharing and other deposits.

Mega backdoor Roth conversions are “a great tool when used appropriately,” but you need to know your goals first, said certified financial planner Jamie Clark, founder of Ruby Pebble Financial Planning in Seattle.

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Here are some common mega backdoor Roth conversion mistakes and how to avoid them, according to experts. 

While mega backdoor Roth conversions can be appealing, some workers focus on the strategy before they have enough cash reserves or brokerage account assets for shorter-term financial goals, Clark said.

Rather than making after-tax 401(k) contributions, you may need the funds to boost your emergency savings, buy a home, pay for a wedding, take a vacation or other priorities.

Before making after-tax 401(k) contributions, you need to consider the full plan limit and other deposits that may still come from your employer, experts say.

For example, many plans have a “true-up” feature, which deposits the rest of your employer match if you max out the plan early. You also could receive a bonus or profit sharing.

“You always want to be aware of how much money your company is putting into your 401(k),” said Tommy Lucas, a CFP and enrolled agent at Moisand Fitzgerald Tamayo in Orlando, Florida.

For 2024, higher earners could hit the $69,000 plan limit with employee deferrals and after-tax 401(k) deposits. Without leaving space for the true-up or employer profit sharing, “you’re just missing out on free money,” he said.

Ideally, you want to convert after-tax 401(k) contributions to a Roth account before there is time for the deposits to grow. Otherwise, you will owe taxes on the earnings at the conversion.

However, “the mechanism for conversion can differ from company to company and plan to plan,” explained CFP Dan Galli, owner of Daniel J. Galli & Associates in Norwell, Massachusetts.

Before starting after-tax 401(k) contributions, you need to fully understand the process for converting the funds to a Roth account, he added.