Mega backdoor Roth

A 401(k) has two limits. Your own pre-tax or Roth deferrals are capped at $24,500. Everything that goes into the plan for you in a year, from any source, is capped at $72,000 (or 100% of your pay, if less). The mega backdoor Roth uses the gap between the two.

Some plans allow a third kind of contribution, called after-tax. It is not Roth. After-tax money does not lower your taxable income, and its earnings are taxed when withdrawn. On its own it is a poor deal.

The fix is to move that money to Roth as soon as the plan allows, either through an in-plan Roth conversion or by rolling it to a Roth IRA. Once it is Roth, the contributions and all future earnings come out tax-free in retirement. You owe tax only on earnings that built up between contribution and conversion, which is close to zero if you convert quickly.

The plan keeps after-tax money in its own sub-account, so converting it does not pull in your pre-tax deferrals or employer match. That is the main difference from a backdoor Roth IRA, where the pro-rata rule counts every traditional IRA dollar you own.

Your after-tax room is $72,000 minus your own deferrals minus everything your employer puts in (match, profit sharing, true-ups). Catch-up contributions sit on top of the $72,000, so they do not change your after-tax room.

There is no income limit. What matters is your plan, not your salary. Check the summary plan description or ask HR for two things:

• After-tax contributions: the plan must offer a separate after-tax option, sometimes labeled voluntary or non-Roth after-tax.
• A way to convert: in-service withdrawals of after-tax money while you still work there, or an in-plan Roth conversion. Some plans convert automatically every payroll, which keeps taxable earnings near zero.

After-tax contributions also count in the plan's nondiscrimination testing. If lower-paid employees contribute little, the plan can refund part of a highly compensated employee's after-tax money after year end. Ask HR whether that has happened before.

Example: age 45, $24,500 deferral, $10,000 employer match. $72,000 minus $24,500 minus $10,000 leaves $37,500 of after-tax room. You contribute $37,500 after-tax through payroll and the plan converts each deposit to Roth the same week. If that money earned $100 before conversion, $100 is taxed as ordinary income and $37,500 becomes Roth with no tax due, on top of the $24,500 you deferred.

There is nothing to deduct. After-tax contributions come out of pay that has already been taxed, so the wages on your W-2 do not change.

The reporting happens at conversion. The plan sends Form 1099-R showing the amount moved and the taxable earnings. Report the gross amount on Form 1040 line 5a and the taxable earnings on line 5b. If you converted quickly, line 5b is small.

You do not file Form 8606 for the conversion. That form covers nondeductible IRA contributions and IRA-to-Roth conversions, not money moving inside a 401(k) or from a 401(k) to a Roth IRA. Keep the 1099-R with your tax records. If you rolled the money to a Roth IRA, the amount counts as Roth IRA basis, and Form 8606 asks for it only if you later take a nonqualified Roth IRA distribution.