Millions miss the mega-backdoor Roth option in 401(k)s

Millions of workers are not using a lesser-known 401(k) option that can increase Roth retirement savings by allowing after-tax contributions to be converted into a Roth account. Financial advisers call the method the “mega-backdoor Roth.”

The basic mechanics: once an employee reaches the annual elective deferral limit for pre-tax or Roth 401(k) contributions, they can direct extra payroll dollars into an after-tax 401(k) bucket. For 2024, the elective deferral limit is $23,000, catch-up contributions for those 50 and older add $7,500, and the total combined contribution limit from employee and employer sources is $69,000. The strategy uses the space between the deferral limit and the total limit to increase Roth-held funds.

The feature is available only in plans that permit after-tax contributions and that allow moving those funds to a Roth vehicle, either through in-plan Roth conversions or in-service rollovers to a Roth IRA. Employers set plan options, so whether a worker can use the strategy depends on plan design rather than individual tax status. Employees who already max out regular 401(k) deferrals and want to save more are the most likely candidates.

To pursue the option, workers should review their plan’s summary plan description or ask their human resources or benefits office whether after-tax contributions and in-service Roth rollovers are allowed. If the plan permits it, change payroll elections to direct extra contributions into the after-tax account. Request an in-plan Roth conversion or an in-service distribution to a Roth IRA as soon as the after-tax funds post; converting quickly limits taxable earnings. Maintain records separating after-tax principal from investment gains, since the principal generally converts tax-free while gains are taxable on conversion.

There are tax and administrative details to consider. Rolling after-tax 401(k) funds into a Roth IRA while holding traditional IRAs with pre-tax money can trigger the IRS pro rata rule and make part of the conversion taxable. Converting within the 401(k) plan to a Roth 401(k) can avoid that issue if the plan offers it. Employer matches typically apply only to pre-tax or Roth deferrals, not to after-tax contributions. Some plans impose caps or prohibit after-tax contributions for administrative or nondiscrimination testing reasons.

Alicia Chen, a certified financial planner who advises corporate clients on retirement plans, points to plan design and low awareness as the main barriers. When plans add after-tax contributions and a straightforward conversion process, high-saving employees can move large sums into Roth accounts with reduced tax friction, she notes, but many workers do not know to ask and many plans are not set up to handle it.

The method may appeal to higher earners who are phased out of direct Roth IRA contributions and to savers who expect to be in a higher tax bracket in retirement. Financial advisers recommend confirming plan features in writing, asking about limits and fees, timing conversions to minimize taxable earnings, and consulting a tax adviser to understand interactions with existing IRAs and tax filings.