Directed IRA Podcast

Mega Backdoor Roth Explained: What Is It and How It Works

• Mat Sorensen and Mark Kohler

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Unlock one of the most powerful tax and wealth-building strategies available today: the Mega Backdoor Roth. In this episode, Mat Sorensen breaks down how you can contribute up to $70,000 each year into Roth accounts, creating massive tax-free growth for retirement. Originally filmed for the Mat Sorensen YouTube channel, this special episode is now available on the Directed IRA Podcast.

Mat explains step by step:

  • Why the Mega Backdoor Roth is so effective for high-income earners
  • How to use a 401(k) or Solo 401(k) to maximize Roth contributions
  • The role of after-tax contributions and how to convert them
  • Key rules, qualifications, and pitfalls to avoid
  • Why rolling funds to a Roth IRA can provide greater investment flexibility and lower fees

Whether you’re a high earner with a workplace 401(k) or a self-employed professional with a Solo 401(k), this strategy can help you supercharge your retirement savings and build wealth tax free.

Chapters: 

00:00 - Introduction to Mega Backdoor Roth

01:15 - Breaking Down the $70K Strategy

02:12 - After-Tax Contributions Explained

05:17 - Converting to Roth: Two Options

08:19 - Potential Snags and Limitations

10:17 - Disclaimer and Closing

Directed IRA Homepage: https://directedira.com/

Directed IRA Explore (Linktree): https://linktr.ee/SelfDirectedIRA

Book a Call: https://directedira.com/appointment/


Other:
Mat Sorensen: https://matsorensen.com & https://linktr.ee/MatSorensen
KKOS: https://kkoslawyers.com
Main Street Business https://mainstreetbusiness.com



Speaker 1:

Welcome everyone to the Directed IRA Podcast. This is Matt Sorensen, with a special episode for you today, talking about the mega backdoor Roth. I recorded this and want to share it with all of you here on the podcast. Please enjoy.

Speaker 1:

The mega backdoor Roth is my favorite tax and wealth building strategy. All bundled up into one. It is a way you can get $70,000 of Roth money where you pay no taxes. You're making money and no taxes. You pull the money out in retirement. You can do that every year utilizing the mega backdoor Roth strategy.

Speaker 1:

Now, in today's video, I'm going to break down why you want this, how it works, what are the qualifications and the actual steps you're going to need to get $70,000 of Roth money set aside every year. Now you could only put $7,000 into a Roth IRA. So how are we getting to $70,000 every year, matt? How are we doing 10 times that? Well, we're using a 401k. This could be the 401k at work, where you may work. This could be your solo 401k for any of you self-employed. Okay, I'm going to break down how you utilize and execute the strategy. To get 70k in every year All right, so now this assumes that you have a 401k. All right, now, if you have a job, you probably have a 401k. Maybe you're self-employed. This works for you. Now I want to say this at the outset For those of you that are self-employed, where you do have employees in the business and you have a company 401k plan, this doesn't work for you. Okay, I'm just going to rule that out. It doesn't work for you. It doesn't work for me. I have employees and we have 401ks. I can't do this strategy. But if you're an employee at a company, a high income earner, this is a strategy you should be thinking about. If you're a self-employed person with no employees using a solo 401k, this is something you should be thinking about because you can utilize and execute the strategy.

Speaker 1:

70k every year All right, let's break down how this works. Now. The reason we use 70k, and why that is the number, is that is the maximum amount of money you can put into a 401k. Now, if you're 50 plus, you get another 7,500, so 77,500. And even those 60 plus, there's a little additional few thousand dollars you can put in every year. But I'm just going to say 70K in general, because that's the number. No matter what age you are, you can at least put away utilizing the mega backdoor Roth strategy. All right.

Speaker 1:

Now let's talk about how you actually get the money in. Well, the first thing we're going to do is you're going to use the $23,500 you can do as an employee contribution into a 401k. $23,500 you can do as an employee contribution into a 401k. Every 401k out there allows for this and 99% of the 401ks allow for Roth 401k dollars. Okay, remember, this is the mega backdoor Roth strategy here. So we want to do Roth contributions, all right. So the first thing we're going to do 23,500 Roth contributions.

Speaker 1:

Now, most 401ks have a company match where the company matches how much money you've put in and they do a certain amount of match based on your salary. Let's say, for this example, you make $300,000 a year. Okay, I'm using that example because usually it's high income earners that are making good money that are executing on this strategy who want to do more than 23,500. Okay, so if you've made $300K and, let's say, your company does a 4% match that's very common that means they're going to put in $12,000 into the 401k for you. All right, now, remember, the max amount I can do in the 401k is 70K. I did $23,500 of Roth dollars. Now the company put in $12,000. Now, when the company puts money in this is a new law that passed a couple of years ago the match can be Roth dollars. A lot of companies still do traditional dollars as the match. That's just how they've always done it, and that's fine. You can convert it to Roth. At the end of the day, we've got another $12,000 of Roth dollars here. Either way, though, we know we've got another $12,000 in. So, between my $23,500, the match from my employer of $12,000, we've got $35,500 in.

Speaker 1:

But how do I get to $70,000, matt, a lot of people get stuck here and they think well, I've maxed out my 401k. What do I do next? Well, the first thing I'd say is go to a backdoor Roth IRA. By the way, you can do $7,000 a year in a backdoor Roth IRA independent of this strategy, and that's pretty easy. Whether you do the mega backdoor Roth or not, you can still do the backdoor Roth IRA. Okay, but I still got $34,500 left of contributions to get to that 70,000 max. What do I do? How am I getting that 70K? Well, the answer is you're going to make what's called an after-tax contribution to the 401k.

Speaker 1:

Now, this is a little unique contribution. It's not as common the 401k administrator sometimes gets confused. The frontline customer service person may not know what this is. The HR person that works on your 401k plan has maybe talked to two people over their 10 year career that have actually done this All right. So this is not standardized process is what I'm trying to get at.

Speaker 1:

This is a loophole. It's legitimate, it's used often, but I'm just saying it's not like right on the menu staring you in the face. So you will ask does the plan allow for after-tax contributions? About 40 to 50% of 401k plans in the US allow for after-tax contributions. If your plan allows for after-tax contributions, what that means is we can fill the rest of the money up to the 70K with what is called an after-tax contribution of this $34,500. So I throw in $34,500. This could be a one-time thing you put into the 401k. You could be doing it over time. Frankly, most of our clients over the years that have utilized this strategy just do a one-time contribution in from their personal bank account. It's typically not coming off of payroll, but they'll wire it in or they'll ACH it in to their 401k administrator. All right, now I've got that $34,500 in. I've got a total contributed in to the 401k of $70,000.

Speaker 1:

Now you must follow the next step. You are not done If you stop here. You have jacked this up. You must follow this next step and this is critical. You have two options.

Speaker 1:

Option one is to do an in-plan Roth conversion. What that means is you're taking this after-tax contribution bucket and converting it to Roth. You actually have to do that and there's a form you'll fill out to do it. Now, generally, when you convert dollars to Roth, you're typically converting traditional pre-tax dollars over to Roth. You took a tax deduction on it, so you have to pay tax when you convert. But when you convert after tax dollars, you never took a deduction. It becomes Roth dollars and there's no tax. So voila, I just fill out a form and this $34,500 is now Roth 401k dollars in my Roth 401k plan, just like the $35,500 of other dollars I put into the 401k.

Speaker 1:

Now, option two is better, though I actually prefer you to do option two, and this is rolling out the after-tax contributions to a Roth IRA. Now, generally, 401k dollars for a company where you still work and are employed are locked down until you retire, but there is an exception for after-tax dollars. You can roll out after-tax contributions whenever you want, even while you're still employed there, even when you're only 40 years of age you're not retirement plan age so I can roll those dollars out as just after-tax dollars and receive them directly into a Roth IRA. Now, at Directed IRA, we receive these all the time. A lot of high-income earners are utilizing this mega backdoor Roth strategy and they open up a Roth IRA with this to receive this $34,500 of after-tax contributions. We receive it into the Roth IRA and now it's just Roth IRA dollars, no Roth conversion required. We can receive after-tax contributions directly into a Roth IRA and they are immediately Roth IRA dollars, growing as you're investing it with no tax and coming out tax-free at retirement.

Speaker 1:

Now the reason I like the Roth IRA here and rolling it out of the 401k plan is twofold. First, you have more investment options in a Roth IRA. So, like if you're a directed IRA, you can buy real estate with your Roth IRA, invest in a private fund, invest in crypto, in a startup. These are all investments IRAs can own, and particularly Roth IRAs, the most popular account that we have here. So you have more investment options. Sure, you could buy a stock or a mutual fund here as well, but most of our clients are coming here to buy a private, non-publicly traded asset. It's what we do at Directed IRA every day. So that's one reason, just greater investment options. The other reason is there's less fees in IRAs. Your 401k plan the average 401k plan has one to one and a half percent fees. If you got a $100,000 account, you're paying $1,500 in fees, all right, so there's typically more fees also on a 401k plan. So you can analyze that depending on your situation. But look at the investment options you may want to invest into as you're considering whether to roll out or keep it in plan, and also look at the fees that you'll pay for the IRA versus what All right.

Speaker 1:

Now remember there can be two snags to the mega backdoor Roth. First, any of you business owners where you want to do this strategy but you also have employees in your company 401k this doesn't work for you, sadly. If you're self-employed with no employees using a solo 401k we love those set those up for clients every day. You can do the mega backdoor Roth. You can do that every year. Also, if you have a 401k at an employer where you work Roth, you can do that every year. Also, if you have a 401k, add an employer where you work, this is easier.

Speaker 1:

Now. The second snag and the last you need to worry about is the plan must allow for after-tax contributions. When you think about this whole strategy here, what's the loophole in it? Well, the loophole is this after-tax contribution. That's what allows you to get up to this maximum of $70,000, where in the example here, we put $34,500 more away in Roth dollars because we were able to do an after-tax contribution. A lot of plans do allow for that, but make sure you check that before you start executing on this strategy.

Speaker 2:

And thank you everyone for listening. A quick disclaimer and reminder this presentation does not constitute an attorney or CPA client relationship and it is always in your best interest to consult competent legal and tax professionals when conducting your own personal transactions.

Speaker 1:

We also want to make sure you know this is not investment advice or financial advice. We're just trying to give you education, ideas and strategies you can take to your professionals or conduct your own research on. We'll see you next time.