Backdoor Roth IRAs vs. Mega Backdoor Roth: What Physicians Need to Know

Physicians are delayed earners, which makes it especially important to learn about your options for saving for retirement once your paychecks start coming after years of training and school.

The good news is that there are many strategies to do this, and you can pull out all the stops to grow your retirement nest egg when it feels right for you through investing in tax-efficient retirement accounts like traditional or Roth accounts — or both.

Types of Retirement Accounts: Traditional vs. Roth

In this article, we outline several types of employer-sponsored retirement accounts:401(k), 403(b) and 457 accounts. You can also open an individual retirement account (IRA) to supplement your employer-sponsored retirement savings account. Retirement accounts come in two tax types: traditional (pre-tax) and Roth (post-tax):

• With traditional accounts, you pay no income taxes on contributions in the year of contribution. If your income is $250,000 and you contribute $25,000 to traditional retirement accounts, your taxable income for the year would be $225,000. Then, when you withdraw these funds in retirement, you’ll owe income tax on the entire amount, including earnings.
• With Roth accounts, your contributions are taxed in the year they’re put into your retirement account. However, when you withdraw these funds in retirement, you won’t pay income tax on the contributions or the earnings.

How to Maximize Your Roth Accounts

Although Roth employer-sponsored accounts are available to anyone with an employer kind enough to offer the option, Roth IRAs are generally only available to those with income below certain thresholds. However, there’s a totally legal maneuver available that allows high-income taxpayers to contribute to a Roth IRA.

And for those who want to supercharge their retirement savings even further, there’s another maneuver that allows high-income earners to contribute more than the typical $23,000 (2024) to their employer-sponsored retirement contributions.

We’re going to break down two similar-sounding strategies: Backdoor Roth IRAs and Mega Backdoor Roth conversion.

Both maneuvers help high-earning professionals save for retirement in ways that traditional methods don’t allow. Although the benefits are significant, so too is the effort. Let’s review what it takes to pull these off. And since there are nuances to both, make sure to check with a financial advisor about which tactic may be most appropriate for you.

Backdoor Roth IRAs Benefit High Earners

In 2024, only those with modified adjusted gross income (MAGI) of less than $146,000 (filing single) or $230,000 (filing jointly) can contribute to a Roth IRA.

Wait — no, scratch that. There’s another way.

The backdoor Roth IRA strategy allows high-income taxpayers to get around Roth IRA income limitations. Through what some consider a loophole but is actually an expressly permitted maneuver, you can reap the benefits of Roth accounts.

Put another way, money you contribute to a Roth IRA is never taxed again, so long as you withdraw it after you turn 59 ½ years old and have held the account for at least five years.

4 Steps to Completing a Backdoor Roth IRA Conversion

Taxpayers can do a Backdoor Roth IRA conversion each year by following these steps.

Step 1: Open a new traditional IRA

You can open a traditional IRA at any brokerage firm — Charles Schwab, TD Ameritrade, Fidelity, Vanguard … anywhere. If you already have a traditional IRA, stop, and read the “Beware” section. Come back after considering the consequences.

Step 2: Contribute up to the IRA limit

The IRA limit in 2024 is $7,000 or your earned income (money you earned as a physician, not money you earned on investments) for the year, whichever is less. For most physicians, this amount would likely be $7,000.

Step 3: Convert the traditional IRA to a Roth IRA

You should be able to complete this step by following directions through a brokerage online, but there’s a chance you’ll need to call customer support to assist. Here’s an example from Fidelity.

Step 4: Invest your contributions

It’s important that you invest your contributions only after you’ve made the traditional-to-Roth conversion. If you invest before the conversion, you’ll owe income tax on any earnings, which kind of defeats the purpose of the conversion.

If executed correctly and quickly, you shouldn’t owe any additional income tax for making the backdoor Roth IRA conversion (unless you trigger the pro rata rule, discussed later). The key is to minimize the amount of time your money is sitting in the IRA (generating earnings) before you make the traditional-to-Roth conversion.

What is a Mega Backdoor Roth? Key Steps and Benefits

A Mega Backdoor Roth is a more complicated maneuver than the Backdoor Roth IRA strategy, but it provides a greater payoff in the form of a larger additional retirement contribution. With the Mega Backdoor Roth conversion, you’re exploiting a lesser-known rule about 401(k) plan contributions.

You likely know about the employee 401(k) contribution maximum ($23,000 in 2024), but you might not be aware of the combined employer and employee contribution maximum ($69,000 in 2024). The Mega Backdoor Roth conversion lets you contribute beyond the employee-only maximum, up to the employer and employee maximum. So if your employer contributes $19,000 per year, a Mega Backdoor Roth lets you contribute a whopping $50,000 instead of the typical $23,000. This would bring your total contributions up to $69,000.

The Mega Backdoor Roth Requirements:

• A 401(k) or 403(b) account that allows a) in-service distributions for any reason and b) after-tax contributions (not the same thing as Roth contributions). Some plans allow in-service distributions, also called in-service withdrawals, only in the event of a hardship; to pull off a Mega Backdoor Roth conversion, you’ll need fetterless access to in-service distributions.
• A lot of extra money to contribute to retirement.
• Access to a professional who’s done this before. Don’t Mega Backdoor Roth alone. The steps may seem simple, but they’re not, and the consequences of a mistake include a not-so-fun tax bill. Note that the pro rata rule — mentioned earlier and discussed later — applies.

4 Steps to Completing a Mega Backdoor Roth Conversion

Taxpayers can do a Mega Backdoor Roth conversion each year by following these steps.

Step 1: Determine your maximum Mega Backdoor Roth contribution

Subtract the amount you’ll contribute to your 401(k) this year (it should be the maximum, which is $23,000 in 2024) and the amount of employer contributions (from matching or discretionary contributions) from the statutory maximum annual employer and employee 401(k) contribution ($69,000 in 2024)

Example: If you contributed $23,000, and your employer contributed an additional $10,000, you can contribute another $36,000 through a Mega Backdoor Roth ($69,000 - $23,000 - $10,000).

Step 2: Make an after-tax contribution

You can make an after-tax contribution up to the amount determined in Step 1. Think about calling it quits if you haven’t done a Backdoor Roth IRA and the amount you want to contribute is less than the annual IRA contribution limit.

Step 3: Request an in-service distribution in the amount

And make it quick to minimize your current-year tax impact. You might be able to do this online, but be prepared to call your 401(k) provider for help.

Step 4: Move that money to a Roth IRA or Roth 401(k)

Talk to a tax professional and your 401(k) provider to decide which is the better choice for your situation.

Step 5: Invest the newly contributed money

Like the Backdoor Roth IRA strategy, it’s important that the money be invested only after the contributions are made.

The Pro Rata Rule: How to Avoid Income Tax Liability

Those with an existing traditional IRA should know that a Backdoor Roth IRA can result in an income tax liability in the year of the conversion. Likewise, those with a traditional 401(k) can wind up with an income tax bill due to a Mega Backdoor Roth conversion. This is all because of the pro rata rule.

Example: You have a traditional IRA to which you’ve contributed $25,000 over the years. Due to some wise investments, the account balance is $50,000. This year, you decide to do a Backdoor Roth IRA conversion by contributing $5,000 to a traditional IRA and immediately converting the account to a Roth account.

But for a split second, you had a total of $55,000 in traditional IRA accounts, right? Even if you had $50,000 in one IRA and $5,000 in another, the IRS treats them as one pot of money. When you convert that $5,000 from traditional to Roth, it’s as if you’re taking 91% ($50,000 ÷ $55,000) of that amount, or $4,545 from your existing traditional IRA. And you’ll owe income tax on that amount.

Backdoor Roth IRA vs. Mega Backdoor Roth: Which is Better For Physicians?

Although it’s not necessarily an either-or question — you can pull off both strategies in the same year, if you have desire, patience, and money — here’s a summary of what you should think about before executing one of these retirement savings strategies.

Go with a Backdoor Roth IRA if:

• You don’t have a tax professional on speed dial — erm, on your favorites list — to help you out.
• You want to contribute no more than an additional $7,500 (in 2024) for your retirement.
• You don’t have a traditional IRA, or you accept the consequences of the pro rata rule.

Explore the benefits of a Mega Backdoor Roth with a tax professional if:

• You’ve already maxed out your employee-side 401(k) contributions and have at least $7,500 (in 2024) more to contribute for your retirement.
• Your 401(k) plan allows in-service distributions for any reason.
• All of your 401(k) contributions are Roth, or you accept the consequences of the pro rata rule.
• You have a traditional IRA that you don’t want to mess with.

Join the Discussion

Beyond contributing to IRAs, what else are you doing to save for retirement? What advice have you either given or received about planning for the future? Let us know in the comments below.