The Mega Backdoor Roth Rollover
By: David Ferrara
Tags: Personal Finance, Taxes, Investing, Retirement

That is the beauty of the Mega Backdoor Roth Rollover. The 2020 limit to contribute to your individual IRA is $6K, and the limit within your 401K plan is $19.5K, but with this strategy, you can contribute an additional $37.5K in 2020 that will grow tax-free.

Who should use this?

If you don’t plan on putting more than $25.5K into retirement accounts ($19.5K for your 401K plus $6K for your IRA) for 2020, there’s no need to use this plan. But if you are trying to figure out a way to further maximize what you put away with the greatest tax advantages, then this is a way to do that.

The in-plan transfer option is critical

The Company I worked at had their 401K plan managed through Merrill Lynch. One day in, it must have been 2016, I received an e-mail stating that in-plan transfers were now an option that was available for employees.

Having followed FIRE for years, I knew the principles behind the Mega Backdoor Roth but just did not see how it would be possible without triggering tax consequences years down the road when I left my job and started to roll over these funds.

That is to say, without an in-plan transfer option, the only time I could transfer funds from the pre-tax bucket to the Roth bucket would be by leaving my Company. And even if I knew I was going to leave within the next year or two, the tax consequences of letting the funds grow for a period of time, then being taxed on the appreciation was not appealing.

But with the in-plan transfer, I could now contribute from each paycheck with after-tax funds. Then immediately transfer that money to a Roth IRA.

Or so I thought.

What did I learn when I set this up for myself?

So, first, what I learned is I think very few people take advantage of this. Either that or I was one of the first to do so with Merrill Lynch once they opened up the option.

I also learned that the in-plan transfer was locked, so that I could not do it online. For the first transfer I made, I had to call up Merrill Lynch and got told by the first person I talked to that I couldn’t do the transfer. Apparently, they don’t read their own e-mail notices they send out :/

I asked for their supervisor, and they didn’t understand why I was doing what I was doing but could facilitate the transfer. After warning me many times of the potential tax consequences of what I was doing, they did the transfer for me.

I called again the next pay period and had it done again. Both times I asked why I couldn’t just do it online and received no real answer. Weirdly though, the third time, it was suddenly unlocked online. My theory is that myself and dozens of hundreds or more FIRE disciples such as myself were overwhelming Merrill Lynch, so they just opened it up online.

I also learned that there is always going to be a delay between your 401K deposit via your paycheck and being able to make the in-plan transfer. This will be a day or two, and there will be realized gains or losses that you will have to pay taxes on. For the full year, this never amounted to more than $1K in total, even though I did forget to make the transfer timely a few times. If I did it exactly on payday for every paycheck, it probably would have been less than $100.

I also learned that there is no way in the Merrill Lynch set-up to automate the transfer. So, I had to go in and make the transfer twice a month (thankfully, I wasn’t paid weekly).

I also learned it complicates your taxes slightly (really only slightly).

Typically, when you receive your 1099-R (that’s your tax stub you receive for your 401K, or IRA, or any of your retirement accounts) for your 401K, there are no taxable events and zero taxes owed. Well, as I mentioned above, because there is always a delay between paycheck deposit and the transfer, you will probably end up with some realized gains and have to account for that in your tax returns.