How the ‘Mega-Backdoor’ Roth Works

Key Takeaways

• The backdoor Roth strategy is a traditional IRA contribution followed by a Roth IRA conversion, which allows for circumvention of the income limit for people who can’t contribute to a Roth IRA through traditional methods.
• Aftertax company retirement accounts are a hybrid of the traditional and Roth 401(k) accounts.
• The IRC Section 415(c) limitation dictates how much money can go into retirement plans. For 2026, that maximum amount is $72,000.
• If a plan has these aftertax 401(k) contributions available, they will most likely also have an in-plan conversion.
• Every withdrawal out of that aftertax account comes pro rata between your contributions and the growth.
• Aftertax contributions are generally going to be most beneficial to heavy savers.

Christine Benz: Hi, I’m Christine Benz for Morningstar. More and more large 401(k) plans are offering what are called aftertax 401(k) contributions, which can be used in a strategy that has been called the mega backdoor Roth. Joining me to discuss what to know before you make these aftertax 401(k) contributions is Tim Steffen. He’s the Director of Advanced Planning at Baird. Tim, thank you so much for being here.

Tim Steffen: Good to see you again, Christine.

What Is a Backdoor Roth IRA?

Benz: It’s good to see you, too. These aftertax 401(k) contributions are getting more commonplace, especially if you work for a large employer. So let’s talk about the “mega-backdoor” strategy. I wanted to start by talking about the basic version of a backdoor Roth IRA strategy. What does that mean, and who should give it a look?

Steffen: So, the backdoor IRA strategy, or backdoor Roth strategy, is kind of an unfortunate name because it kind of tells the IRS, I’m doing something that you probably don’t want me to do, but I’m going to do it anyway. It’s really a way for people who can’t get money into a Roth IRA through the traditional methods to still get it in there. Normally, you would either contribute to a Roth or convert traditional IRA dollars to a Roth. If you’re not able to contribute because your income’s too high and you don’t have any IRA dollars to convert, the backdoor’s a way to do that. You put money into the traditional IRA and then wait some period of time, sometimes a day, sometimes longer, depending on what people want to do. Then, you convert that to a Roth IRA. Backdoor Roth isn’t really a thing; it’s really just a traditional contribution followed by a conversion, which anybody can do. That’s a perfectly legitimate strategy. Now, it’s been taken to the extreme with these 401(k) plans, as you were saying.

How Aftertax 401(k) Contributions Differ From Roth Contributions

Benz: Let’s get into that, because company retirement plans come into play with this “mega-backdoor” Roth. Specifically, those plans that allow what are called aftertax 401(k) contributions, can you discuss what those are and how they’re different from Roth contributions, which you also make with aftertax dollars? It gets a little confusing here.

Steffen: Think of your 401(k) plan at work as really having, perhaps, three components to it. You’ve got the traditional component, which has been around forever. You put money in there, you get a deduction for it. Then, a couple of decades ago, they added the Roth version of that, where you put the money into the Roth 401(k). No deduction for it, but when it comes out, it’s totally tax-free. Tof a here are limits on how much you can do to one or both of those two accounts combined. Well, the aftertax account kind of fits in the middle of those two. It’s a traditional account like the deductible one, but it’s a nondeductible contribution. It’s money where you’ve already matched or maxed out on how much you can put into the plans, either the pretax or the Roth account. They’re allowing you to put extra money in there, but it can’t go to the Roth.

It’s got to go to the traditional account. So what you end up with is kind of like a non-deductible IRA account, which I think many people are somewhat familiar with. You’re getting money into an account that is after tax, but the growth on it will be fully taxable when it comes out. It’s a hybrid of the traditional and the Roth account. It kind of fits in the middle between the two. It creates taxable income, but the contributions themselves will be tax-free when they come back out.

When Should Investors Make Aftertax Contributions?

Benz: A question is, would there ever be a reason to favor these aftertax contributions before I’ve maxed out on my regular 401(k) contributions, whether I’m doing traditional tax-deferred or Roth?

Steffen: No, absolutely not. I’d say your first decision is, do you want the deduction, or is the deduction not important to you? If it is, then you would do the regular pretax 401(k). If the deduction’s not important to you, then you would do the Roth. The issue is that both of those have limits on how much you can put in. What happens is the employer says, “OK, once you’ve done those, we’ll let you put additional money into the plan, but you can’t put it in either of those two.” So it’s got to go, at that point, into the aftertax traditional plan. It’s your third option. You’re going to decide between one of the first two or a combination of the first two. Once those are done, then you go into the other because if you’re not going to get a deduction for it, you might as well do the Roth. Why put it into an account that’s going to create taxable income if you don’t have to? Max out one of the other two first, then this becomes your next choice.

Maximum Contribution Limits for Retirement Accounts in 2026

Benz: At the high end, roughly with both major account contributions, including my Roth or traditional tax-deferred, plus these aftertax, how high can the contributions go, roughly, for 2026?

Steffen: In this case, you become subject to something called the Section 415(c) limit, which is a section of the code that dictates how much money can go into retirement plans. For 2026, that maximum amount is $72,000. Of that, you have to take out the regular contribution you’re making first. The pretax or the Roth contribution, that’s $24,500. That comes off of it first. You also have to count any matching contribution that your employer might make to you or any profit-sharing contribution that they make. Now, matches are usually pretty easy to identify; employers define those. Profit-sharing can be very, very wild. You never know what it’s going to be until it’s well after the end of the year. You have to take that $72,000 max, back off your regular contribution, your match, and the profit sharing, and whatever’s left is what you can do into the aftertax plan.

Because it’s kind of an unknown, you don’t really know what that number’s going to be. Many employers will say, “Well, we’re just going to put a hard cap on it, just to make sure you don’t go over that threshold. We don’t know what our profit-sharing is going to be, but we’ve got a rough idea. We’ll back that off, and we’ll say, all right, we’re going to give you X amount that you can put into the aftertax plan.” If you do go over that $72,000 amount, then you’ve got to take the money back out, and that becomes a much more complicated mess. They try to avoid that if they can.

Advantages to In-Plan Conversions for Aftertax 401(k) Contributions

Benz: OK, that’s helpful. Ideally, if a plan has these aftertax 401(k) contributions available, they’d also have what’s called an in-plan conversion feature. Can you talk about what that means and what the advantages are?

Steffen: When they started adding Roth versions of 401(k)s many, many years ago, shortly after that, they said, “Well, you can also do an in-plan Roth conversion.” You could take your traditional pretax 401(k) that you have now and do a conversion of that into your Roth 401(k). You could do that today with any money you’ve already got in there. It’s going to be fully taxable, though, because that traditional plan was all pretax money. Where this aftertax plan becomes an option, then you put money into this, and it’s a separate account from the pretax account. It’s under the traditional banner, but it’s a separate account from the pretax one. You’ve got this pretax or this aftertax account in the traditional plan, the contribution is in there, and that’s the basis, for lack of a better term. When you do a conversion out of that, all that would be taxable is the growth on that contribution itself, not the full amount that you would take out of the pretax one.

It’s a little complicated to kind of get your arms around until you start putting some numbers into play. What we see a lot of people do is put the money into the aftertax account and then immediately do a conversion of that over to the plan’s Roth 401(k). Some cases may even take it out into your Roth IRA if the employer allows you to do that. If you’re going to do the aftertax contribution, the Roth conversion part of it is almost an automatic next step.

Do All Plans With Aftertax Contributions Have In-Plan Conversions?

Benz: Most plans that offer aftertax contributions also offer these in-plan conversions, or is it kind of dependent on each company’s rules?

Steffen: It’s absolutely dependent on each company’s rules, but I think the majority of them, if they’re going to offer this, they’re going to take that next step to allow the conversions as well. As always, check with your HR department, make sure you know before you commit to this thing. In all likelihood, if they’ve gone one step, they’ve probably gone to the next couple as well.

The Pro Rata Rule and Aftertax Account Withdrawals

Benz: Tim, let’s go back over what happens if a worker has been making aftertax contributions and not converting inside the plan. How are those aftertax contributions, and the investment earnings that they may have gained, taxed when they’re withdrawn?

Steffen: It’s going to work a lot like your nondeductible IRA contributions that many people might be familiar with today. You’ve got a pool of money that has a basis in it, for lack of a better term. It’s your contributions you made that were made on an aftertax basis. Those dollars will come out tax-free. The growth on those will come out taxable. What you have to be aware of is something called the pro rata. It says you can’t just take your contributions out tax-free. Every withdrawal out of that aftertax account comes pro rata between your contributions and the growth. You’re going to get a little bit of taxable income and a little bit of tax-free income out of every one of those. Ideally, you’d convert that to a Roth, so all that appreciation is in the Roth account, totally tax-free. If you don’t, and there can be reasons why you might not want to do that, leaving it in the aftertax plan will create this hybrid of sorts inside the account where the pro rata rule comes into play.

Key Considerations for Aftertax Versus Taxable Brokerage Account Contributions

Benz: These aftertax contributions, as you’ve alluded to, are generally going to be most beneficial to heavy savers, the people who have the plans with all the bells and whistles that have the aftertax contributions and the in-plan conversion feature. How should people in that situation approach whether to make aftertax contributions or contribute to their taxable brokerage accounts? What are the key considerations?

Steffen: Well, a big one is flexibility. Obviously, when you put money into a regular taxable brokerage account, you can get at it whenever you need to. There may be tax implications for doing it, but you have full flexibility to access it, whatever you want. It can be used for charitable giving. You can use it to gift to family members. You can do whatever you need to with it. Once you put it in the 401(k), whether it’s in the pretax, the Roth, or the aftertax, whichever version of it you’re doing, you become subject to the rules of those plans, which means that if you’re working, you may not be able to touch that money until you leave the employer. If you’ve retired, there are going to be tax implications of taking it out. You get the advantage of tax-deferred growth inside of it, which you don’t get outside the plan, but the trade-off is that you’re giving up some flexibility and some taxes on the backend.

Again, it all comes down to what your priority is. Do you want the flexibility to do whatever you want, even though it comes with some current tax costs, then you do the taxable account. If you’re willing to give up that flexibility in exchange for some tax deferral and other advantages, then you would maybe look at the employer plan.

Benz: Tim, it’s always great to get your perspective on these matters. Thank you so much for being here.

Steffen: Thanks, Christine. Good seeing you.

Benz: I’m Christine Benz for Morningstar. Thanks for tuning in.

Watch 5 Things to Do Today If You Want to Retire in 2030 for more from Christine Benz.