The Mega Backdoor Roth Solo 401(k) for Solopreneurs

by | Nov 6, 2020 | Financial Planning, Insights, Retirement Planning, Tax Planning, Wealth Management

In The Mega Backdoor Roth – A Hidden 401(k) Benefit, we show how a few big companies enable their employees to supercharge their tax-free retirement income. But what about you – the solopreneur? Without the bells and whistles of a large company benefit package, are you out of luck? Fortunately, there’s an option for you. Let’s look at the What, Who, Why, and How of this strategy so you can access this Fortune 500 benefit for your solopreneur shop.

What is the Mega Backdoor Roth Solo 401(k)?

A Solo 401(k) is a retirement plan for businesses with no employees other than the owner and a spouse. It’s one of the simplest and most effective retirement plans for owners of these companies. They usually allow two types of contributions:

  • Salary Deferral. Up to $23,000 – plus an additional $7,500 catch up contribution if over age 50 – can be contributed to a pre-tax or Roth 401(k) from your wages.
  • Profit Sharing. Up to $46,000 – or 25% of business net income, whichever is less – can be contributed to a pre-tax 401(k).

The “Mega Backdoor Roth” component involves a tweak to this plan that allows you to redirect the additional $46,000 – to a Roth, building a tax-free retirement nest egg.

How does it work?
  1. Set up a Solo 401(k) and, with the help of a qualified Third Party Administrator, add two key features.
    • Voluntary after-tax contributions. Beyond the basic salary deferral, you’ll need your plan to allow additional after-tax contributions. These contributions aren’t deductible, and the gain would be taxed as income if left in the after-tax account until retirement – but we don’t plan to leave them here!
    • In-plan Roth conversions. Like the original Back Door Roth IRA contribution, this allows you to convert your after-tax dollars to your Roth. You won’t owe any taxes if you move immediately to Roth.
  2. Contribute the $23,000 salary deferral contribution as normal to the pre-tax or Roth account, whichever you’ve chosen.
  3. Contribute the additional $46,000 to your after-tax account rather than the pre-tax profit sharing account.
  4. Convert the after-tax balance immediately to the Roth account. These funds now grow tax-free and can be withdrawn tax-free for retirement after age 59.5.
Why should I consider this?

If you’re hitting the $23,000 limit each year and looking for ways to save additional dollars tax-free, this is well worth your time – here’s why.

  • You have 15 years until retirement.
  • You’re saving the full $23,000 each year to your 401(k) each year and deciding between the profit sharing or this Mega Backdoor Roth for the remaining $46,000 each year.
  • That $46,000 invested at 7% each year would give you just over $1 million after 15 years.

If invested using the Mega Backdoor Roth strategy, you’ll get that entire $1 million – tax-free.

Who is this right for?

You’re a prime candidate if:

  • You can save more than the $23,000 salary deferral maximum – preferably the full $46,000 each year – toward retirement.
  • You’re a high earner in your 20s, 30s, or 40s because you have a long retirement runway to see tax-free growth out of those Roth dollars.

However, if you’re self-employed, in your later working years, and have most of your nest egg in pre-tax retirement accounts, this could still be a way to balance the tax scales and create more flexibility in retirement.

Alterra Advisors - Josh Whelan

Joseph Kuehn

Financial Advisor Associate

About the Author

​Joseph became fascinated with personal finance while studying Accounting at the University of Redlands, where he discovered a gap in basic financial understanding. Soon after, he was accepted into a financial planning internship where he started a series of financial literacy classes – he knew he had found his calling. Financial planning aligned his financial skill sets with his passion for helping people.

Joseph has always been a problem solver. He loves helping clients take the complexities of the financial world and create effective strategies they can understand. As a Financial Advisor Associate, Joseph plays a key role on a client’s advising team, building strategy, and ensuring their plan is implemented and kept on track.

Joseph finished his studies with a degree in Financial Economics. He also played Quarterback for the University of Redlands Bulldogs and varsity golf. Outside of the office, he is always active. You’ll find him on golf courses, cheering on the Seahawks and out running the roads and trails – a true Pacific Northwesterner.

The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.

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