Solo Biz Owner? No Employees? Is the Mega Backdoor Roth for You?

Mega Backdoor Roth

Say you prefer the Roth retirement account.

If your income is too high to contribute to a Roth IRA, the backdoor Roth allows you to contribute to a traditional IRA and then convert that traditional IRA contribution of $7,000 ($8,000 if age 50 or over) to a Roth.¹

But if you have no employees and operate your business as a corporation or a sole proprietorship, you may want to utilize the mega backdoor Roth and invest up to $70,000 ($77,500 if you are age 50 or over). You can also accomplish this as a partner when the partnership has no full-time employees.

Key point. The mega backdoor enables a tenfold increase in contributions to the Roth.

Overview of the Roth versus the Traditional IRA

Roth

With the Roth retirement account, you invest previously taxed income so you pay the taxes up front. Your Roth earnings are federal-income-tax-free.

Traditional

With the traditional retirement account, you get a federal tax deduction for the money you invest. When you take the deducted money and earnings out, you pay federal income taxes at ordinary rates.

Think of it this way:

The Roth is front-loaded with taxes.

The traditional retirement fund is back-loaded with taxes.

Four Steps to Put the Mega Plan in Place

Four Steps to Put the Mega Plan in Place

Step 1 Set up a solo 401(k) that

(a) allows after-tax contributions, and

(b) permits in-service withdrawals or in-plan Roth conversions.²

You need both (a) and (b) to make this strategy work without a hitch.

In this first step, make sure your brokerage firm or retirement plan vendor offers this type of solo 401(k).

Step 2 Decide where you want the Roth funds:

• In a separate Roth IRA

• Inside your solo 401(k)’s Roth component

Step 3 Get the money into the plan.

Assume you want the full $70,000.³ Your strategy is to:

• Use the elective deferral to designate your after-tax contribution as a Roth contribution of $23,500 ($31,000 if age 50 or older),⁴ and

• Use the voluntary after-tax rule⁵ to contribute $46,500.

Is the Mega Backdoor Roth for You?

Key point. You avoid the employer contribution with this method. The employer contribution is pre-tax and goes into a traditional plan. This two-step method allows after-tax contributions to go to a Roth.

Step 4 Make it a Roth.

For your elective deferral of $23,500 or $31,000, you have two options:

1. Designate it as a Roth contribution directly when making the contribution. This is the simplest approach and preferred if available.

2. Make it as a traditional pre-tax contribution. This is generally undesirable because traditional contributions typically cannot be converted to Roth until age 59½, separation from service, or plan termination.

For the voluntary after-tax contribution of $46,500, your options depend on your plan:

1. Do an in-plan Roth conversion within the solo 401(k).

2. Do an in-service distribution of only the after-tax contributions to a separate Roth IRA.

Advantages of the Roth over the Traditional Plan

In most cases, Roth accounts do not produce more after-tax spendable cash than traditional accounts. However, Roth accounts offer these advantages:

• No required minimum distributions at age 73 or any age

• Continued tax-free growth for life. Tax-free inheritance for heirs (non-spouse beneficiaries generally must withdraw within 10 years)⁶

• Roth IRAs allow withdrawal of original contributions at any time without tax or penalty

Dollar Comparison: Traditional versus Roth (35 Percent Tax Rate)

• 35 percent tax rate now and in retirement

• 20-year investment period

• $50,000 annual investment

• 6 percent growth

• Contributions made at the beginning of each year

Traditional Retirement

• Pre-withdrawal balance: $1,949,636

• Taxes paid at withdrawal: $682,373

• Final after-tax value: $1,267,264

Roth IRA – Scenario 1

Equal pre-tax contributions ($50,000 before taxes)

• Pre-tax equivalent: $50,000

• After-tax contribution: $32,500

• Taxes paid up front: $350,000

• Final balance: $1,267,264 (tax-free)

Roth IRA – Scenario 2

Equal after-tax contributions ($50,000 after taxes)

• Pre-tax equivalent: $76,923

• After-tax contribution: $50,000

• Taxes paid up front: $538,462

• Final balance: $1,949,636 (tax-free)

Key Insights

• With identical tax rates at contribution and withdrawal, traditional and Roth (Scenario 1) produce the same after-tax value

• If you can contribute $50,000 after tax, the Roth produces a significantly higher final balance

• When tax rates are equal, the decision depends on flexibility, RMDs, estate planning, and future tax policy expectations

Takeaways

If you are a solo business owner with no employees and prefer the Roth retirement account, the mega backdoor Roth can be a powerful strategy.

The regular backdoor Roth IRA caps annual contributions at $7,000 ($8,000 if age 50 or older). The mega backdoor Roth allows contributions up to $70,000 ($77,500 if age 50 or older).

To use this strategy, your solo 401(k) must allow after-tax contributions and either in-service withdrawals or in-plan Roth conversions. Once established, you fund the plan through elective deferrals and voluntary after-tax contributions, then convert the funds to Roth.

The Roth benefits include tax-free growth, no required minimum distributions, and tax-efficient wealth transfer. In most cases, after-tax spendable cash remains similar to a traditional plan.

Whether this strategy is right depends on your overall tax strategy, expected future tax rates, and estate planning goals.

References

1. Backdoor Roth IRA Conversions: Smart Move or Hidden Tax Trap?

2. IRC Section 402(c); Notice 2024-54; IRS Pub. 560 (2024); IRS Pub. 590-A (2024)

3. Notice 2024-80

4. Ibid.

5. IRC Section 401(a)(4); Reg. Section 1.401(m)-1(b)(4)(ii); Notice 2014-54

6. IRC Section 401(a)(9)

*Thank you - Bradford Tax Institute