Unlocking the doors in a mega backdoor Roth account

Roth writes: What’s the benefit of using my mega backdoor Roth versus moving my Roth 401k funds into a Roth IRA? For instance, my after-tax 401k contributions are moved into a Roth 401k. Should I also then move these into a Roth IRA?

The only thing I’ve seen for a Roth IRA is that it generally has more investment options. But I feel keeping the funds in the 401K would be better because 401k accounts generally have better court precedent for bankruptcy protection.

Dr. Adam says: First of all, congratulations on having a mega backdoor Roth option at your employer. For my readers, a mega backdoor is where an employee who makes too much to contribute to a Roth IRA can contribute to a Roth 401k using after-tax contributions. While these contributions are not tax deductible, the aggregate contribution for this strategy is $69,000 in 2024. This is substantially larger than the $23,000 for a pre-tax 401k.

A Roth account is beneficial because contributions go in after-tax, but are withdrawn tax-free. However, many folks do not know that there are stipulations for the tax-free withdrawals for a Roth account.

Specifically, a Roth account’s withdrawals are tax free if taken after a 5-year holding period once the account owner reaches 59.5 years old. Yet, a Roth 401k and a Roth IRA have two different clocks.

If you open a Roth IRA, it starts a 5-year clock. If you have a Roth 401k, it also starts a 5-year clock. But each Roth 401k you have utilizes its own separate clock. However, all your Roth IRAs run off the single clock from your earliest opened Roth IRA.

This means that if you open a Roth IRA in 2024, your 5-year holding period is up on Jan 1, 2030. However, your Roth 401ks, if opened separately in 2024 and a new employer in 2030, would only have one account meeting the 5-year holding period.

Most investment advisors would suggest opening a Roth IRA as soon as possible, then moving funds to the Roth IRA from Roth 401ks to keep the single 5-year clock.

In terms of creditor protection, IRAs are protected up to an aggregate amount of $1,512,350 across all IRA accounts (Roth and traditional). This may be a concern for high net worth individuals, but other asset protection strategies are available if you discuss the finer points with your attorney.

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