What is a Traditional 401k?
A Traditional 401k is a retirement account type that may allow an individual to contribute pre-tax dollars, taking advantage of a tax deduction in the year they contribute to the plan.
There are limits on an individual's annual contributions to a Traditional 401k
There is a different limit, or maximum, on annual aggregate employer and employee contributions to a Traditional 401k. This may allow you to contribute after-tax dollars.
Traditional 401k withdrawals are taxed at the individual's ordinary income tax rate
Traditional 401ks have a 10% penalty for withdrawals prior to age 59.5
Traditional 401ks require Required Minimum Distributions at age 72
What is a Roth 401k or IRA?
A Roth 401k or IRA is an account type that that may allow an individual to contribute after-tax dollars and avoid income tax on any future qualified withdrawals. So, Roth accounts are considered tax exempt or tax free.
There are limits on annual contributions to a Roth 401k or a Roth IRA
There are income limits on contributions to a Roth IRA. You may not qualify for a direct contribution, or you may not qualify for a full contribution if your income exceeds certain thresholds.
What is a Mega Backdoor Roth?
A Mega Backdoor Roth is not an account type, it is a strategy to circumvent the annual limits on contributions to a Roth IRA or Roth 401k.
If your employer offers either in-service withdrawals to a Roth IRA or in-plan rollovers to a Roth 401(k), you may be able to take advantage of this strategy.
A Mega Backdoor Roth works like this:
You contribute after-tax money to your 401k
You perform in-service withdrawals to a Roth IRA or in-plan rollovers to a Roth 401(k)
Your Roth dollars grow tax free
How do I enter a Mega Backdoor Roth in My Plan?
The best way to account for a Mega Backdoor Roth in your plan is to create a Roth 401k or Roth IRA account and add contributions that represent the after-tax dollars you plan to withdraw to your Roth IRA or rollover to your Roth 401(k). When you do this, there will be no tax modeling. The contribution will be entered after-tax.
What if my plan does not allow in-service withdrawals to a Roth IRA or in-plan rollovers to a Roth 401(k)?
If your plan does not allow in-service withdrawals to a Roth IRA or in-plan rollovers to a Roth 401(k), and either:
your 401k account contains after-tax dollars
you contribute after tax dollars to your 401k
your 401k account contains after-tax dollars and you contribute after tax dollars
we recommend you create 2 separate accounts to ensure accurate income tax modeling. Create one account for the tax-deferred dollars, and another account for the after-tax dollars. Add contributions as appropriate.