Mega Backdoor Roth: Why Must I Make an Election by Year-End?

Mega Backdoor Roths are excellent retirement structures. By contributing after-tax dollars to a 401(k) plan and then converting those contributions into a Roth, individuals can sidestep the strict income limits typically imposed on Roth IRA contributions.

This strategy provides the dual benefits of significant annual contribution potential—up to the combined 401(k) limit. This gives you the ability to enjoy tax-free growth and withdrawals in retirement.

There are a variety of compliance tasks you need to make in order to accomplish the Mega. One of which is the requirement to make a year-end election. In this post, we discuss this election and also spell out other considerations when funding a Mega.

We will also give you a few implementation tips. Let’s jump in!

The IRC 415 Limit

The IRS spells out maximum annual contribution limits to 401(k) plans in IRC code section 415. The annual cap if often referred to as the “annual additions limit. “

For most business owners, this maximum amount is often broken into two components:

1. The employee deferral (also called employee contributions); and
2. The employer profit-sharing contributions (also called employer contributions).

Employee deferrals represent IRS limits that are indexed annually for inflation. Profit-sharing contributions are limited to 25% of the W-2 or 20% for a sole proprietor.

But what happens when the employee deferral and the employer profit-sharing do not equal the annual cap? That’s when the Mega Backdoor Roth comes into play.

For 2025, the Internal Revenue Code (IRC) Section 415(c) limit for defined contribution plans, including Solo 401(k) plans, is $70,000 ($77,500 for people age 50+). This limit encompasses all contributions made to the plan, such as employee elective deferrals, employer contributions, and any after-tax contributions.

Employee elective deferrals are capped at $23,500 for 2025, with an additional catch-up contribution of $7,500 allowed for individuals aged 50 or older, bringing their total elective deferral limit to $31,000. Take a look at the summary table below:

Employer contributions can be made up to 25% of the participant’s compensation, but the combined total of all contributions cannot exceed the $70,000 limit set by IRC Section 415(c).

It’s important to note that catch-up contributions for those aged 50 or over are not included in the Section 415(c) limit. Therefore, eligible participants can potentially contribute up to $77,500 in total for 2025 when accounting for both the standard limit and the catch-up contributions.

Mega Requirements

Before you run out and start making after tax contributions to your 401(k) plan, there are a few compliance considerations you need to have:

• The 401(k) plan document must specifically state that after-tax contributions are allowed along with in-plan Roth rollovers.
• The amount entered for non-Roth after-tax contributions may not be more than 100% of your plan compensation.
• The total combined elective deferral contributions and after-tax contributions may not exceed 100% of your plan compensation.
• Your plan must be a solo plan. In most cases, group plans will not pass IRS testing rules.

It is important to note that the Mega will almost never work when you have eligible non-owner employees. The reason is that it will not pass compliance testing because too much of a contribution will be going to the owner and not enough to the employees. This makes sense because rank and file employees usually are not compensated high enough to afford to make after-tax contributions.

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What Does the IRS say?

The IRS discusses the specifics of 401(k) plans in IRS Publication 560. You can find the publication here: https://www.irs.gov/publications/p560

In Publication 560, the IRS defines “elective deferral” as follows:

“An elective deferral is the contribution made by employees to a qualified retirement plan.

• Non-owner employees: The employee salary reduction/elective deferral contributions must be elected/made by the end of the tax year and deposited into the employee’s plan account within 7 business days (safe harbor) and no later than 15 days.

• Owner/employees: The employee deferrals must be elected by the end of the tax year and can then be made by the tax return filing deadline, including extensions.“

Based on the above, the IRS appears to include both the deferral and after-tax (Mega) contributions as employee deferrals since both are made by the employee.

Election Form

An employee election must be made to report the following transactions:

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1) Elective deferrals;
2) After-tax contributions; and
3) An in-plan rollover from an After-tax 401(k) contribution to a Roth 401(k) contribution.

To make an election statement for after-tax 401(k) contributions, the following items should be included:

1. Participant Information:
   • Full name of the participant.
   • Social Security Number or Employee Identification Number (if applicable).
   • Address and contact information.
2. Employer Information:
   • Employer’s name.
   • Employer’s address.
   • Plan name (e.g., “ABC Company 401(k) Plan”).
   • Plan identification number (EIN or other applicable identifier).
3. Election Details:
   • Declaration of the participant’s intention to make after-tax contributions.
   • The percentage or specific dollar amount of after-tax contributions to be deducted from each paycheck.
   • Effective date of the election.
4. Acknowledgment of Contribution Limits:
   • A statement that the participant understands and agrees to abide by IRS limits, including the Section 415 limit for total contributions.
5. Tax Implications Disclosure:
   • Acknowledgment that after-tax contributions are not tax-deductible.
   • Notification that earnings on after-tax contributions will be taxed upon withdrawal unless rolled over into a Roth IRA or Roth 401(k).
6. Amendment and Revocation Clause:
   • A statement clarifying that the participant may amend or revoke the election at any time, subject to plan rules.
7. Signature and Date:
   • Participant’s signature.
   • Date of the election statement.
   • Employer or plan administrator’s signature (if required by the plan).
8. Plan-Specific Disclosures (if applicable):
   • Any additional disclosures required by the employer’s plan document, such as the process for rollover to a Roth account or limits on after-tax contributions.

These components ensure the election statement is clear, compliant with IRS regulations, and consistent with the plan’s requirements. Please note that the election form should NOT include an election by the company to make a profit-sharing contribution.

Other Compliance Issues?

There are a few other compliance issues that you need to be aware of:

• Required Minimum Distributions (RMDs) and hardship distributions are not eligible for rollover.
• Investments that are currently in a Roth Account will not be included in an in-plan Roth rollover.
• I understand that I will receive a form 1099-R only if a contribution was rolled over to an IRA.

What Does Emparion Do?

We will include the form in your file and retain it to support your contribution or if the IRS requires evidence. The form will also form a basis for your contributions made after year-end.

At Emparion, we are a full-service third-party administrator (TPA). As such, we hold your hand through the process and provide you with an election statement to support your employee deferrals. We answer any questions you would have and make sure you understand the IRS requirements.

Final Thoughts

In summary, Mega Backdoor Roths offer an unparalleled opportunity for high-income earners and super-savers to maximize their retirement savings while leveraging the tax-free growth and withdrawal benefits of Roth accounts. By allowing significantly higher contribution limits than traditional Roth IRAs, these structures enable individuals to optimize their financial future and hedge against potential tax increases.

For those with access to an eligible 401(k) plan, the Mega Backdoor Roth strategy is a powerful tool to build a robust, tax-efficient retirement portfolio. This structure, when executed within a well-designed 401(k) plan, allows high savers to significantly bolster their retirement security while minimizing their tax liability over time.