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

For those who prefer the Roth retirement account.

Suppose your income is too high to contribute to a Roth IRA; then the backdoor Roth provides an option to contribute to a traditional IRA and subsequently convert it to a Roth IRA. This allows for a traditional IRA contribution of $7,000 ($8,000 if age 50 or older) to be made, followed by a conversion to a Roth IRA.

Those who have no employees and operate their business as a corporation or a sole proprietorship may use the mega backdoor Roth and invest up to $70,000 ($77,000 if they are aged 50 or above). You can achieve this as a partner when the partnership has no full-time employees.

The mega backdoor enables a tenfold increase in contributions to a Roth IRA.

Overview of the Roth versus the traditional IRA

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

Traditional: With the conventional retirement account, you get a federal tax deduction for the money you invest. When you deduct the money and earnings, you pay federal income taxes at ordinary rates.

Think of it this way: Roth is front-loaded with taxes. The traditional retirement fund is back-loaded with taxes.

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-plant Roth conversions. You need both (a) and (b) to make this work without any hiccups. Ensure your brokerage firm or retirement plan vendor offers the type of solo 401(k) described.

Step 2: Decide where you want the Roth funds:

In separate Roth IRA
Inside your solo 401(k) Roth component

Step 3: Get the money into the plan. For the full $70,000, this is the strategy:

Use the elective deferral to designate your after-tax contribution as a Roth contribution of $23,000 ($31,000 if 50 years and above), and
Use the voluntary after-tax rule to contribute $46,500

Step 4: Make it a Roth. For your elective deferral of $23,500 or $31,000, you have two options:

You designate if as a Roth contribution directly when contributing.
You contribute to a traditional pre-tax contribution. You generally cannot convert a traditional contribution to a Roth account until you meet specific plan requirements.

For the voluntary after-tax contribution ($ 47,000), you have two options depending on your plan:

Do an in-plan Roth conversion within your solo 401(k).
Do an in-service distribution of only the after-tax contributions to your separate Roth IRA.

Advantages of the Roth over the traditional plan

If you opine that Roth would produce more after-tax spendable cash, then revise your thinking. But Roth has more benefits over the traditional plan:

Roth IRAs do not require you to take distributions at age 73, which means your investments can continue growing tax-free for as long as you want.
Roth accounts can be passed to heirs tax-free
With a Roth IRA specifically, you can withdraw your original contributions at any time without penalties or taxes.

Dollar Comparison: Traditional Vs. Roth

With a consistent 35 per cent tax rate for both current income and retirement withdraws, here are the two IRA types that compare over 20 years with a $50,000 annual investment at 6 per cent growth, assuming the investment is made at the beginning of the 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

Pre-tax equivalent: $50,000
After-tax contribution: $32,500
Taxes paid upfront: $350,000 (over 20 years)
Final balance: $1,267,264 (tax free withdrawal)

Scenario 2: Equal after-tax contributions

Pre-tax equivalent: $76,923
After-tax contribution: $50,000
Taxes paid upfront: $538,462 (over 20 years)
Final balance: $1,949,636 (tax free withdrawal)

Key insights

With identical tax rates at contribution and withdrawal, the traditional IRA and Roth IRA (Scenario 1) yields exactly the same after-tax value of $1,267,264.
If you can contribute $50,000 after tax, the Roth IRA provides a much higher final value ($1,949,636 vs. 1,267,264)
If the tax rates are equal during contributions and withdrawals, your decision hinges more on other factors like expected tax policy and rate changes, flexibility needs, estate planning and required minimum distribution.

BergerCPAFirst, with over 30+ years of experience, offers comprehensive tax preparation services for individuals and businesses nationwide. Our commitment is to provide personalized attention while ensuring compliance and maximising tax benefits. If you have any questions or would like to schedule a consultation, please call (201) 587-9200 or send us an inquiry.