IRA Financial Blog

What is the Mega Roth Strategy?

Mega Roth Strategy

Many people know that IRA or 401(k) plan contributions can be made pretax or Roth.  However, many retirement savers mistakenly think that a non-deductible or after-tax contribution is the same as a Roth contribution. It is not. With a Roth Solo 401(k) plan contribution, once the plan participant is over the age of 59 1/2 and the Roth has been opened at least five years, all Roth 401(k) distributions will be tax-free. Another option is the mega Roth strategy.

Whereas, in the case of an after-tax or non-deductible 401(k) contribution, the amount of the contribution can be taken as a tax-free distribution anytime, however, all earnings generated by the contributions are subject to tax, much like a pretax 401(k) contribution.

What is Mega Roth Strategy for 401(k) Plans?

The advantage of making after-tax contributions and employing the “Mega Roth” strategy versus a typical mix of employee deferral and profit sharing contribution is that you can:

  • Make a dollar for dollar contribution up to $66,000 or $73,500 for 2023 versus an employee deferral up to $22,500 or $30,000 if age 50+.
  • Make a profit sharing contribution, which is based off a percentage of your compensation (20% or 25%).  

Unfortunately, not all Solo 401(k) plans allow for nondeductible contributions, but IRA Financial Group’s 401(k) plan documents do.

After-tax 401(k) plan contributions are not a new phenomenon, but new IRS regulations (Notice 2014-54) make after-tax contributions more attractive in a few ways. The new IRS regulations allow the retiree to effectively segregate the after-tax assets from the pretax funds. 

The pretax funds can be rolled into a Traditional IRA, whereas the after-tax dollars can be converted into a Roth IRA.  Prior to Notice 2014-54, there was a question as to whether after-tax funds can be converted to a Roth IRA. 

Can After-Tax Funds be Converted to a Roth IRA?

Notice 2014-54 clarified this rule and allows the pretax and after-tax funds that were distributed from a plan on a pro-rated basis to be separated once a distribution is made.  

For example, if a self-employed sole proprietor under the age of 50 made $50,000 in 2021, elected to use the “mega Roth” strategy, she would be able to defer most of the $50,000 she earned.  In contrast, if her plan did not include the ability to make after-tax 401(k) contributions, she would only be able to contribute $22,500 plus 20% of her salary, allowing her to defer approximately $29,500 for the year, versus close to $50,000 using the “Mega Roth” strategy. 

One of the nice things about after-tax contributions is that it can really help boost a plan participant’s annual plan contribution amount and allow for automatic in-plan rollovers to an IRA or another 401(k) plan.

IRS Reporting of After-Tax Conversion to Roth

IRS Form 1099-R

Based on IRS Notice 2014-54, the plan participant can now segregate and convert the amount of the after-tax contributions to Roth. Assuming no earnings were generated from the after-tax contributions, the Roth conversion would not be subject to tax. 

When it comes to reporting Roth 401(k) plan conversions, one must complete an IRS Form 1099-R the following year by January 31.  Reporting an after-tax conversion to Roth is quite simple. The key points to remember when completing the form is the Box 2A – Taxable Amount should be $0 and code “G” should be used in Box 7.  This is important because an after-tax Roth conversion should not be treated as a taxable distribution.  

To learn more about the advantages of employing the Mega Roth Solo 401(k) plan strategy, please contact one of our 401(k) specialists at 800-472-1043.


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