What is the Optional After-Tax account? (After-Tax vs Roth)
In your contribution accounts, you’ll see an Optional After-Tax account as well as a Roth account.
Since both Roth and After-Tax contributions are made with “after tax” income, many people confuse the difference between the two types.
If you’re making a normal contribution to your solo 401k, you should always choose between pre-tax and Roth. Pre-tax gives you a tax deduction on your contribution, and Roth gives you tax-free withdrawals in retirement.
The After-Tax account is an OPTIONAL account that should only be used if you want to do a mega backdoor Roth conversion.
What is a mega backdoor Roth?
The mega backdoor Roth allows you to bypass the Roth solo 401k contribution limits by contributing to an After-Tax account first, and then immediately transferring the funds over into a Roth solo 401k.
Here’s how it works…
The contribution limit for a solo 401k is: $66,000 for 2023 ($73,500 if age 50+).
Only employee contributions can be made as Roth. Employer contributions must always be pre-tax.
Employees can only contribute up to: $22,500 for 2023 ($30,000 if age 50+),
If you max out your employee contributions, that leaves you with $43,500 for 2023.
To implement the mega backdoor Roth conversion, you would contribute up to the remaining room left over to your After-Tax account instead of contributing to your Employer Pre-Tax account.
Once you contribute to your After-Tax account, it gets immediately converted into your Roth solo 401k. Doing this allows us to bypass the yearly Roth solo 401k contribution limits since there are no limits on conversions.
Essentially, with a mega backdoor Roth conversion, you could deposit up to $61,000 into a Roth solo 401k for 2022 and up to $66,000 for 2023. If you’re at least 50 years of age, with catch-up contributions, you could deposit up to $67,500 for 2022 and up to $73,500 for 2023, entirely into your Roth solo 401k.