The Mega Backdoor Roth Strategy for BP Employees

Transcript

Greetings everyone! My name is Kyle McClain, and I’m a Partner and Senior Wealth Manager here with Rhame & Gorrell Wealth Management.

Today, we’ll be covering one of the most potentially lucrative strategies within the BP Employee Savings Plan: the Mega Backdoor Roth. This strategy gives BP employees a way to turbocharge tax-advantaged 401(k) savings beyond normal IRS limits.

If you or someone you know could benefit from this strategy or the other services our firm offers, feel free to contact our team for a complimentary consultation, where we will review your financial situation to determine opportunities for optimization from an investment, tax, estate planning, employer benefits, and retirement strategy perspective.

Without further ado, let’s jump into today’s topic: the Mega Backdoor Roth.

So, what is the Mega Roth? At its core, the Mega Roth is a tax strategy embedded within the BP ESP.

By undertaking a series of transactions, employees can make contributions beyond normal IRS limits. For instance, in 2025, employees can contribute $23,500 either via Pre-Tax or Roth contributions, with a catch-up contribution of $7,500 available if you’ll be 50 or older by the end of the year.

The Mega Roth allows certain employees to add tens of thousands of additional dollars beyond this to the plan annually.

I’d like to take a moment to refresh everyone’s memory on how Pre-Tax versus Roth contributions work for tax purposes:

As I previously mentioned, for 2025 employees can contribute $23,500 to the Pre-Tax or Roth account, or some combination of the two.

Pre-Tax contributions, as we may know, involve making contributions before federal income taxes are paid. However, all of your contributions and your growth on these contributions will taxed upon distribution. Roth contributions, on the other hand, are made after federal income taxes are paid, and therefore all of your future growth and your original contributions are tax-free upon distribution.

The determination of whether an employee would want to make Pre-Tax or Roth contributions is entirely dependent upon their current tax rate vs. their anticipated future tax rate. If you’d like a deeper analysis of this topic, please see our Pre-Tax vs. Roth contributions video.

Concurrently with your Pre-Tax or Roth contributions, the company will be making a 7% matching contribution, which is also Pre-Tax.

Based on the contributions discussed above, the total going into the 401(k) for an individual maximizing the Pre-Tax contribution and making $300,000 per year is $44,500 from a combination of the employee’s contributions as well as BP’s.

This $44,500 total is well below the IRS maximum contribution limitation for all sources of contributions, which is $70,000 for those under the age of 50 and $77,500 for those over.

So, where can this $25,500 difference between the IRS limit and the other maximum contributions go?

You guessed it, the After-Tax account.

Let’s discuss the tax features of the After-Tax account, because they’re a bit of a blend of the tax features of the Pre-Tax and Roth accounts:

After-Tax contributions, as the name implies, are made after federal income taxes have been paid from the funds. However, growth that occurs while in the After-Tax account will be taxed as ordinary income upon distribution.

So, you might ask yourself, why would I contribute to an account with no current tax bill reduction, but all my growth will eventually be taxed as ordinary income?

This is because we don’t leave the funds in the After-Tax account to grow indefinitely.

The BP Employee Savings Plan allows participants to convert these After-Tax funds to Roth.

And the best part? If funds are converted to Roth before growth occurs, the conversion is entirely tax-free!

Here’s how it works: Once the normal Pre-Tax or Roth limit for contributions is reached, the employee may defer additional funds into a third repository within the plan, the After-Tax account.

Subsequently, these additional funds are converted into the Roth account, where you will enjoy tax-free growth until they are distributed in your retirement years.

At this point, we hope it’s becoming clear that this strategy can be an absolute tax home run for retirement savers.

It’s also important to note that most 401(k) participants outside of BP cannot use this strategy.

While some large companies do have this capability, if you look at all eligible 401(k) plans in the U.S., only about 3 in 10 offer the Mega Roth strategy.

So let’s consider a comparison of an individual who fully utilized the Mega Roth strategy over the course of their career with $1 million of earnings within the Roth Conversion account vs. an individual who alternatively diverts the funds into their brokerage account.

Given that the Roth earnings are tax-free, while the brokerage account earnings will generally be subject to a 15-20% tax rate on long-term capital gains and an ordinary income rate of up to 37% on interest income or short-term capital gains, the differential is at minimum several hundred thousand dollars of needless taxes paid.

Before we wrap up our conversation today, I’d like to draw your attention to a few important considerations surrounding the Mega Backdoor Roth.

If you have a pre-existing After-Tax balance within the ESP, or growth on recent contributions, you should be aware of the Pro-Rata Rule. The Pro-Rata Rule states that if an After-Tax account contains a mix of contributions as well as taxable earnings on those contributions, any conversion or distribution from that account will be partially taxable depending on the ratio of contributions and earnings.

In some cases, it can make sense to execute a rollover distribution of your After-Tax account to your IRAs outside of the plan. This strategy allows employees to remove pre-existing After-Tax balances to effectively “clean the slate” for future conversions. This transaction requires supervision for successful completion, and these numbers are different for everyone, so we absolutely recommend that you discuss the effect of any current balance that you may have within the After-Tax account with a tax expert, such as our in-house CPAs, who can help you understand the tax implications of any future conversions.

Thanks again for spending some time with us today to learn about the Mega Roth strategy.

At Rhame & Gorrell Wealth Management, we provide advice on over $1 billion in client portfolios. As a firm, we strive to serve as an effective one-stop shop for comprehensive retirement planning.

The many CFP® and CPA tax professionals on our staff specialize in helping our clients take advantage of advanced financial strategies to materially enhance their financial ability to enjoy their lives before and after retirement.

We invite you to schedule a complimentary consultation with our team by giving us a call, sending us an email, or simply visiting our website today!

Need Some Help?

If you’d like some help from one of our CPAs or CERTIFIED FINANCIAL PLANNER (CFP®) advisors regarding this strategy and how it applies to you, the Rhame & Gorrell Wealth Management team is here to help.

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Feel free to contact us at (832) 789-1100, [email protected], or click the button below to schedule your complimentary consultation today.