Mega Backdoor Roth 401(k) and RSU Income: A Kestrel Bay Retirement Advisors Walkthrough

Is a mega backdoor Roth 401(k) worth it with RSU income?

It is worth it when two things are true. Your plan must allow after-tax contributions and let you move them to Roth, either by converting inside the plan or by withdrawing them while you still work there. You also need spare cash after setting aside your RSU tax reserve. Without both, the strategy doesn't work. With both, Leah's numbers below show up to $35,500 a year going into Roth money, which is hard to do any other way at a high income.

The conversion itself costs almost nothing in tax. Funding it is where the bill shows up. If you sell shares with a large gain to replace the paycheck dollars that go into the plan, the capital gains tax on that sale can eat much of the benefit. Kestrel Bay Retirement Advisors prices that sale before anything else, because it's the part people forget.

One more thing comes before Roth room. RSU vests often leave a withholding gap: the flat federal rate taken at vest is often lower than your real bracket, so April brings a balance due. That gap gets cash first. An underpayment penalty plus an April bill costs more than waiting a year for Roth room.

Myths about the mega backdoor Roth 401(k), and what is true

Most of the confusion comes from four claims that sound right and aren't. Each one changes how much you can put in or what you'll owe.

• Myth: any 401(k) allows it. Fact: the plan must accept after-tax contributions and offer an in-plan Roth conversion or in-service withdrawal. Many plans do not.
• Myth: the conversion is tax-free. Fact: converted contributions aren't taxed again, but earnings are, so convert soon after each deposit.
• Myth: the $72,000 sits on top of your deferral and match. Fact: it includes both, so your room is $72,000 − $24,500 − the match.
• Myth: my income is too high for Roth money. Fact: the single-filer Roth IRA phase-out of $153,000 to $168,000 doesn't apply to conversions inside a plan.

Leah's $35,500 of room, funded two ways

Hypothetical: Leah, 38, is single and works as a senior software engineer at a public cloud company. She rents and has never sold a vested RSU. About $1.2 million of her $1.6 million net worth is employer stock, next to a $180,000 401(k), and she wants to sell without creating one enormous tax year. She defers $24,500 and gets a $12,000 match, assuming a full deferral. Subtract both from $72,000 and her after-tax room comes to $35,500.

Because the contribution comes out of payroll, her take-home pay drops, and she replaces it by selling $35,500 of company shares. A recent vest lot with a $34,000 basis produces a $1,500 short-term gain, taxed at an assumed 37%, which is about $555. An older lot with a $20,000 basis produces a $15,500 gain, taxed at an assumed 20%, which is $3,100. Cash savings would cost nothing in tax.

The same $35,500 moves into Roth either way. The lot choice alone changes her tax by $3,100 − $555 = $2,545. The recent vest lot is the cheap one here even though short-term rates are higher, because its price barely moved since vesting. Stock prices can fall, and you can lose money; a share that drops after vest would flip this math.

How do you set up a mega backdoor Roth, step by step?

You set it up by confirming the plan rules, computing your room, and then scheduling a conversion for every deposit. Most of the delay comes from waiting on the plan administrator, so start with the first step.

• Step 1: ask the plan administrator for the summary plan description and confirm after-tax contributions, in-plan conversion or in-service withdrawal, and the match formula.
• Step 2: compute room as $72,000 minus your expected deferral and match. If the match is paid at year end, ask when it is credited.
• Step 3: ask for the maximum after-tax percentage, since the ACP test can cap it for higher-paid employees.
• Step 4: set the payroll percentage. $35,500 over 26 paychecks is about $1,365 each.
• Step 5: schedule the conversion for every deposit and save the January Form 1099-R.

Mistakes that cost real money

The costliest one is leaving after-tax money unconverted. If $35,500 grows 6% in a year, for illustration, the $2,130 of earnings is taxable at conversion, about $790 at 37%. Converting each deposit would have avoided it.

Picking shares to sell without checking basis is the second. In Leah's case the older lot costs $2,545 more tax for the same Roth deposit, and nobody warns you because the brokerage just sells what you click.

Pace matters too. If you start at a percentage that hits the $72,000 total before year end, the plan may stop deposits or fail the ACP test, and you'd be left with a mess to correct. Last, don't cut your pre-tax deferral to fund after-tax money. You'd give up a deduction at a high bracket to buy Roth room, and we'd rather keep the deduction because it's worth more today.

How does the answer change with age and account size?

Catch-up contributions ($8,000 at 50 and over, $11,250 at ages 60 to 63) don't count toward the $72,000, so they neither add nor remove after-tax room. A bigger match does shrink it: at $20,000 the room falls to $27,500, and with no match it is $47,500.

At 38, Leah has about 25 years before a typical retirement for Roth growth to work. But with a $180,000 401(k), cash flow, not room, is her limit. Close to retirement the Roth years matter less and the tax on funding shares matters more.

Our rule of thumb: fund after-tax 401(k) contributions only from cash left after your tax reserve. If selling shares to pay for them would cost more than about 5% of the amount in tax, wait or use a different lot. On $35,500 that line is $1,775, so Leah's $555 lot passes and her $3,100 lot doesn't.

What to do this week if this applies to you

Skip this for now if your plan doesn't allow after-tax contributions plus an in-plan conversion or in-service withdrawal, or if you have no cash left after setting aside the year's tax. A 401(k) with little room for after-tax deposits won't help. If neither applies, spend an hour on these.

• Download the summary plan description and search for the words after-tax, in-plan Roth conversion and in-service distribution.
• Write down your 2026 deferral, expected match and the resulting room.
• Open your brokerage lots page and list basis and holding period for each vest lot.
• Set your tax reserve for the RSU gap before choosing an after-tax percentage.

Questions to ask an advisor before you start

Bring these to a planner, and expect numbers back rather than general talk. Before Kestrel Bay Retirement Advisors suggests any share sale, it estimates the tax cost of that sale. Related topics, such as how RSUs are taxed at vest, equity compensation planning and concentrated stock positions, each have their own pages. If you'd like a second set of eyes on your plan documents, the request form on this site is the way to reach our team.

• Does my plan convert automatically, and how fast after each deposit?
• How much tax would each of my share lots cost to sell this year?
• Do I owe an RSU withholding gap that should be funded first?
• How does the ACP test affect my allowed after-tax percentage?