Category Archives: Retirement

Mega Back Door Roth: This Supersized Option is Good for your Health

This topic has come up for me twice in the last week, so as is often the case, I’ve made it the topic for my newsletter this month.

I often get asked about the best strategies for saving outside of one’s 401(k).

My first caveat is that one size does not fit all, so what is a great solution for your neighbor may not be the best strategy for your situation.

I’ve highlighted in past newsletters the benefits of saving into an HSA, if you have one.

There’s also the option to contribute to an IRA, but regardless of which type of IRA you are to contributing to (deductible, non-deductible, ROTH, backdoor Roth), you are limited to how much you can contribute each year ($6,000 for 2020, $7,000 if you are over 50).

But what if you are in the fortunate position to be able to save more than this?

Introducing the Mega Backdoor Roth

There’s a little known strategy that I’m seeing as an option with more employers as of late. It’s the option to make after-tax contributions to your 401(k).

This strategy can offer tax diversification in retirement, but there are certain criteria that make it most effective.

It’s known in my industry as a  “Mega Backdoor Roth”, but you will not see it described that way in your benefits guide. It allows you to sock away more into retirement than the annual limits on a 401(k) or IRA.

Here’s how it works:

  1. Your 401(k) plan (your employer) allows after-tax contributions. If they don’t, game over.
     
  2. Your employer offers in-service distributions of these after-tax contributions to a Roth IRA while you are still employed or allows you to move the after-tax potion of your 401(k) to the Roth 401(k) part of the employer plan (if they offer one).

    If not allowed, game might be over, but not necessarily. It depends.

    I know, you hate when I say that. 
     
  3. You convert the after-tax contributions to one of the above as soon as allowed in order that the growth on your contributions is tax-free. You will now have a Roth IRA in retirement where there are no RMD requirements and distributions are tax free. Game changer.

When MIGHT this strategy be an effective strategy for you?

  • You already max out on your 401(k) contributions.
  • You max out on your HSA, if your employer offers one.
  • You make too much money for traditional IRA contributions to be deductible.
  • You max out a Roth IRA or backdoor Roth ($6,000 for 2020, $7,000 if you are over 50).

As with most financial planning and tax strategies, there are a lot of ins and outs and I try to stick to top level highlights to educate and make you aware of possible options available to you.  Consulting with your financial advisor or CPA is always prudent to determine which strategies are your best fit.

Financial Fitness Tip

Speaking of 401(k)’s, we are quickly approaching the end of 2020 (thank goodness). It’s a good time to check where you are with your 401(k) contributions for the year. You may have dialed back the % you contribute when things got a little coo coo in the markets or you had a temporary need for increased cash flow.

If things are looking brighter in your financial world, increase your % for these last few paychecks of the year and into 2021. And if there was never a hardship yet you are not maxing out, consider increasing it a percent or two now.

Little steps carry us a long way over time.

Things I Love

I will be pulling out my mom’s tattered and stained copy of her mom’s recipe to try to match what my grandmother used to create – a true masterpiece! I can never quite match it (my mother always said the same thing when she made it), but I can try.

And besides, it’s simply the tradition of making it and remembering them both that is my true Favorite Thing!

Happy Thanksgiving!

This Triple Scores You a Homerun

The Basics of an HSA

An HSA is a savings account for health care expenses tied to what’s known as a High Deductible Health Plan, often offered as a health care option through your employer. This type of account is different from a Flexible Spending Account (FSA), where you can lose any unused portion of your dollars set aside for a given year.

The money set aside in an HSA stays with you forever, similar to how your 401(k) would work. So even if you leave your current employer, your HSA dollars go with you. And like your 401(k), you can invest them.

You own the assets in your HSA forever.

How the high deductible health plan works and whether it is right for your circumstances is a newsletter for another time, but many who currently have this type of plan with an HSA don’t understand the benefits of the HSA in and of itself.

Triple Tax Advantaged

  1. Your contributions are pre-tax, so they lower your taxable income in the year they are made. Think of this tax savings in the same way you think of your pre-tax 401(k) contributions. 
     
  2. You can invest your contributions and they will grow tax free, meaning any growth on the account is also NOT taxable. This works like a Roth IRA in this regard, so for high income earners who are phased out of making Roth contributions, this is an excellent tax savings vehicle that offers the same tax free growth one gets from a Roth. 
     
  3. Withdrawals, AS LONG AS USED FOR QUALIFIED MEDICAL EXPENSES, are 100% tax free.

Boom!!! A Triple Tax Homerun!

Now the caveat is that although you can make contributions to this account on an annual basis to pay for current medical expenses, the goal is to instead pay out of pocket and invest that savings, like you would any other qualified savings account, allowing it to grow tax free for as many years as possible.

With our ever increasing health care costs, this is a great tool for our future selves to have a bucket of tax free money to help cover our future medical care costs.