Category Archives: Savings Strategies

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!

Sea of Letters

You are likely in the middle of open enrollment, or will be soon, so I thought this month would be a great time to review some of the crazy acronyms you see as your eyes glaze over the 100+ page benefits guide from your employer.

I can’t say here which benefits are the “best fit” for you. Reviewing benefit options is part of what I do with my clients each year. Lives change. Families change. Benefit packages change. For many, the confusion stays the same. 

The Biggest Offenders

FSA – Flexible Spending Account
HSA – Health Savings Account
HRA –  Health Reimbursement Account

These are NOT the same thing.

I’ll get the HRA out of the way, as it is not as common as the other two. This is an EMPLOYER owned and funded account an employee can use for medical expenses. It generally stays with your employer if you leave, unless they offer a retirement continuation. 

FSAs are offered with a standard HMO or PPO (I’m going to assume you know these two old friends).

I wrote a newsletter on HSAs a few months ago and the triple tax benefit they offer. They are only offered in conjunction with a HDHP. 

HDHP – High Deductible Health Plan

Similarities

  • Both are employee funded, although some employers will make contributions as an added benefit.
  • Both are funded with pre-tax dollars. Always a PLUS.
  • Both are used to pay for qualified medical expenses. 

Differences

  • Pre-tax contribution limits are higher for the HSA than the FSA. The HSA also offers a catch up contribution for those over age 55.
  • The up front, out of pocket medical payments are higher for Team HSA/HDHP.
  • FSA contributions are forfeited if not used in the same calendar year. There is some flexibility for carry over and grace periods, but forfeiture is the general rule. 
  • HSA contributions are yours forever. AND they can be invested. AND they can grow tax deferred. 
  • Your FSA is not portable. If you leave your company, the funds in the account do not go with you. An HSA is yours forever. 

While the HSA offers more flexibility than the FLEXIBLE Spending Account (oh the irony), it does not mean it is the right choice for you, even if both are offered by your employer. Every situation is unique.

Almost done, but a distinction I explain in this next section is REALLY important.

STD  – Short Term Disability
LTD – Long Term Disability

Granted, you probably know these two acronyms, but are you aware of the distinction when it comes to whether this benefit it taxable or not? 

It all comes down to how the premium is paid. I’ve worked with many clients who were not aware of the key difference because most benefit guides don’t do a great job of explaining it. 

It makes a big difference in how much money you actually take home, should you become disabled. 

  • If premiums are paid by you with after-tax dollars, then the disability benefit will not be taxable.
  • If premiums are paid by your employer, then the disability benefit will be taxable. 

Most LTD benefits offer coverage for “60% of salary”. If that 60% is not taxed, you are in OK shape.

If that 60% is taxed, your monthly benefit will be significantly less than your regular pay. 

One final scenario offering a TAX FREE disability benefit: 

  • Your employer pays the premium BUT adds the amount paid on your behalf to your gross earnings. By you paying taxes on the premium, any disability benefit you receive will be tax free

If your employer offers a tax free disability benefit option, this is the option you want. Otherwise, you may want to consider a private policy to supplement your employer plan.

Financial Fitness Tip

I often tie in both personal and professional experience to my newsletter and this time is no different. I was in a minor fender bender this morning (thankfully, everyone is OK), so I thought this was a good time to touch on auto insurance. Ironically, I also worked on a client plan this week where I recommended they increase their coverage. 

Most states require a minimum level of insurance, and if you are using a lender, they require proof of this coverage as well. Many folks go with the minimum requirements for Uninsured/Underinsured coverage and Property Damage. I don’t recommend this. Increase your coverage limits where you can. Back in my 20’s, I worked for an auto insurer as a claims adjuster, and believe me, these coverages come into play more often than we would like. 

Things I Love

I could probably do an entire newsletter devoted to binge worthy shows. My current fave is “Heartland” on Netflix. It’s a modern day Little House on the Prairie, which of course was the favorite of my 7 to 11 year old self. As I said in my January newsletter about The Marvelous Mrs. Maisel, it allows me to fall asleep with a happy heart. 

From a Google review:
“This sprawling family saga takes place where an unfortunate tragedy has glued a family together to pull them through life’s thick and thin moments. Follow young Amy Fleming as she slowly discovers she possesses her now-deceased mother’s ability to aid injured horses as well as maintaining good relationships with those who are trying to get by one day at a time.” 

Netflix has all 13 seasons and Heartland has been renewed for its 14th. When I saw that, I knew it must be a hit! 

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.

Out of the Mouths of Babes

I recently had the opportunity to help out at our local high school with a group of students who were participating in a program called “Credit for Life”. I had never heard of it, but with a quick Google search, I learned it is a nationally recognized program designed to help high school students develop personal financial management skills. SIGN ME UP!

I had a blast. I really did. I was assigned to the “Savings and Retirement” booth. I got so jazzed up talking with these kids about real world money matters. OK, granted, some of them I was talking at instead of with, but that was to be expected. But for the ones that were really listening and trying to take in what I was saying, it was very fulfilling. I had my first glimpse into the satisfaction teachers get out of molding young minds.

The advice I was repeating over and over to each group is really no different than what I would tell a client. At any age, the foundations of financial security and independence are the same. I didn’t want to throw so much at them that they walked away feeling overwhelmed and having learned nothing, so I kept repeating the following during those precious few minutes I had their attention:

Don’t spend more than you make.

Pay yourself first.

Most eyes glazed over when I spoke the phrase, “power of compounding interest”, but when I pulled out my graph to show them a visual of what their money could do for them if they committed to paying themselves first, and how that money could grow exponentially over time, their eyes lit up. I pointed out on their expense tracker that this sum of money they were “spending” from their paycheck was different than every other expense they had listed on that sheet because IT WAS STILL THEIR MONEY!

Imagine my excitement when I heard one student approach a group of friends and say something along the lines of, “guys, go over there, pay yourselves first”. Eureka!  My heart skipped a beat. And my pure, unadulterated joy when a friend shared with me that her daughter told her,  “Mrs. Danson said I can start contributing to a Roth IRA and it will keep growing and growing and I won’t have to pay taxes on it”. Wowzer! This young lady is going to be just fine when it comes to her future financial well-being.

Full disclosure, there was another student I overheard saying, “don’t go there, she takes 10% of your money”. I laughed out loud and said to the huddle of teens, “I’m not Uncle Sam, this is still your money”! I’m sure none of them understood the Uncle Sam joke, but I knew you would appreciate my humor. They’ll understand soon enough.

But interesting, isn’t it, that this was student #2’s interpretation of my message?

To that end, I leave you with this-

Spend less than you make and pay yourself first.