Latest / Masters in Business / At The Money: The Mega Backdoor Roth

Transcript

At The Money: The Mega Backdoor Roth · Masters in Business

• 0:02
  Speaker 1: Bloomberg Audio Studios, podcasts, radio news.
• 0:31
  Speaker 2: Tax deferred portfolio is also known as qualified accounts, have
• 0:35
  Speaker 2: become one of the most popular ways to invest. There
• 0:38
  Speaker 2: are about one hundred million households nearly seventy five percent
• 0:41
  Speaker 2: of every household in America with some sort of a
• 0:44
  Speaker 2: formal tax advantage. Retirement savings total defined contributions are nearly
• 0:50
  Speaker 2: fourteen trillion dollars. The latest edition in your Tax Deferred
• 0:55
  Speaker 2: Portfolio Choices is the Mega Backdoor Row. To help us
• 1:01
  Speaker 2: unpack all of this and what it means for your
• 1:03
  Speaker 2: retirement savings, let's bring in Dan L.
• 1:05
  Speaker 3: Rosa.
• 1:06
  Speaker 2: He's an expert in qualified retirement accounts and works with
• 1:10
  Speaker 2: clients all over the country. In full disclosure, Dan leads
• 1:15
  Speaker 2: the corporate retirement plans at my Firmer Helts Wealth Management
• 1:19
  Speaker 2: and is one of my partners. So let's start with
• 1:22
  Speaker 2: the basics. Most of our listeners are certainly familiar with
• 1:26
  Speaker 2: four oh one ks, and they're probably familiar with variations
• 1:31
  Speaker 2: such as a ROTH four oh one K or a
• 1:32
  Speaker 2: ROTH IRA. What is a Mega backdoor WROTH?
• 1:37
  Speaker 4: So a regular four one K allows you to contribute
• 1:40
  Speaker 4: up to twenty four and a half thousand dollars into it.
• 1:43
  Speaker 3: Right.
• 1:43
  Speaker 4: The mega backdoor of ROTH feature just allows you to
• 1:47
  Speaker 4: contribute above and beyond that twenty four and a half
• 1:49
  Speaker 4: thousand dollars up to potentially seventy two thousand dollars. So
• 1:54
  Speaker 4: it uses the same type of strategy that you have
• 1:56
  Speaker 4: in your regular backdoor ROTH IRA. Right, that's just a
• 2:01
  Speaker 4: way for high earners to get money into a ROTH account.
• 2:04
  Speaker 4: They're going to make a non inductible contribution to a
• 2:07
  Speaker 4: traditional IRA and then convert that to a ROTH IRA.
• 2:11
  Speaker 4: It works, it's great, but the dollar amount is pretty small, right,
• 2:15
  Speaker 4: it's seven five hundred dollars. The Mega backdoor ROTH uses
• 2:20
  Speaker 4: the same strategy, but inside of your four one K plan,
• 2:24
  Speaker 4: where the contribution limits are significantly higher.
• 2:28
  Speaker 2: So mega backdoor four oh one k ROTH sounds kind
• 2:33
  Speaker 2: of complicated, but it really seems like that's a huge
• 2:37
  Speaker 2: increase in your after tax contributions that theoretically grow tax
• 2:44
  Speaker 2: free and are withdrawn tax free. Is that right?
• 2:48
  Speaker 3: That's right.
• 2:48
  Speaker 4: It's it's a cheap when it works and your plan
• 2:51
  Speaker 4: allows it. It's a cheat code, right, There's nothing else
• 2:54
  Speaker 4: out there that's going to allow you to get that
• 2:57
  Speaker 4: much money into a qualified and that means that much
• 3:00
  Speaker 4: rock dollars into a qualified retirement account.
• 3:03
  Speaker 2: So cheat codes and back doors sounds a little shady.
• 3:06
  Speaker 2: Is this legit with the irs? Have they blessed this? Yeah?
• 3:11
  Speaker 4: Yeah, it's just the backdoor part that sounds kind of sketchy.
• 3:14
  Speaker 2: It is.
• 3:14
  Speaker 4: It is not a gray area, it is not a loophole.
• 3:18
  Speaker 4: It's completely legit. The rules are actually very much clear.
• 3:22
  Speaker 4: The real challenge is just whether or not your plan
• 3:24
  Speaker 4: allows you to use it.
• 3:26
  Speaker 2: So let's go through that. If the I R S
• 3:29
  Speaker 2: says it's kosher, I would imagine your employer or the
• 3:33
  Speaker 2: benefits provider, maybe even the custodian who who has to
• 3:36
  Speaker 2: sign off on it? Is Is it any of the
• 3:38
  Speaker 2: above or all the above whose approval is required?
• 3:44
  Speaker 3: Yeah, it's There's really nothing to do with the custodian
• 3:46
  Speaker 3: with this.
• 3:46
  Speaker 4: It's more of a plan level decision that's going to
• 3:49
  Speaker 4: be made by the employer, right. They're the ones that
• 3:52
  Speaker 4: are going to control the plan design and would ultimately
• 3:55
  Speaker 4: make the decision to offer the after tax contributions in
• 4:00
  Speaker 4: plan Wroth conversion features that make up this megabactoor Wroth.
• 4:05
  Speaker 4: The formul k provider is obviously involved and they need
• 4:08
  Speaker 4: to be able to administer this, but that's generally.
• 4:11
  Speaker 3: Not a problem.
• 4:12
  Speaker 2: Huh. So typically twenty four and a half twenty four
• 4:17
  Speaker 2: point five is a regular four oh one K. I'm
• 4:20
  Speaker 2: assuming catch ups and things like that are separate. So
• 4:24
  Speaker 2: if you could go to seventy two thousand in this
• 4:28
  Speaker 2: and it's after tax, why would the employer object? This
• 4:31
  Speaker 2: sounds like a great deal for anyone who wants to
• 4:34
  Speaker 2: throw more money into their four o one K.
• 4:36
  Speaker 4: Yeah, and this feature has gotten a lot more popular
• 4:39
  Speaker 4: in recent years, but the reality is the most likely
• 4:44
  Speaker 4: answerest to why.
• 4:45
  Speaker 3: More plans don't do it.
• 4:46
  Speaker 4: It just doesn't work for every plan after tax contributions
• 4:50
  Speaker 4: and the inplan wealth conversions do add some complexity to
• 4:53
  Speaker 4: the plan design that most importantly, they trigger additional compliance testing,
• 4:58
  Speaker 4: and that extra compliance test thing it failed can prevent
• 5:02
  Speaker 4: the whole strategy from working all together.
• 5:05
  Speaker 2: So I know our plan in our shop offers this
• 5:08
  Speaker 2: in house, and I've been taking advantage of it personally.
• 5:12
  Speaker 2: So I'm thinking about other service companies, lawyers, accountants, advisors, architects,
• 5:20
  Speaker 2: anybody that's you know, a white collar office with reasonable salaries.
• 5:27
  Speaker 2: It would seem that this should be something that all
• 5:31
  Speaker 2: those people should take advantage of Why don't all of
• 5:36
  Speaker 2: these sort of firms take advantage of it? It sounds like, hey,
• 5:41
  Speaker 2: seventy two thousand triple what you normally allow. That's seventy
• 5:45
  Speaker 2: two thousand above what your traditional for one K is giving.
• 5:50
  Speaker 2: Why wouldn't everybody jump on this?
• 5:52
  Speaker 4: Yeah, it was seventy two thousand and actually the total
• 5:54
  Speaker 4: that's you're all in that each individual can get into
• 5:57
  Speaker 4: each plan. But why don't more plans or companies use
• 6:03
  Speaker 4: this feature? Again, it just doesn't always work. So, without
• 6:07
  Speaker 4: getting too deep into the weeds on the compliance tessing side,
• 6:12
  Speaker 4: if the only individuals that are interested in using this
• 6:16
  Speaker 4: feature and contributing making these after tax contributions are the
• 6:20
  Speaker 4: owners and highest wagoarners, it's not going to work.
• 6:25
  Speaker 3: It's as simple as that.
• 6:27
  Speaker 4: So the company either has to be big enough or
• 6:29
  Speaker 4: have enough wayjarners where it's just not the top twenty
• 6:32
  Speaker 4: percent or so using it in order for.
• 6:35
  Speaker 3: It to work.
• 6:36
  Speaker 2: So what does it typically look like in a firm
• 6:40
  Speaker 2: that does this? What sort of buy in do you
• 6:42
  Speaker 2: need from management as well as the rest of the
• 6:46
  Speaker 2: staff or partnership.
• 6:47
  Speaker 4: Yeah, I mean listen as far as buying from the staff.
• 6:51
  Speaker 4: If you have a lot of employees that are contributing
• 6:53
  Speaker 4: and maxing out, right, If you have a lot of
• 6:55
  Speaker 4: people that are maxing their contributions and would do more
• 6:58
  Speaker 4: if they could, that's good sign, right, It's worth looking
• 7:01
  Speaker 4: into in that situation. But you also have to have
• 7:04
  Speaker 4: enough highly compensated individuals.
• 7:08
  Speaker 3: Right if you just have If you have.
• 7:10
  Speaker 4: Thirty people and eight of them are the big wag journers,
• 7:15
  Speaker 4: it's just again, it's not going to work.
• 7:16
  Speaker 3: It's going to be top heavy.
• 7:17
  Speaker 4: So if you have enough highly compensated individuals that are
• 7:21
  Speaker 4: interested in using this feature, there's a good shot at
• 7:23
  Speaker 4: all work.
• 7:24
  Speaker 2: So I immediately thought of professional services companies, financial advisors, attorneys, accountants, bankers, doctors, etc.
• 7:34
  Speaker 2: But you know, what sort of industries do you see
• 7:37
  Speaker 2: use this? What sort of businesses? Is this really well
• 7:39
  Speaker 2: suited for.
• 7:41
  Speaker 3: All the professionals that you just listed?
• 7:43
  Speaker 4: Tech companies, I mean, i'd say all just about all
• 7:46
  Speaker 4: of the big tech companies have this feature available. Again,
• 7:49
  Speaker 4: and I think any industry or any company where a
• 7:54
  Speaker 4: large percentage of the population would be considered highway journers,
• 7:58
  Speaker 4: meaning say over one hundred and fifty hundred sixty thousand
• 8:00
  Speaker 4: dollars a year and that are interested in making these
• 8:04
  Speaker 4: significant contributions.
• 8:06
  Speaker 3: It could work.
• 8:07
  Speaker 2: So let's assume you have a traditional four oh one
• 8:10
  Speaker 2: K and everybody is maxing out their twenty four point
• 8:14
  Speaker 2: five plus whatever catch up over fifties out there, and
• 8:18
  Speaker 2: they want to be able to save more money. What
• 8:22
  Speaker 2: is the process like converting that to a megabackdoor roth?
• 8:26
  Speaker 2: Walk us through that process.
• 8:28
  Speaker 4: Yeah, Ultimately it's going to have to come from the employer, right,
• 8:31
  Speaker 4: so whoever at the company is in charge of running
• 8:34
  Speaker 4: and administering the four to one K will need to
• 8:36
  Speaker 4: be involved in that decision. You know, if you're an
• 8:39
  Speaker 4: influential employee, of course you can try and influence and
• 8:43
  Speaker 4: push on that decision. But ultimately the plan sponsor the
• 8:46
  Speaker 4: employer will work with the four to one K provider
• 8:50
  Speaker 4: to update the plan documents add a couple of features.
• 8:53
  Speaker 4: For the megabackdoor ROTH to work. A plan has to
• 8:58
  Speaker 4: allow two things. The first is the ability to make
• 9:01
  Speaker 4: after tax contributions and the second is a way to
• 9:05
  Speaker 4: move those after tax dollars into.
• 9:08
  Speaker 3: A ROTH account.
• 9:09
  Speaker 4: Moving the after tax dollars into WRATH can happen one
• 9:12
  Speaker 4: of two ways first you have an implan WROTH conversion
• 9:17
  Speaker 4: where the after tax dollars are converted to ROTH and
• 9:20
  Speaker 4: stay in the four to one K plan. And the
• 9:23
  Speaker 4: second is an in service distribution where the after tax
• 9:27
  Speaker 4: dollars are rolled into an outside ROTH IRA mplan. ROTH
• 9:33
  Speaker 4: conversion is probably more common. It's just simpler to execute,
• 9:36
  Speaker 4: and it keeps all the money inside the plan.
• 9:39
  Speaker 2: Huh, I mean this is really attractive. I'm assuming someone
• 9:44
  Speaker 2: reaches out to HR or one of the managing directors
• 9:48
  Speaker 2: or partners or whatever the title is and says, hey,
• 9:51
  Speaker 2: this is a great opportunity. Want don't we do this?
• 9:54
  Speaker 2: Is there like an extra cost? Why would there be
• 9:56
  Speaker 2: any reluctance to do this assuming it's the sort of
• 10:01
  Speaker 2: mix of high wage employees.
• 10:05
  Speaker 4: Yeah, there is no additional costs. You could say, there's
• 10:09
  Speaker 4: a little bit of an additional headache. Right again, you're
• 10:11
  Speaker 4: adding more complexity, another layer of compliance testing.
• 10:14
  Speaker 3: So whoever you know is.
• 10:16
  Speaker 4: In charge of administering the four O one K company? Yeah,
• 10:19
  Speaker 4: maybe it amounts to a little more work, but when
• 10:21
  Speaker 4: it works, it works really well, and these significant benefits
• 10:26
  Speaker 4: far outweigh you know, the minor administrative additional administrative burden.
• 10:32
  Speaker 2: So we're talking about companies with partners and hr et cetera.
• 10:37
  Speaker 2: What about either a solo practitioner or a ten ninety
• 10:41
  Speaker 2: nine contractor. Can you do this sort of megaback door
• 10:45
  Speaker 2: roth if you're self employed?
• 10:47
  Speaker 4: Yes, absolutely, megabacdoor roth works perfectly for solo or owner
• 10:51
  Speaker 4: only four one K plans. There are no compliance tests
• 10:55
  Speaker 4: and headaches or administrative burdens when the plant only covers owners.
• 10:59
  Speaker 3: So we we're.
• 11:00
  Speaker 4: Huge fans of the megabacdoor wroth in solo formal case.
• 11:04
  Speaker 2: So let's talk about timing. How does this work? How
• 11:08
  Speaker 2: much are people converting? You know, what does this look
• 11:11
  Speaker 2: like in terms of best practices, either daily or each
• 11:15
  Speaker 2: pay period or quartterally. How often does this occur?
• 11:19
  Speaker 4: It really depends on the plan or on the plan provider.
• 11:23
  Speaker 3: Some plans only allow.
• 11:25
  Speaker 4: A certain number of conversions or distributions each year, which
• 11:29
  Speaker 4: is obviously not ideal and it really kind of pushes
• 11:33
  Speaker 4: the burden onto the participant to figure out when and
• 11:37
  Speaker 4: how to do that. Others have daily automatic roth conversions,
• 11:40
  Speaker 4: which is just awesome.
• 11:43
  Speaker 3: I've done it both ways, right, I've had the once a.
• 11:46
  Speaker 4: Year manual paper form after tax conversions and we now
• 11:52
  Speaker 4: have the daily automatic.
• 11:54
  Speaker 3: Wroth conversions with Fidelity, and it's a game changer. It's great.
• 12:00
  Speaker 4: As an employee, you don't have too much control over that.
• 12:03
  Speaker 4: It really depends on the provider. But whatever the case,
• 12:06
  Speaker 4: I certainly recommend reaching out to your four to one
• 12:09
  Speaker 4: key provider the first time you do this, the first
• 12:12
  Speaker 4: time you convert, and making sure you get it right,
• 12:15
  Speaker 4: do it.
• 12:15
  Speaker 3: The right way.
• 12:16
  Speaker 2: So you and I have talked about this in the past,
• 12:19
  Speaker 2: and you discussed automatic wroth sweeps. Is that something that
• 12:24
  Speaker 2: again gets set up by the provider or the employer
• 12:27
  Speaker 2: or the employee. How do you make sure that each
• 12:30
  Speaker 2: payroll period or in the event of any distribution or
• 12:35
  Speaker 2: yield or dividend, how do you make sure that stays
• 12:37
  Speaker 2: on the wroth side.
• 12:40
  Speaker 3: Yeah, it's a great point.
• 12:41
  Speaker 4: So that daily automatic roth sweep or automatic roth conversion
• 12:45
  Speaker 4: is awesome, but only some record keepers, only some providers
• 12:49
  Speaker 4: offer it.
• 12:50
  Speaker 3: Right.
• 12:50
  Speaker 4: So the answer, as it usually is with these types
• 12:54
  Speaker 4: of plans, as it depends right. Every plan is different,
• 12:56
  Speaker 4: every provider is different. If your plan does offer it,
• 13:02
  Speaker 4: or if you're not sure, reach out to the four
• 13:03
  Speaker 4: one K provider. If your plan does offer it, the
• 13:06
  Speaker 4: employee generally has to activate this daily automatic growth conversion feature.
• 13:12
  Speaker 2: All right, so I know my four oh one K
• 13:14
  Speaker 2: is a Fidelity all of these daily sweeps and other
• 13:17
  Speaker 2: things that you know, from my perspective, it was set
• 13:20
  Speaker 2: and forget, I don't have to pay much attention to it.
• 13:23
  Speaker 2: What about some of the other big four oh one
• 13:25
  Speaker 2: K provider Schwab, Vanguard, Is it possible to do it
• 13:31
  Speaker 2: with those? And do they allow for these daily sweeps
• 13:35
  Speaker 2: like what's the landscape look like out there?
• 13:37
  Speaker 3: Yeah?
• 13:38
  Speaker 4: As this feature has gotten more and more popular in
• 13:41
  Speaker 4: recent years, which it certainly has, more providers are getting
• 13:44
  Speaker 4: better at it.
• 13:44
  Speaker 3: Right five years ago, I.
• 13:47
  Speaker 4: Don't know if anyone outside of Fidelity did it now
• 13:49
  Speaker 4: if there, certainly, if your plan is big enough, you
• 13:52
  Speaker 4: can pretty much do whatever you want for it. I
• 13:56
  Speaker 4: think if Fidelity just happened to be the first one
• 13:59
  Speaker 4: that was really good at administering it.
• 14:01
  Speaker 3: But other providers are catching up quickly.
• 14:05
  Speaker 2: Last question. People hear this described as tax free growth forever,
• 14:10
  Speaker 2: and obviously that gets people excited, But what are the risks?
• 14:14
  Speaker 2: What scenarios? Does this not make any sense? Where are
• 14:17
  Speaker 2: you just better off investing in a taxable account?
• 14:21
  Speaker 4: Yeah, I think the excitement is warranted. I'm a huge
• 14:25
  Speaker 4: fan of the megabactoor roth feature. If your plan offers
• 14:28
  Speaker 4: it and you can afford the extra contributions, my answer
• 14:32
  Speaker 4: is usually do it.
• 14:34
  Speaker 3: Just keep in mind a couple of things.
• 14:35
  Speaker 4: First, if you use that in plan Wroth conversion, the
• 14:39
  Speaker 4: money stays in the plan and then follows the Wroth
• 14:42
  Speaker 4: four to H one k rules all right, So that
• 14:45
  Speaker 4: means you generally can't access that money until age fifty
• 14:48
  Speaker 4: nine and a half or distributable event. So I think
• 14:52
  Speaker 4: the biggest thing answer your question when does a taxable
• 14:55
  Speaker 4: account make more sense if present day liquidity is important?
• 14:59
  Speaker 2: What about out megabeck door roths. Is there the same
• 15:04
  Speaker 2: required minimum withdrawal requirements?
• 15:08
  Speaker 4: Actually, I think effective last year, the Secure two point
• 15:12
  Speaker 4: zero removed the R and D requirement from Wroth four
• 15:16
  Speaker 4: one case, so there.
• 15:17
  Speaker 3: Are no rm D requirements for a row for one case.
• 15:20
  Speaker 2: Really interesting. So if you're working in a firm, or
• 15:24
  Speaker 2: if you're a solo practitioner and you're making a decent
• 15:27
  Speaker 2: amount of money but you want to save more for retirement,
• 15:32
  Speaker 2: the megabackdoor rowth allows you to use after tax dollars
• 15:37
  Speaker 2: up to seventy two thousand to put into this account
• 15:41
  Speaker 2: that will not only grow tax free, but you can
• 15:45
  Speaker 2: withdraw a tax free whenever you want after age fifty
• 15:48
  Speaker 2: nine and a half, with no minimum requirements when you
• 15:51
  Speaker 2: turn seventy three. It sounds like a great opportunity, and
• 15:55
  Speaker 2: a lot of people just are unaware of it and
• 15:58
  Speaker 2: are not taking advantage of it. You should look into
• 16:01
  Speaker 2: this if you're in those circumstances and you have an
• 16:04
  Speaker 2: employer who will work with you to create a better
• 16:08
  Speaker 2: corporate retirement plan. I'm Barry Dults you're listening to at
• 16:13
  Speaker 2: the Money