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Maxing Your 401(k)? The Backdoor Roth, the Mega Backdoor, and the Old IRA Trap · Align Your Retirement

• 0:00
  Hey, welcome back to Align Your Retirement.
• 0:02
  I'm Hazel Seco, CFP and CDFA, founder of Aligned Financial Solutions.
• 0:07
  We're fee-only advisors and fiduciaries 100% of the time.
• 0:11
  Today's episode is about what happens after you max out your 401, whether you can still do a backdoor Roth, where the after-tax option fits, and the order that makes sense when you can do more than one.
• 0:24
  Let's get into it.
• 0:25
  Somewhere around her mid-50s, a woman who has been maxing her 401for 20 years hears a colleague mention a backdoor Roth, and she has the same two reactions almost everyone has.
• 0:37
  First,"I thought I was already doing everything I could." Second,"Does that replace what I'm doing or go on top?" The answer to the second one is on top.
• 0:48
  A backdoor Roth is an IRA move, and your 401limit has nothing to do with it.
• 0:54
  But once you know that, you discover there are more than two places your money can go, and they don't all work the same way.
• 1:01
  Some of them are a choice between A and B, others stack, and the real limit on them is your cash flow, not the IRS.
• 1:09
  So today, I'm going to walk through one hypothetical person, Lauren, who maxes her 401and has just been told to do a backdoor Roth.
• 1:18
  I'll lay out the five places her next dollar can go, show you which one stack, walk through the one trap that catches people who change jobs, and give you the three questions that decide the order for you.
• 1:30
  I'm Hazel Seco.
• 1:31
  I'm a certified financial planner, a CDFA, and a fee-only fiduciary.
• 1:35
  One note, I'm a financial advisor, but I'm not your financial advisor.
• 1:39
  This is education, not advice.
• 1:40
  Grab something to write on.
• 1:42
  Let me introduce you to Lauren.
• 1:44
  She's hypothetical, but her question is a common one.
• 1:46
  Lauren is fifty-four, a vice president at a technology company.
• 1:50
  She has maxed her 401pre-tax every year since her 30s.
• 1:54
  She has well over one million dollars saved, almost all of it pre-tax, including a three hundred thousand dollar rollover IRA from the job before this one.
• 2:04
  A colleague told her last week she should be doing a backdoor Roth, and she came to me with two questions: Am I allowed to?
• 2:12
  And does it replace what I'm already doing?
• 2:14
  The answer to both is simple.
• 2:16
  Yes, she's allowed to, and no, it doesn't replace anything.
• 2:20
  Her 401limit and her IRA limit are two separate limits.
• 2:25
  One has nothing to do with the other one.
• 2:27
  But once Lauren knows that, the real question shows up.
• 2:30
  There are five places her money can go, and nobody has ever shown her how they fit together.
• 2:36
  Think of five shelves in the order most people fill them.
• 2:39
  Shelf one is the employer match.
• 2:42
  Whatever her company matches, she takes all of it every year.
• 2:45
  That never changes.
• 2:46
  Shelves two and three are the two sides of her own 401contribution.
• 2:51
  For twenty twenty-six, the base limit is twenty-four thousand five hundred, and she can put it on the pre-tax side, the Roth side, or split it.
• 3:00
  This is a choice, pre-tax or Roth.
• 3:02
  It is the same twenty-four five hundred either way.
• 3:06
  Once you're fifty, you can add a catch-up on top.
• 3:10
  If you earned over one hundred and fifty thousand dollars in Social Security wages from that employer last year, that catch-up has to go Roth.
• 3:18
  Shelf four is the backdoor Roth IRA.
• 3:20
  This is a separate account with a separate limit, seventy-five hundred dollars for twenty twenty-six plus eleven hundred dollars catch up from age fifty.
• 3:29
  To keep the numbers simple, I'll use the seventy-five hundred for Lauren.
• 3:33
  For this example, assume she has enough eligible compensation and her income is above the direct Roth IRA limit for her filing status.
• 3:42
  If you qualify to contribute directly, you may not need the backdoor.
• 3:46
  So she puts it into a traditional IRA, takes no deduction, then converts it to Roth.
• 3:53
  Two steps, and the result is seventy-five hundred dollars a year in a Roth that she could not have reached directly.
• 4:00
  This shelf stacks on top of the 401.
• 4:02
  It doesn't take anything away from it.
• 4:05
  Shelf five is the one most people have never heard of.
• 4:08
  Some 401plans let you put in after-tax money beyond the regular deferral limit, then move it to Roth through an in-plan conversion or a permitted rollover to a Roth IRA.
• 4:21
  The overall limit for contributions to the plan this year is$72,000, including her$24,500 and whatever her employer puts in.
• 4:30
  Her catch-up sits outside of that Whatever room is left between those seventy-two thousand dollars can be after-tax money that becomes Roth if the plan's testing allows it.
• 4:42
  People call it the mega backdoor Roth.
• 4:44
  This shelf also stacks, but the plan has to allow after-tax contributions and a route to move them to Roth.
• 4:50
  Any earnings moved to Roth are generally taxable, so she checks how often the plan lets her make that move.
• 4:57
  That is one email to HR.
• 4:59
  So when Lauren asked whether the backdoor Roth replaces her 401, the picture answers it.
• 5:04
  Shelves two and three are the only place she chooses.
• 5:09
  Everything else adds up.
• 5:11
  Now, before Lauren goes and opens that IRA, there is one thing in her situation that would turn a clean move into a tax bill, and she almost certainly has it.
• 5:20
  Remember Lauren's three hundred thousand dollars rollover IRA from her last job?
• 5:25
  Here's the problem: when she converts money from a traditional IRA to Roth, the IRS doesn't look at the seventy-five hundred dollars she just put in.
• 5:34
  It adds up all of her traditional IRAs at the end of the year, including any SEP or SIMPLE IRA, and treats the conversion as coming out of the whole pot in proportion.
• 5:44
  So her seventy-five hundred dollars of already taxed money goes into a pot of about three hundred seven thousand five hundred dollars.
• 5:52
  When she converts seventy-five hundred, the IRS says only about two percent of it is the after-tax money.
• 5:59
  The other ninety-eight percent is counted as pre-tax, and she owes tax on it.
• 6:04
  She has turned a tax-free move into a mostly taxable one, and the after-tax money she put in is still mostly stuck in the IRA.
• 6:13
  The rule is called the pro rata rule, and it is why she needs to check the old IRA before converting.
• 6:19
  One possible fix is to move the pre-tax IRA money into her current 401if the plan accepts it and the fees and investment options make sense for her.
• 6:29
  Only pre-tax money can go into the plan.
• 6:32
  What matters is that no pre-tax IRA balance is left on December 31st of the year she converts.
• 6:39
  Money in the 401doesn't count for this rule, so if she converts the seventy-five hundred dollars before it earns anything, there is no additional income tax.
• 6:48
  If her plan won't take the rollover, she compares the tax cost and her other options before going ahead.
• 6:54
  If you change jobs even once and roll the 401into an IRA, assume this applies to you until you check.
• 7:01
  You might be thinking,"I can't fund all five of these." Most people can't.
• 7:05
  That's why the order matters, and three questions decide it.
• 7:09
  First How big is your pre-tax pile already?
• 7:12
  Lauren has well over$1 million that will all be taxed as income later, and required withdrawals that will start whether she needs the money or not.
• 7:20
  That makes Roth worth comparing, but the balance alone doesn't decide it.
• 7:25
  She compares the tax rate she avoids today with what she expects to pay when she withdraws.
• 7:31
  If she gets a deduction at a higher rate now and withdraws at a lower rate later, pre-tax can still leave her ahead, even with a large balance.
• 7:40
  Second, what does your plan actually allow?
• 7:43
  Four things to ask HR in one email.
• 7:46
  Is there a Roth side to the 401?
• 7:49
  Does the plan accept rollovers in from an IRA?
• 7:52
  Does it allow after-tax contributions beyond the limit?
• 7:55
  And what route and timing does it allow for moving that after-tax money to Roth, an in-plan conversion, or a rollover to a Roth IRA?
• 8:04
  The answers tell you whether the shelf five exists for you and whether the trap fix is available.
• 8:11
  Third, do you have a traditional or rollover IRA sitting outside your plan?
• 8:16
  Include any traditional SEP or Simple IRA, too.
• 8:19
  If there is pre-tax money, check the ProReta result before using shelf four.
• 8:24
  Even without that issue, the paperwork matters.
• 8:27
  Report the non-deductible contribution and conversion on Form 8606 and keep the basis records.
• 8:35
  With those answers, Lauren's order is clear.
• 8:37
  Match first, then her regular 401deferrals, choosing pre-tax, Roth, or a mix from the tax comparison, plus any catch-up she's eligible to make.
• 8:47
  If the rollover makes sense and the plan accepts it, she can move the old IRA in and use the backdoor Roth, because$7,500 a year is small, but it's simple, and it's hers wherever she works next.
• 9:01
  Then, if her plan allows it, after-tax money into the plan as far as her cash flow lets her go.
• 9:07
  She fills the shelves in order and stops when the money runs out.
• 9:11
  There is no rule that says she has to reach the top.
• 9:15
  Let me pull this all together.
• 9:17
  Lauren asked whether she could do a backdoor Roth on top of her 401, and the answer was yes in 10 seconds.
• 9:24
  What she didn't know was that she had five shelves, not two, that only one of them was a real choice, and that the old IRA from her last job would have taxed basically the whole backdoor if she hadn't moved it first.
• 9:38
  If you're maxing your 401and wondering what comes next, here are three things to do this week.
• 9:43
  Write these down.
• 9:44
  Number one, send HR the four questions, Roth, rollovers in, after-tax contributions, how after-tax money gets to Roth.
• 9:52
  The answers tell you which shelves you have.
• 9:55
  Two- Add up every traditional or rollover IRA you own.
• 9:59
  If the total is anything other than zero, that is your first job before a backdoor Roth.
• 10:04
  Three, decide your order on paper.
• 10:07
  Match, then 24,500, and the backdoor, then after-tax, if you have it.
• 10:14
  Fill in order and stop where your cash flow stops.
• 10:18
  Before you do anything else this week, log into every old retirement account you have and write down what kind it is.
• 10:25
  A rollover IRA you forgot about is the difference between a tax-free backdoor Roth and a mostly taxable one.
• 10:32
  If you want the full picture on where Roth money fits in your plan, my free guide, The Retirement Tax Playbook, is linked in the show notes.
• 10:40
  The link to book an online call is there, too, if you would like to talk through your own order.
• 10:45
  It's a 15-minute conversation.
• 10:47
  If you know someone who just got told to do a backdoor Roth and isn't sure what that means for their 401, send them this episode.
• 10:55
  Retirement is too important to wing.
• 10:57
  I'm Hazel Seco.
• 10:58
  Talk to you next time.