Everyone thinks about saving for retirement, and not many people want to work forever. However, have you thought about the best way to save for the future? If you are setting aside the yearly max in your 401(k) and channeling extra savings to your brokerage, you might be missing out on powerful tax-advantaged saving opportunities. In this article, we will show you how we help clients maximize savings, minimize taxes and secure their future using the Mega Backdoor Roth IRA.
Most people know they can contribute to their employer’s retirement plan from their paychecks through pre-tax and Roth contributions up to $19,000 a year ($25,000 if age 50 or older; IRS, 2018). What people miss is whether their retirement plan allows for additional after-tax contributions beyond this limit. Enter the supercharged savings!
It turns out that some company plans permit you to contribute up to the IRS maximum for total contributions to a retirement plan, which is $56,000 in 2019 ($62,000 with catch-up contributions; IRS, 2018). The IRS maximum counts contributions from all sources, including pre-tax employee deferrals, employer matching contributions, and even after-tax contributions for the Mega Backdoor Roth. That means you might be able to contribute an additional $20,000 or more after-tax each year after maxing your elective deferral and receiving your match. You can then convert the extra after-tax savings to Roth dollars tax-free. This more than doubles what most individuals can contribute to their retirement plan, and you won’t have to pay taxes on your Roth account distributions in retirement. This benefit is even greater when both spouses have this option available through their employers, so be sure to check both plans.
Retirement plans like those at Boeing, Facebook, and Microsoft permit easy conversions of after-tax to Roth dollars within the retirement plan. Other companies offer a variation where you can make in-service distributions and move after-tax dollars into a Roth IRA. Make sure to check with your benefits team to find out if your company’s retirement plan supports after-tax contributions and Roth conversions, the steps involved and the maximum amount you can contribute to the after-tax portion of your retirement plan. It’s important not to run afoul of plan rules or IRS requirements, so also be sure to consult experts like your accountant or financial advisor if you have any questions.
Why contribute extra after-tax? Now that we have covered the high-level view, let’s hammer down the why. The benefit of contributing to your employer’s after-tax retirement plan is that those contributions can subsequently be converted to Roth tax-free. This is sometimes called a ‘Mega Backdoor Roth,’whereby you can contribute and convert thousands of dollars per year depending on your retirement plan. Once converted, these Roth assets can grow tax-free and be distributed in retirement tax-free. After several years of Mega Backdoor Roth contributions, you can amass a meaningful amount of wealth in a tax-free retirement account
How do I contribute? 1. Log in to your employer’s retirement plan through their provider website, such as Fidelity.
2. Find the area where you change your paycheck and bonus contributions (i.e., deferrals).
3. Find “after-tax” on the list showing how much you elected to contribute pre-tax, Roth, or after-tax to your 401(k).
4. Enter a percentage to have withheld after-tax from your upcoming paychecks and bonuses that works for your budget.
5. Select an automated conversion schedule, such as quarterly (Microsoft’s retirement plan even offers daily conversions!). If your plan doesn’t offer automated periodic conversions, contact your retirement plan provider regularly throughout the year to convert the assets.
6. Remember to select an appropriate investment allocation for your retirement account that aligns with your overall investment plan.
Is any part of the conversion taxed? For retirement plans that don’t convert after-tax contributions to Roth daily, there may be growth in the account prior to conversion. This growth is subject to taxation at ordinary income tax rates. For example, if you converted $22,000 ($20,000 contributions + $2,000 investment growth over the period), you’ll owe income tax on the $2,000.
We suggest speaking with a Merriman advisor to determine if your retirement plan allows additional after-tax contributions, how to fit it within your budget and its impact on your retirement savings goals.
The RMD is the amount that Traditional, SEP, SIMPLE IRA owners and qualified plan participants must begin distributing from their retirement accounts in the year in which they reach 70.5. The RMD must then be distributed each subsequent year.
The standard deadline for taking your RMD is December 31st. However, you can use a one time exemption for your first RMD and delay until April 1st of the following year. If you choose to utilize this deferral you will have to take both your first and second year distributions that year.
The amount of your RMD is calculated by dividing the year end value of all of your IRAs by your distribution factor. Your distribution factor can be found using the IRA Uniform Lifetime Tables which are prepared by the IRS.
Our friends at Thomson Reuters have provided another wonderful checklist of year-end tax planning opportunities. As we enter the final week of the year, it’s worth considering if any of these options can save you money. (more…)
It seems like every year there’s a slew of tax breaks in danger of expiring. Sometimes Congress extends the tax break, other times they actually expire and fall by the wayside. 2011 is no different, with 3 potentially useful tax breaks on the cutting room table. Those who may be able to benefit from these tax breaks should consider taking advantage of them soon, before it’s too late.
Sales Tax Deduction – Individuals who itemize their deductions can elect to deduct their sales tax or their state and local income taxes, whichever is greater. There are seven states without a state income tax, so those residents would surely elect the sales tax deduction. Residents of other states may find that they paid very little in state income taxes and may decide to elect the sales tax deduction instead. For those who are taking the sales tax deduction and considering a large purchase, such as a new car, it may be worthwhile to complete the purchase this year in order to maximize this tax benefit while it’s still available.
Energy Efficiency Credit – Individuals can take a credit of up to $500 for making energy efficient improvements to their homes, including upgrades for roofs, doors, insulation, windows, furnaces, air conditioners, and many others. There are limitations on the amount of eligible credit for the various improvements, and you can find a list of those here. It’s also important to note that unlike many other credits, this one is a lifetime credit–so if you’ve utilized all of the $500 credit in the past, you cannot take any more regardless of your qualified expenditures now. However, if you haven’t benefited from this tax break yet, and are considering making energy efficient improvements to your home, you may want to do so before year end.
Qualified Charitable Distributions from IRAs – Individuals older than 70 ½ can make tax-free distributions from their IRA to qualified charities. The distribution is not includable in the donor’s income, but it is not deductible as a charitable donation either. This provision primarily benefits individuals who are charitably inclined but don’t have enough deductions to itemize. The qualified charitable distributions will count towards an individual’s required minimum distribution (RMD) for the year, allowing those who don’t need the money from their IRA to donate it without being taxed on it. With year-end fast approaching, individuals who have yet to take their RMD may want to consider this option.
Each of the tax breaks above had been due to expire at some point in the past but was subsequently extended at the last minute. It is possible that Congress will extend these breaks again, but nothing is certain given the deficit and debt problems currently facing our country.
If you think you may benefit from any of these tax breaks, please be sure to consult with your accountant to see how these tax savings may apply to your specific situation.
Have you ever heard the term “stretch IRA”? According to the IRS, there is no such thing. What has become known as a stretch IRA is really a withdrawal strategy geared to spread the tax-deferred status of your IRA assets across multiple generations. Basically this is a provision you can add to any traditional IRA, ROTH, SEP-IRA, or SIMPLE IRA by using a beneficiary designation form.
Typically, a spouse is named as the primary beneficiary of an IRA, with children as the contingent beneficiaries. In this approach, after your death your surviving spouse rolls the balance of your IRA into his or her own IRA. This will allow your spouse to use the money from your IRA to cover his or her living expenses.
Alternatively, if your spouse will not need the assets in your IRA for living expenses in retirement, then you may consider naming your children and/or grandchildren as the primary beneficiaries. This will create the “stretch IRA.” After your death, your beneficiaries would each acquire what’s known as an inherited IRA from which he or she would have to withdraw a required minimum distribution each year thereafter. Here is an example to illustrate: