- The Physician Philosopher, https://drcorysfawcett.com/tax-surprises-my-retirement-year/. The after-tax money grew in the 401k, but what next? You earn $300,000 as a household and after taxes, youre setting aside about $80,000 per year for retirement. During the next 4 years Im going to Roth convert about $1,360,000 (341,000/yr) which will take me to the top of the 24% bracket for an effective tax rate of 18% on my converted money. So, if you have a good employer contribution/match, then Roth money will be diversifying your dollars. The standard deduction is now $25,900 per couple in 2022. This can be done in addition to your employee contribution of $20.5k (plus the catch-up if you are over 50), either pre-tax or Roth. I wrote a post about that, coming to a similar conclusion as you, but the commenters seemed to think I was being too hard on myself. Certainly there are many paths that smooth the conversion and it depends on how you intend to spend/not spend the Roth. She has a traditional 401k of about $250000. First, take a distribution after you separate from service. Plan is to retire at age 45 (13 yrs from now) so my thought is that at that point I could convert all of the Roth 401k funds over to Roth IRA and have tax free access to my total contribution amount at that time. Even a $1.5M IRA RMD will soon run you out of the 12% bracket once mixed with SS. I hadnt considered the natural spender vs saver part of the equation, but that makes a lot of sense. This means you can sock away up to an additional $38,500 into what's known as a Mega Backdoor Roth. The prevailing thought was that there would be a one-year window in which high earners could legally do a Roth conversion. Earn easy 1099 income with quick surveys for healthcare professionals with InCrowd, Register with All Global Circle and receive a bonus of up to $50, This website uses cookies to improve your experience. While this is a borderline redundant bullet point, high income is subjective, whereas marginal tax brackets have no gray areas. Or waste $100 a month doing so. I was in the traditional bucket until a recent discussion with my business partner. More than five years have passed, which means I can withdraw the entire $278,000 sum that I converted penalty-free and tax-free. Is it correct? Thanks to that, I should be able to just hit the $58k maximum this year. 2) I dont plan on retiring early, I enjoy my job and hope to work into my 60s (and if Im healthy and happy enough), perhaps into my 70s. 2) deductions Lets go over some advanced topics when considering the Mega Backdoor Roth 401k. The above portfolio is entirely possible and the tax burden is calculated using the schwab RMD calculator and taxplancalculator. I consider this a reason to make tax-deferred contributions. I hope you enjoyed it! Don't subscribe I'm 27 and really excited to be packing my 401(k) early in life. 2021 Physician on FIRE, All rights reserved. This could also be a good place to hedge your bet and make both traditional and Roth contributions. If this box is checked with an incorrect code, you might be forced to pay taxes again on your after-tax contribution. Again, a small amount of taxes will be paid on the earnings while the money sits in after-tax 401k limbo, but it is nice to have every dollar you can in Roth. You can go online and do the Roth conversion in two simple steps.]. It will be enough and you will likely have the account keep growing during your retirement. Among other factors. That means you can have $25,900 in taxable income without paying a penny in tax. Ive realized it really doesnt matter much which one you choose. We transferred $13K of after-tax contributions and $200 of growth (which will be fully taxable at our ordinary income tax rate) into a Roth IRA. Stop it! Mega Backdoor Roth - our journey to FIRE Home Retirement Mega Backdoor Roth In 2021, an individual is allowed to have a total overall contribution of up to $58,000 or $64,500 (if you're 50 and above) into a 401K. Lets say Ive got $750,000 today in the Roth IRA. Replies to my comments This site uses different types of cookies. Finally, the money is in our Roth IRA! The Roth grows to $1,900,000 during the conversion and continues o.n tax free from there. Thank you for the in-depth analysis, Johanna. Here, there is a $50 charge for any distribution transaction. She had already set up a Roth IRA to receive the rollover. But there are lots of ways to automate savings and if youre afraid to make traditional contributions because youre afraid youll spend the tax refund, you need to change your spending behavior, not your investment type. I will have some 401(k) money to rollover into an IRA and convert to Roth over the years, though. Yes, our net worth would be a larger number if I hadnt made the conversion. I had originally expected rather meager income in retirement, but now that I am close and look at our expectations (for me and non-working wife), I am pleasantly surprised that between social security here, my wifes foreign social security, a small pension from a former employer, a little rent, and a 3.5 to 4% withdrawal rate from retirement and investment accounts, it looks like six figure income is entirely feasible and we may struggle to stay in the 12% tax bracket (though converting traditional to Roth over the next 6 years should help). I guess the best way to look at it is a good news / bad news situation. Or pay taxes never? We did similar with my wifes IRA into her Solo 401k. Ill still be able to take advantage of those Roth conversions in much lower tax brackets down the line. No capital gains tax on yearly dividends pretty much justifies this method by itself. . The point is to get tax diversification through Roth Optimization. When I was 35, the thought of an early retirement hadnt crossed my mind. It is also done with after-tax money. I always thought that the sequencing rules for taxable income were: Keep saving with either method and you will retire well. I think this is an important FIRE topic and thought this something to add. Cookies are small text files that can be used by websites to make a user's experience more efficient. True and true. The Roth money would have been taxed already so **hopefully** it would be kept out of that calculation. Should you invest in Roth or Traditional 401(k)? seems to be one of those questions that has no right answer that applies to everyone. $395 fee can be more than offset with travel credit & annual point bonus. That pushes the break even to over 20 years. I would guess youre in the 24% bracket (but a high state income tax, too) with a marginal tax rate over 30%. Due to this fact, this strategy is best for medical students and/or residents/fellows that are under the income limits for direct contributions to a Roth IRA still. Employer does not allow after tax 401k contributions so the mega backdoor is not an option. The goal: take after-tax money from your salary (that you have already paid taxes on) and get it into a Roth IRA. Therefore, traditional contributions, which lower your AGI, would be a good option. I was able to circumvent the pro-rata rule when I became an employed physician by rolling several years worth of post-2010 SEP-IRA money into my employers 401(k). But now Ive got a lot more of that good Roth money that will (presumably) never be taxed again. Depending on the industry you are in, and where you are relative to the phase-outs, you may want to make pre-tax, Roth, or after-tax contributions in your solo 401k. If you will likely stay put and possibly retire sooner than 20 years from now, that would push me toward recommending tax-deferred. Look closely at the off the shelf versions of popular custodians and make sure they can do a Mega Backdoor Roth if you have a Solo 401k and enough business income. The SEP IRA, after 5 years of tax-deferred contributions of $25,000, $45,000, $45,000, $49,000, and $49,000 had grown to $242,000. If retirement is a long ways off, retirement is more like a box of chocolates; you never know what youre going to get. No annual fee. The IRS allows 401k plans to have a ton of flexibility. I needed to make the Roth conversions before December 31st. This is a Step-by-Step Guide to how to do the Mega Backdoor Roth using my Mega Backdoor Roth as an example! There are no limits on traditional IRA contributionsyou cant deduct them if your MAGI is too high. I currently have ~10K in my employer 401K (all pre-tax) and ~50K (all pre-tax) in a IRRA (rollover retirement account; this is like a traditonal IRA but has money from previous employer 401Ks in it). And now I will pay ordinary income taxes on that amount. IRA, backdoor Roth IRA would be out of the question- or else would be taxed on the converted amts. Start the Roth conversion ladder on that money once I retire. Lets look at a step-by-step process for doing a Mega Backdoor Roth. Take advantage while the loophole exists or wait to see if the BBB passes? There are many moving. The net effect was that the government allowed you to convert $107,114 from a taxable account to a Roth account. A mega backdoor Roth is a special type of 401 (k) rollover strategy used by people with high incomes to deposit funds in a Roth individual retirement account (IRA). All Do you know if I can perform the Mega Roth contribution still, in 2020, on a new account/new purchases? In addition, the IRS views all of your IRAs as a single account, so you run into tax problems if you try to convert funds that are both pre-and post-tax. PoF asked me to post a recent email I sent to him on this blog post: >>I believe you made an incredibly good decision, not the (possibly) huge mistake you wrote about. It is crucial to get it into a Roth IRA because the GROWTH of a Roth IRA is also tax-free! Nice of them to take that money from my basis! The Pease provision wasnt in effect in 2010, nor was the ACA tax, plus I lived in a lower tax state than I do now. If you're eligible, the mega backdoor Roth can let you contribute thousands of dollars extra towards your retirement. Of course, thats assuming you had actually invested the money in your taxable account rather than doing something else with it (as most people would have done), including letting it sit there. As a young(er) couple in this conversation, and seeing some of the movements in politics. Of course, I didnt know that was going to happen. The annual addition limit for 2021 is $58,000. We make the best decisions we can with the knowledge we have at the moment. Converted assets can be accessed tax and penalty-free after it has seasoned in the Roth for 5 years (technically January 1st of the year 5 years later, so closer to four years if you convert late in the year). No annual fee. My math tells me youve got about 10 years to make those conversions, but with a multimillion dollar retirement account, just converting the market returns in a good year will bump you into the upper tax brackets. I also have some inherited IRAs and Roths. That same high-income professional making 100% Roth contributions to her 401(k) or 403(b) will pay $7,000 to $10,000 more in income taxes in 2022 compared to the person making traditional contributions. I dont have a screenshot of this before rollover, but you can see where it keeps track of my non-Roth amount in a separate account. Do you make mostly traditional or Roth contributions? Your info is awesome, Thank you. In addition, you dont use form 8606, which is for IRAs. If you have a good 401k plan. That is as crazy as trying to time a market top! Do Not Sell My Personal Information. No 401K match. Money has burned no holes in my pockets. If you have a household taxable income that subjects you to a phase-out or elimination of a tax deduction or credit, the tax deferral can be particularly advantageous. My taxable SS is $33,600 at age 70. The Mega Backdoor Roth. In addition, all of the growth on the tax payments that w/h/b taxable gain is tax free and you would owe taxes on all gains in the taxable account. Far-fetched? Once the pre-tax contributions are maxed out, I will adjust the after-tax contribution to max out the 401k limit. Ive contributed for many years but only maxed out the last 4-5 years. Then your contributions would be deducted from your income when calculating your AGI and tax liabilitybut theres an income limit to whether or not you can get the deduction. Id lean toward Roth contributions, as youre effectively investing more of your own money in a tax-protected account. Of course, as Ive said, they will be lower in early retirement. Many physicians are thus excluded from making either deductible IRA contributions or direct Roth IRA contributions. Slightly off topic, but maybe of interest to you and some readers: What to do if you like to contribute more to a Roth out of your taxable account wealth but you cant because you max out the $5,500 ($11,000 for married) every year already? The $53,577 we paid in 2013 would have grown 130.9% in 7 years and 7 months, an 11.67% annualized return. Basically everything except my 401(k) match which has to be pre-tax. If so, does your 401(k) Plan accept rollovers? Found you through Mr and Mrs Pies blog! I am really proud of the $107000 in my Roth account. I pondered this question with a traditional IRA I have from an old 403b. The Mega Backdoor Roth 401k is a 401k, so there are no pro-rata issues. For example, you may be in academic family medicine earning under $200,000. If you are earning a great income now, you can use all the help you can get given the progressive nature of our federal income tax. Lets say $10,000 comes from qualified dividends in a taxable account, $50,000 comes from selling shares from that taxable account, generating $25,000 in long-term capital gains, and $60,000 comes from a traditional 401(k) (or traditional IRA, etc). Manage Settings I may be close to retirement. Marketing cookies are used to track visitors across websites. Tax-deferred investments account for 17% of our retirement assets. Indeed. Figure 6 (Note the amount of After-Tax Contributions available to Rollover). Our modified adjusted gross income (mine + my spouse) is $150k. I wasnt going to let that one year window pass me by! Analytics cookies help website owners to understand how visitors interact with websites by collecting and reporting information anonymously. Income solves most money problems! The other thing I like about a Roth is its indifferent to dividends whereas Ive always constrained my taxable money to being tax efficient. Should You Invest in a Roth or Traditional 401(k)? Not great if you have a small amount invested, but at least it is not a percentage of the investments! It used to be a pro-rata distribution with separation of service, but no more. Use our link to Join and receive a bonus of up to $50 . Assuming you can do a mega backdoor Roth, here's how it works: You max out individual additions to your 401 (k): $22,500 in 2023 or $30,000 if 50+. I do blend my 401k with a majority traditional (~$14k) and minority Roth (~$4k). If youve got children under 17 at home, you can take a much larger withdrawal (or make Roth conversions) without owing tax since you now get a $3,000 tax credit per child. You can go well beyond the $6k limit in 2021 up to as much as $38.5k extra a year. Lets say youre like Dr. C. Raising a family, paying the mortgage, and living well, youre spending $160,000 in your working years. 1% back on all else. I had not previously focused on the fact that the gains are taxed at ordinary income. Its a form of forced savings. 2% back on first $25,000 combined at gas stations & restaurants. Our federal government liked the tax revenue from all the 2010 conversions so much that the AGI limit was lifted permanently (for conversions only). A Step-by-Step Guide to the Mega Backdoor Roth, My Mega Backdoor Roth IRA RolloverIn-Service Distribution, How the Mega Roth is Different from the Regular Backdoor Roth IRA, How the Mega Backdoor Roth WorksStep-by-Step, Pictorial Step-by-Step Guide to the Mega Backdoor Roth, Step-by-Step: Mega Backdoor 401k to Roth IRA Rollover, Advice-Only Retirement Planning for Physicians, marketing pitch for cash value life insurance products, In-Plan Rollover to Designated Roth Account, tax diversification through Roth Optimization. I think I have the same problem you did (though not those amounts thank god!).