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Mega Backdoor Roth Conversion Primer

/// Posted by Rob Simons

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Background

There is growing interest in a design strategy known as the Mega Backdoor Roth Conversion (the Conversion). The Conversion allows 401(k) or 403(b) Plan participants who are already deferring the maximum allowed to contribute After-Tax funds to the plan. The participant may then convert the money from After-Tax funds to Designated Roth funds. This two-step process has the effect of allowing plan participants to contribute additional Roth money to the plan and shelter the gains from taxes.

Questions and Answers?

Q1: Why does this work?

A1: The After-Tax contribution works because each of the three types of participant contributions to a 401(k) or 403(b) plan has different contribution rules. The following table details the contribution and taxation differences.

The Conversion works because the Roth conversion of After-Tax accounts is independent of the contribution. The IRS explicitly authorized the ability to convert After-Tax funds to Roth funds in 2015.

Q2: Why would a participant execute a Mega Backdoor Roth Conversion rather than contribute After-Tax and leave it in the After-Tax source?

A2: A participant would want to have money designated as Roth rather than After-Tax as the gains become tax free when withdrawn after satisfaction of the 5-year rule.

Q3: What about the income limit on making Roth contributions?

A3: The income restriction on Roth contributions is an IRA limit, not a qualified plan limit. Designated Roth deferrals into a 401(k) plan have no income test. Additionally, this is an After-Tax contribution that is then converted to Roth.

Q4: When would Sapers & Wallack recommend that a client not add the Conversion?

A4: If participants are not contributing at an amount that would provide deferrals up to the $19,000 / $25,000 limit, the participant should increase their 401(k) or Roth deferral percentage to maximize their deferrals prior to executing a Conversion. If the plan does not have participants who maximize their deferrals and would like to shelter more money, Sapers & Wallack would not recommend installing a Conversion process.

Also, if:

  • The plan does not have a matching contribution; or
  • The plan does not currently pass the match nondiscrimination test by a comfortable margin; or
  • The plan would fail the nondiscrimination test if not for a Safe Harbor Match provision;

Sapers & Wallack would not recommend installing the Conversion provisions as After-Tax contributions to the plan require nondiscrimination testing with the match, and a failing test or low NHCE Conversion percentages would severely limit or eliminate the ability for HCE Conversions.

Q5: How much can a participant contribute on an After-Tax basis to later convert to Roth?

A5: The After-Tax contribution amount is limited to $56,000 or 100% of pay, reduced by:

  • 401(k) & Designated Roth Deferrals
  • Matching Contributions
  • All other employer contributions

NOTE: The $56,000 limit is not reduced by Over-Age-50 Catch-Up contributions.

The following are two examples of how all the contributions work together to determine the maximum allowable After-Tax contribution. The examples assume matching contributions of 100% of pay on contributions up to 6%.

NOTE: Employers may wish to limit the After-Tax contribution to less than the maximum allowed by law. Sapers & Wallack can work with you to determine an After-Tax contribution policy to help with efficient administration of the contribution and Conversion.

Q6: What are the plan requirements to add the Conversion and steps required to execute a Conversion?

A6: Sapers & Wallack will work with you to:

  • Determine an appropriate After-Tax contribution policy to limit the contributions as necessary;
  • Amend the plan document; and
  • Create workflows to make the Conversion as easy as possible for you and your employees.

Summary

The Mega Backdoor Roth Conversion allows a plan participant to take advantage of the different rules governing 401(k) Deferrals and After-Tax contributions and the IRS Notice authorizing Roth conversions of After-Tax accounts to contribute beyond the standard $19,000/$25,000 limit. While the Conversion is not right for every client or participant, for super savers and top earners, it can be a way to increase tax deferred savings and take advantage of the institutional fund lineup of their company’s 401(k) Plan.

As always, we are here and ready to help you secure the best path forward.

Lion Street Financial does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.

/// Posted byAviva Sapers & Peter Stoner

Whether your 65th birthday is fast approaching or decades away, it pays to understand the basics of how Medicare works and what it does and does not cover—and then plan accordingly for any additional coverage that you may need in retirement.

Enrolling in Medicare can be more complicated and frustrating than many might expect, and the rules and regulations are changing.

Parts A & B (Original Medicare): Applying for Medicare A/B is handled through Social Security and can be administered on-line rather than going to a Social Security office. An on-line Social Security account will require setting up a username and password and may require the answering of “security questions” based on credit bureau information—some of which can be very specific and based on older data they have on record. Unfortunately, this can sometimes result in failed attempts and needing to go to a Social Security office to complete the enrollment process.

Medicare Part A is used for hospital insurance and covers inpatient stays at medical facilities, as well as costs of hospice care, home health care, and nursing homes (which are limited). If you will be spending the remainder of your life in a nursing home, Medicare will not cover it. Part A has a per “benefit period” deductible of $1420 in 2020. A new benefit period begins after a beneficiary has been released from the hospital for at least 60 days, meaning the deductible can be incurred multiple times throughout a year.

Part A has a $0 premium for most people, but will only pay for a maximum of 100 days of nursing home care (after certain conditions are met). After 20 days of full coverage, a significant daily co-pay is required for days 21-100 at skilled nursing facilities.

Medicare Part B provides medical insurance to help cover the costs of physical therapy, physician visits, durable medical equipment costs, and other medical services, such as lab tests, and screenings.

Part B requires a monthly premium based on income level, along with an annual deductible of $197 in 2020. It also requires a co-pay of 20% of costs.  

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Aviva Sapers, President and CEO of Sapers & Wallack, and Peter Stoner, President and CEO of Stoner & Company, answer questions about our October blog ‘Medicare Coverage: What to expect, how to enroll, and will you need supplemental plans for retirement’.

Why Retirement Planning Must Account for the Rising Cost of Healthcare

/// Posted by Scott Tuxbury

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For most Americans in 2019, the idea of retirement is associated more with a sense of anxiety than the promise of relaxation it once inspired. Have I saved enough? When should I stop working? Will I have a guaranteed source of income? And more than ever before, how can I plan for the rising costs of healthcare?

These are all valid questions that need answers, but the stressors around future medical expenses and the cost of insurance coverage, in particular, have never been more pressing.

We are living longer, healthcare costs are rising faster than general inflation, government coverage and subsidies are less, and we won’t have the same employer and union-based benefits that our parents’ generation enjoyed. According to a 2019 Fidelity Benefits Consulting estimate, the average cost for healthcare after the age 65 will be $285,000 per couple.[i] But our own internal estimates find that the costs will likely be much higher, and possibly even double, depending on your income levels in determining Medicare coverage.

Many pre-retirees believe that Medicare will cover all of your health care costs in retirement, but that isn’t the case. Medicare only covers 60% of medical expenses, and whether you expect it or not, healthcare premiums and out of pocket medical payments will account for a significant percentage of yearly expenses throughout your retirement. There are numerous factors that will determine how much of an expense you’ll face, including when and where you’ll retire, how healthy you are, how long you’ll live, and above all, how much taxable income you bring in. 

On average, it is estimated that a largely healthy couple will spend between 8k-12k/year on healthcare after Medicare. If an unforeseen accident or illness arises, those costs are likely to spike exponentially. According to government findings, 70% of individuals will require an extended period of long-term care at some point over the age of 65.[ii]  Everyone thinking about retirement should look up the Medicare Modified Adjusted Gross Income (MAGI) to see what bracket they fall into in terms of premium payments for Medicare Part B.   

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Scott Tuxbury, Vice President and Leader for the Retirement and Wealth Management Practices at Sapers & Wallack answers  questions about our September blog, “Why Retirement Planning Must Account for the Rising Cost of Healthcare”

 

Why a Family Succession Plan is Important

/// Posted by Aviva Sapers

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It’s a storyline played out in best-selling books, movies and TV dramas:  the successful family that’s torn apart after the death of the matriarch or patriarch and transition of the business and other assets. This isn’t the stuff of fiction. A succession plan addressing how to take care of your family business—and your relatives who are part of it—is key to a successful, perhaps drama-free, transition.

Why business succession planning is important

Transitioning your family business requires time, attention, empathy and communication as its effect on family members and on the business itself are vast. A succession plan is important because:

  • It ensures that your business will survive your death (or a major illness). If the business is the primary source of income supporting your family, a thoughtful, detailed succession plan reflects your family’s values and supports its goals, identifies future leadership, and addresses potential issues before they arise.
  • It can help ensure family members are taken care of emotionally and financially.
  • It will also address ways that family members outside your business can still receive income, whether from the business itself or through other assets or trusts.

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Podcast: Q&A on Why a Family Succession Plan is Important

/// Posted by Aviva Sapers

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Aviva Sapers, President and CEO of Sapers & Wallack answers questions about our August blog ‘Why a Family Succession Plan is Important’.

Roth Conversions for Retirement

/// Posted by Scott Tuxbury

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On average, Americans are living longer than ever before. This reality has complicated the planning and saving stage of retirement as we struggle to secure enough income to cover our needs for the duration of our lifetime. One increasingly critical tool of financial planners for retirees is the use of Roth IRA conversions. A Roth conversion refers to taking all or part of the balance of a pre-tax traditional IRA and moving it into a Roth (after-tax) IRA.  

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Podcast: Q&A on Roth Conversions for Retirement

/// Posted by Scott Tuxbury

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Scott Tuxbury, Vice President and Leader for the Retirement and Wealth Management Practices at Sapers & Wallack answers  questions about our July blog, “Roth Conversions for Retirement”

How to Not Outlive Your Income

/// Posted by Wayne Slattery

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After extensive polling, the number one concern for most retirees is outliving their income. Much of today’s workforce do not have enough to guarantee success in retirement, and a recent study found that the average median savings of millennials is only $8,000—promising that adequate saving for retirement will be a problem for a long time to come. For this reason, and for the struggle I see and work I do on behalf of my clients every day, I wanted to discuss a few factors that can erode retirement designated wealth, as well as pose some solutions.

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