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Unlocking the Potential of the Mega Backdoor Roth 401(k): A Comprehensive Overview

01.17.2023 by admin // Leave a Comment

A mega backdoor Roth 401(k) is a good tool for high-income individuals to save more money for retirement and reduce future taxes. It is called a “backdoor” Roth 401(k) because it allows individuals to contribute above the 401(k) limit – which is $22,500 in 2023. Through a mega backdoor Roth 401(k) you can contribute up to $66,000 in 2023 if you’re under 50 years of age. There are some important considerations to keep in mind when using this strategy. This includes whether or not the plan includes automatic conversions. Learn if this strategy of using a mega backdoor Roth 401(k) is right for you.

What is a Mega backdoor Roth 401(k)

A mega backdoor Roth 401(k) is a way to contribute additional funds to a 401(k). It involves making after-tax contributions to your 401(k) through your employer. It is a useful tool for high earners who want to take advantage of tax-free growth and the withdrawal benefits of a Roth retirement account and have already maxed out the pre-tax maximum of their 401(k). Because the tax is paid prior to the contribution, any earnings are tax free. These tax savings can really add up the earlier you leverage this tax strategy in your career.

How Much Can You Contribute to a Mega Backdoor Roth 401(k)

Every year, the IRS sets the employee pre-tax and Roth 401(k) contribution limits. The maximum combined amount you and your employer can put into a 401(k) in 2023 is $66,000 for under age 50. For over age 50, the maximum is $73,500 in 2023.

Does Your Mega Backdoor Roth 401(k) Plan Offer Automatic Conversions

When signing up for the mega backdoor Roth 401(k) through your employer, it is important to understand if the plan supports automatic conversions. This means that once new contributions are made to your after-tax account they are immediately converted to your Roth account. Though the contributions have already been taxed, any earnings from the contributions haven’t been taxed. An automatic conversion can reduce your tax liability on each conversion. This is because it eliminates the time the incoming money would be accruing taxable earnings. If your company does not offer this, you may have to do it manually and it could result in higher taxes. Converting any earnings to a Roth will trigger a tax bill in the year of the conversion. So, if you have to do a manual conversion you’ll want to do it the same day the contribution is made.

When Can You Start Withdrawing From a Roth 401(k)

As of 2023, the earliest you can withdraw from your 401(k) is 59 ½ years old without incurring a penalty. There are some exceptions to this rule. You may be able to take penalty-free withdrawals of your contributions at any time, as long as you held the account for at least 5 years. You can also withdraw 401(k) earnings if you meet these exceptions:

You become disabled
The funds are used for certain qualified higher education expenses
The funds are used to buy a first home (up to $10,000 lifetime limit)
The funds are used to pay for unreimbursed medical expenses that are more than 7.5% of your adjusted gross income
You use the funds to pay for health insurance premiums while you are receiving unemployment benefits

Laws do change, so it is always best to consult your accountant before you make any withdrawals of your Roth 401(k). These also are available for Roth 401(k) accounts and may not apply to other types of retirement accounts. If you do withdraw early, even following these exceptions, you will lose out on tax free future earnings.

Should You Contribute the Full Amount to a Mega Backdoor Roth 401(k)

Ultimately, how much you contribute to a Mega Backdoor Roth 401(k) depends on your situation. You may want to stay more liquid in your taxable accounts given the current economic uncertainty. Your 401(k) plan may not offer as many investment options as your Roth IRA. The tax savings now with a pre-tax 401(k) may also be more impactful than the tax savings realized 30 years from now. Or, you may have better investments available outside your 401(k) which outweigh any future tax savings. As you start earning more money though, your financial plans should be reassessed. It is a great time to consider to if the Mega Backdoor Roth 401(k) should be part of your retirement savings strategy.

How to Buy Treasury Bills at Charles Schwab

01.10.2023 by admin // Leave a Comment

After over a decade of low interest rates, Treasury bills are finally starting to look attractive. Treasury bills are some of the safest investments in the world, and as of January 2023, are paying over 4% interest.

So, how do you buy Treasury bills? You can buy Treasury bills at Treasury Direct and brokerages, including Charles Schwab. I already have an account at Charles Schwab, which is why I started looked into how to buy Treasury Bills with them, though other brokerages may be just as easy. Here is how I bought a 3 month Treasury Bill at Charles Schwab.

What is a Treasury bill

A Treasury bill, also known as a T-bill, is a short-term debt obligation issued by the U.S. government. Treasury bills have different maturity time frames including 3 month, 6 months, 9 months, a year and longer fixed timeframes. T-bills are sold at a discount to their face value. This means you will pay less than face value, and receive the interest + initial principle (face value) when the T-bill is redeemed at maturity. Treasury bills are considered some of the safest investments because they are backed by the U.S. government.

Why To Buy A Treasury Bill

Before we go into how to buy a Treasury bill, why should you buy a Treasury bill in the first place? Right now, there is a lot of uncertainty in the economy and stock indices have been in a downtrend. There are limits to how much you can invest in Series iBonds, and also a mandatory 1 year holding period w/ a 5 year mandatory holding period to avoid a 3 month interest penalty. With inflation expected to go down, the value of buying Series iBonds isn’t as simple. Though the interest rates in January 2023 are 6.89%, in 6 months it will likely be lower and potentially comparable to the interest Treasury bills offers. With the recent increase in Treasury Bill interest rates, there are options to make 4%+ interest. And, you don’t have to hold for long with the options to buy 8-week and 12-week Treasury Bills.

Additionally, while Treasury bills are taxed federally, they are except from state and local taxes.

How to Buy a Treasury Bill at Charles Schwab

To buy a Treasury bill at Charles Schwab you will need a brokerage account. If you do not have a brokerage account, go to Charles Schwab and click “Open an Account.” You’ll need provide personal and financial information as well as transfer funds after the account is open, and it usually takes a few days before the cash is available to trade or buy Treasury bills.

Once you have a brokerage account:

Log in and open the “Trading” tab
Click on the “Bonds” heading
On the “Bonds” page, scroll down to “U.S. Treasuries” and click the term you want to buy
Select the specific Treasury bill you wish to purchase and enter the desired quantity
Review and confirm the details of your order, including the price and any fees
Double check the price, as that will be the amount moved from your cash to the Treasury bill
Submit your order and wait for it to be processed. If the market is open, it will be processed that day. If the market is closed, it will be processed the next business day.
Once your order is complete, go to the “Accounts” tab, select “Positions” and scroll to “Fixed Income”. You will now see your Treasury bill there in your account.

How to Cash Out Your Treasury Bill On The Maturity Date

When a Treasury bill in a Charles Schwab brokerage account matures, the proceeds will automatically be credited to your in cash. No actions are needed to sell the Treasury bill or receive the proceeds.

The cash in your account will be the face value of the Treasury bill along with any accrued interest. If you hold the Treasury bill in a taxable brokerage account you will pay federal taxes on the earnings but are exempt from state and local tax. If you hold it in a retirement account like an IRA or Roth IRA, the tax rules will follow the tax rules for those accounts.

What Does Charles Schwab Charge to Buy A Treasury Bill

Pricing isn’t static, so be sure to check out https://www.schwab.com/fixed-income/pricing for the latest fees. As of January 4th, 2023 it is free to purchase online, and $25 if purchased broker assisted.

Why To Buy a Treasury bill at Charles Schwab vs Treasury Direct

When I started researching how to buy Treasury bills, I learned you could also buy directly with Treasury Direct. However, when I bought Series I-bonds on Treasury Direct I found the UI to be complex and a pain to log into my account. Since it is easy to log into Charles Schwab, and they also have an easy to use mobile app, I decided to buy through Charles Schwab.

Maximizing Your 401(k) Contributions in 2023: The Benefits and How To Do It

12.28.2022 by admin // 4 Comments

A 401(k) plan is a retirement savings plan sponsored by employers that allows employees to contribute to their retirement savings pre-tax. If you can, you should always max out your 401(k) plan. The 401(k) contribution limit for 2023 is $22,500, an increase of $2,000 from 2022. 401(k) plans have many benefits including tax benefits, employee company match and accelerating funding your retirement. Maxing out your 401(k) every year, or contributing up to the contribution limit, enables you to take full advantage of all of these benefits. Even if you’re not sure how you’ll be able to afford contributing $22,500 to your 401(k) in 2023 there are steps you can take throughout the year to get closer to this goal.

When to Plan Your 401(k) Contributions

The beginning of the year is the best time to plan 401(k) contributions for the year. This way, you can spread out your contributions evenly throughout the year. The amount taken out per paycheck will be consistent that way. However, if you do hit the maximum amount early you’ll get a nice surprise of extra money in your take home pay at the end of the year as well as extra money taken out for taxes. If you wait until later in the year to plan your 401(k) contributions it may not be financially feasible. You’ll have to contribute more per paycheck to hit the max, or you may not earn enough the rest of the year to hit $22,500 in contributions. Don’t forget to check your 401(k) in the summer to ensure your contributions are on track to max out your 401(k) this year.

If you are short on cash this year, or are concerned about liquidity use these tips to get more cash quickly before you decide to cut your 401(k) contributions.

Make Sure To Always Get the Company 401(k) Match

Does your company automatically enroll you into their 401(k) plan? If not, make sure you sign up! Most companies that offer a 401(k) plan also offer a company match. At minimum, you should always contribute enough to your 401(k) to get the full company match. This is free money! The 401(k) company match is one of the top benefits of a 401(k) plan.

It’s hard when you first graduate college and starting from scratch- all the fees with the first apartment, first furniture buys, starting those student loan payments, etc. You may also have to save for bigger purchases like a house down payment and a car. It’s easy to feel like there is just no money to save for retirement.

Instead, look at how you are spending your money and find a way to contribute enough so you get the full company 401(k) match. After that, there are strategies to increase your contributions without feeling like you now have less money to spend over time.

Increase Your 401(k) Contributions During Raises and Promotions

Every time you get a raise or promotion you could afford to increase your 401(k) contribution more. Most companies have an annual raise cycle and if you’ve set your 401(k) contributions to a percentage of your salary your contributions will automatically increase when you get your raise. This time of year is also a great time to increase the percentage you contribute. You have already learned to live on your previous salary, do you desperately need that increase to buy more stuff? If you get a $5,000 raise you can increase your contributions by $1,000 a year and still have $4,000 of your raise. You won’t miss that last $1,000 while you’re adjusting to the extra $4,000 you are now earning every year. Using the table below, you can take the annual amount and divide it by the amount of paychecks per year to get the amount withheld out of each paycheck.

Increase Your 401(k) Contributions When You Finish Paying A Big Expense

Whether it’s putting down your first down payment, or paying off your last student loan, you now have one less expense. Reallocate what you would have spend on that expense to your 401(k) contributions. You won’t miss having the “extra” money because you didn’t have it before.

Enroll In The 401(k) Annual Increase Program

Some plans offer an annual increase program where you can establish annual increases. It depends on the plan, but at least some Fidelity plans allow 401(k) contributions to increase 1% or more each year automatically. You have the ability to align it to pay increases as well and then just set it and forget it. Automating 401(k) contribution increases is the easiest way to increase your contributions. If you end up needing more cash every paycheck you can always go online to your 401(k) plan provider website and reduce your contributions.

401(k) Tax Benefits

Have you ever done the math as to how much you’re saving in taxes by contributing to your 401(k)? You may think you can’t contribute anymore but don’t forget you’ll also save money on taxes.

If you contribute $22,500 to your 401(k) in 2023 here are the tax savings you can expect. These tax savings are based on the 2023 federal tax brackets. For example, you are single and making $205,000 a year you’ll avoid $7,200 in federal income taxes. Contributing the maximum amount to your 401(k) through pre-tax contributions really helps you save a decent amount of money every year.

The additional 1% contribution assumes the mean of the income bracket.

401k contributions in 2023 tax savings for single filers — 401k Contributions in 2023 Tax Savings for Single Filers

401k contributions in 2023 tax savings for married filing jointly filers — 401k Contributions in 2023 Tax Savings for Married Filing Jointly Filers

401(k) Benefits Include Compound Interest

If you need a little more motivation to max out your 401(k) don’t forget about compound interest. The hardest time to contribute to your 401(k) is when you’re young. When you’re young, you have a lot of big expenses on the horizon and a starter income. But, thanks to compounding, the more you save early on the less you’ll need to save later. Take this example from the team at J.P. Morgan Asset Management in their 2014 “Guide to Retirement.” Here, they share how much money you can make from investing $5,000 a year over time depending on when you start.

Compounding interest graph showing how much you will make from investing $50,000 over time. — Example of Compounding from J.P. Morgan Asset Management 2014 Guide to Retirement

Don’t forget, a 401(k) is one of several options to save for retirement. After you’ve hit your employee match in your 401(k) plan, it’s good to start contributing to your Roth IRA account. This way, you can fully optimize the tax benefits in your retirement savings strategy. Then, contribute the rest to max your 401(k) contributions.