On December 23, 2022, Congress passed the Secure 2.0 Act into law, as part of a significant $1.7 trillion spending bill. Just like its predecessor, Secure 2.0 includes an extensive list of retirement-related changes designed to expand access to retirement savings accounts and provide more options for contributing to and drawing from these accounts.¹
To help you understand what Secure 2.0 means for you, here are eight significant changes it brings and the impacts they might have:
1. Required Minimum Distributions (RMDs)
One of the most significant changes comes to the way RMDs are handled. Previously, retirees had to begin taking RMDs at 72. Secure 2.0 raised this minimum age to 73 for 2023, and it will increase again to 74 in 2033. Penalties for failing to take an RMD have also dropped to 25%, compared to 50% before.
This provision may benefit those who can afford to hold off on RMD withdrawals because they don’t need access to the funds immediately. So, if you’re turning 72 in 2023 and you’ve already scheduled your withdrawal, you might want to consider making an adjustment to your plan.
2. Retirement Account Catch-Up Contributions
Beginning in 2025, individuals between the ages of 60 and 63 can make catch-up contributions to their 401(k) plans of up to $10,000 or 150% of their regular contributions.
For IRAs, the annual catch-up amount has remained the same since 2006 at $1,000. Starting in 2024, this contribution limit will be indexed to inflation and, therefore, subject to an increase each year.
3. Qualified Charitable Distributions (QCDs)
Secure 2.0 has also expanded the types of charities that can receive a QCD. Individuals who are 70.5 years or older can now give a one-time gift of up to $50,000 to either a charitable remainder unitrust, annuity trust, or gift annuity. However, this money must come directly from your IRA by the end of the year for it to count toward your annual RMD. It’s also important to note that QCDs are not applicable to all charities.
4. 529 College Savings Accounts
Starting in 2024, Secure 2.0 makes it possible for you to move money from a 529 plan directly to a Roth IRA. However, there are a number of conditions you must meet before you can use this provision:
● The maximum lifetime amount you can move is $35,000.
● The annual limit you can move is that year’s IRA contribution limit.
● The beneficiary must have had the 529 plan for at least 15 years.
● The Roth IRA must be under the beneficiary’s name.
● You can’t move any contributions that were made in the last five years.
5. Part-Time Employee Access to Retirement Savings Accounts
Long-term part-time employees can now participate in their employer’s 401(k) plans, provided they meet certain criteria. To qualify for an employer-sponsored retirement plan, you must either:
● Complete one year of service (totaling at least 1,000 hours).
● Or two to three consecutive years of service (with at least 500 hours of service).
For plans beginning in 2025, this three-year rule is reduced to two years.
6. Student Loan Payments
For students who might not be able to save for retirement because they’re paying off student debt, Secure 2.0 allows employers to match employee student loan payments in a retirement account.
7. Automatic Enrollment in 401(k)s
In 2025, businesses adopting new 401(k) or 403(b) plans will be required to automatically enroll eligible employees at a contribution rate of at least 3%. This rule is aimed at increasing retirement savings participation, especially in younger demographics. While employees aren’t required to contribute, they will have to take the extra step of opting out of the program.
8. Emergency Savings
To help people save for unexpected expenses, Secure 2.0 will enable defined contribution plans to add an emergency savings Roth account in 2024. Annual contribution limits are set at $2,500 (or lower, depending on your employer), and may be eligible for an employer match. In addition, the first four withdrawals won’t be taxed or penalized.
Next Steps
SECURE 2.0 brings many changes to the realm of retirement planning, including some that haven’t been addressed here. Consider consulting with an Ausperity Private Wealth team member to determine how these changes might impact you.
Best,
Robert (Rory) J. O’Hara III, CFP®, CRPC® Founder I Senior Managing Partner
Endnotes 1 “Secure 2.0 Act of 2022.” United States Senate Committee on Finance, December 19, 2022. https://www.finance.senate.gov/imo/media/doc/Secure%202.0_Section%20by%20Section%20Summary%2012-19-22%20FINAL.pdf
Disclosures:
This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.
A 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. Every state offers at least one 529 plan. Before buying a 529 plan, you should inquire about the particular plan and its fees and expenses. You should also consider that certain states offer tax benefits and fee savings to in-state residents. Whether a state tax deduction and/or application fee savings are available depends on your state of residence. For tax advice, consult your tax professional. Non-qualifying distribution earnings are taxable and subject to a 10% tax penalty.
Securities offered through Sanctuary Securities Inc, Member FINRA, SIPC Advisory services offered through Sanctuary Advisors, LLC. A SEC Registered Investment Advisor. Ausperity Private Wealth is a DBA of Sanctuary Securities, Inc. and a DBA of Sanctuary Advisors, LLC. Do not transmit orders regarding your Sanctuary Securities, Inc. account(s) or Sanctuary Advisors, LLC account(s) via e-mail. Sanctuary Securities, Inc., Sanctuary Advisors, LLC, and Ausperity Private Wealth will not be responsible for executing such orders and or instructions. This e-mail message is intended only for the use of the individual or entity to which the transmission is addressed. Any interception may be a violation of law. If you are not the intended recipient, any dissemination, distribution or copying of this e-mail is strictly prohibited. If you are not the intended recipient, please contact the sender by reply e-mail and destroy all copies of the document.
Mutual funds have become an increasingly popular investment tool due to their widespread accessibility, the diversification they can provide, and the fact that they’re managed by industry professionals.1 In fact, over 115 million individuals in the US – and more than 52% of US households – owned mutual funds in 2022.2 But despite their place in so many investors’ portfolios, these funds are not free of risk.
To help you better understand how these funds work, what their benefits could be, and the risks you might face when investing in them, we’ve put together this guide detailing some of the things you might want to know about mutual funds before investing.
What is a Mutual Fund?
Mutual funds pool money from their different shareholders and invest them in various assets, such as stocks, bonds, and other types of securities. Each shareholder then receives gains or losses that are proportional to their total investment in the fund.
These funds have a relatively low barrier to entry, offering even the most casual market participants the opportunity to participate in a professionally-managed investment vehicle. As with any type of investment fund, the structure and asset allocation of each mutual fund are guided by its stated investment objective – called a prospectus – which varies from fund to fund. Depending on your individual circumstances and financial goals, certain mutual funds may suit you better than others.
8 Types of Mutual Funds
Before we dive into the pros and cons of mutual funds, let’s take a look at some of the different categories that are available for you to choose from.
Stock funds typically invest in equities. Depending on the fund’s stated goals, its managers may determine its holdings based on things like market cap, dividend structure, or growth prospects.
Bond funds focus on income-generating investments like corporate and government bonds, as well as other investments that offer a fixed rate of return.
Balanced funds, sometimes referred to as asset allocation funds, combine different assets to reduce the risk of overexposure to one particular asset class. They can be divided into two subcategories for fixed and dynamic allocation strategies.
Money market funds function similarly to savings or checking accounts in that they hold short-term debt instruments like US treasuries that are lower risk but offer more modest returns.
International and global funds invest in foreign assets. While international funds only acquire assets outside of the country in which they’re based, global funds can invest anywhere – domestically or abroad.
Specialty funds may be further divided into subcategories, such as:
● Sector funds target specific economic sectors, such as healthcare or technology.
● Regional funds focus on a specific geographic area.
● Values-based funds abide by specific criteria for investments based on shareholder beliefs and values.
Potential Pitfalls of Mutual Funds
While mutual funds vary in size, scope, and allocation strategy, they share some potential pitfalls that bear consideration before deciding whether or not to invest in one:
● High Costs & Fees: Professional management often entails higher costs, and some investors may be put off by the associated fees. These payments differ from fund to fund, but they’re generally required regardless of performance.
● Tax Liabilities: Selling assets triggers capital gains taxes, which get distributed regularly with mutual funds. Since you don’t control when assets are bought and sold within a mutual fund, your annual tax burden may be higher or lower than you anticipate.
● Cash Drag: Mutual fund managers may hold a significant portion of cash to maintain liquidity, but this cash doesn’t earn as much as it might if you invested it elsewhere.
Potential Benefits of Investing in Mutual Funds
Mutual funds may be able to provide a handful of benefits including:
● Portfolio Management: With a professional portfolio manager, you don’t have to worry about doing your own research. Mutual fund managers work full-time to monitor investments, maintain a specific risk/return profile, and align the fund with its stated goals.
● High Liquidity: Buying and selling mutual funds can be relatively easy compared to other investment options. Because they hold a large amount of cash, you can often access your money quickly when you need to.
● Diversification: The wide range of mutual fund categories and the mixture of assets within each can allow you to diversify your portfolio. This method can be cheaper and simpler than researching and buying individual assets. Interested in Getting Started?
If you’ve weighed the potential benefits and pitfalls of mutual funds and are still looking to invest in one, consider discussing it with a financial professional who can help you identify the fund that best suits your needs. As with any important financial decision, your choice to invest in a mutual fund should be colored by your individual circumstances and investment goals. Reach out to a Financial Planner at Ausperity Private Wealth to learn more.
Best,
Robert (Rory) J. O’Hara III, CFP®, CRPC® Founder I Senior Managing Partner
This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.
Mutual Funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing in Mutual Funds. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.
Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
The retirement landscape has shifted in the United States. Gone are the days of the defined-benefit pension plan that saw employees rewarded for their many years of loyal service with a steady stream of checks in retirement. Now, the responsibility of saving for retirement rests on your shoulders. The question is, are you effectively utilizing all the accounts at your disposal?
Everyone deserves to enjoy a comfortable retirement after a long career, but getting there takes discipline and careful planning. With costs rising and life expectancies increasing each year, retirement is becoming more costly. Among the expenses to consider are housing, healthcare, leisure activities, and taxes.
While most taxpayers will qualify for Social Security, those benefits may only account for a fraction of what you need. Luckily, there are many retirement plans available that can make saving for the next phase of your life less daunting. Let’s take a look at some of the more popular options.
The Individual Retirement Account (IRA)
An individual retirement account (IRA) is a tax-advantaged investment account that’s meant to make it easier for Americans to save money for retirement. IRAs generally afford superior flexibility and access to a broader range of investments when compared to other popular accounts like the popular 401(k) but at the cost of lower contribution limits. A variety of different IRAs exist, and each comes with its own set of tax and regulatory implications. The one you choose will likely depend on your employment circumstances and how much you earn. Let’s break down some of the most common types below.
Traditional IRA
The most common type of IRA, the traditional IRA, is available to anyone who earns income within the calendar year they wish to contribute to one. The account is funded with pre-tax dollars and contributions can be invested within the account on a taxdeferred basis. What it means to be tax-deferred is that your account’s earnings (interest and capital gains) are not taxed until you withdraw them, at which point they’re treated as ordinary taxable income. This treatment essentially allows you to kick your income tax burden down the road.
IRA owners are able to invest in almost any asset they choose to, from stocks, bonds, and mutual funds to ETFs and real estate. Another benefit of the traditional IRA is that you can receive a tax deduction for your pre-tax contributions, thus lowering your total taxable income. The annual contribution limit for traditional IRAs is $6,000, or $7,000 if you’re over 50 and qualify for catch-up contributions.
Roth IRA
The Roth IRA is similar to the traditional IRA in terms of which investments you’re able to hold within it, but it differs in terms of how it’s taxed and how you can access your contributions. Roth IRAs are funded with after-tax dollars and the investments within these accounts are allowed to grow tax-free. This means that withdrawals after the retirement age of 59½ occur without having to pay income taxes or other penalties.
Another benefit of the Roth IRA is that you can withdraw contributions (but not the earnings on those contributions) to make important purchases or cover qualifying expenses like college tuition. However, Roth contributions don’t entitle you to a tax deduction, since you’ve already paid income taxes on the money you’ve contributed. The annual contribution limit for Roth IRAs is $6,000 (or $7,000 if you’re over 50) and total combined contributions to Roth and traditional IRAs cannot exceed this figure. Roth IRA contributions are subject to a phase-out of income, meaning if your income is above; $129,000 to $144,000 (single taxpayers and heads of household), $204,000 to $214,000 (married, filing jointly), and $0 to $10,000 (married, filing separately) then you cannot contribute. If this is the case, you should explore if a Backdoor Roth IRA contribution could be a solution for you. For more on a Backdoor Roth IRA refer to a previous article we wrote in early 2022.
SIMPLE or SEP IRA
SIMPLE and SEP IRAs exist to fulfill the retirement-saving needs of small business owners and self-employed individuals, respectively.
If you run a small business, the Savings Incentive Match Plan for Employees (SIMPLE) IRA can help you create a retirement plan for yourself and up to 100 workers. You’ll be required to match your employees’ contributions up to 3% and make a 2% nonelective contribution for all eligible employees each year. The annual limit allows for $14,000 in contributions if you’re under 50 and $17,000 if you’re over 50. SIMPLE IRAs are taxed upon withdrawal, and there’s a costly 25% penalty for any withdrawals made within two years of opening the account.
In the case of the Simplified Employee Pension (SEP) IRA, all contributions are made on behalf of your employer, and the annual limit for 2022 is the lesser of $61,000 or 25% of your compensation. There’s also no Roth option, so any withdrawals in retirement will be taxable as income.
The 401(k)
The employer-sponsored 401(k) is the most widely used workplace retirement planning tool. These plans are established to encourage employees to save for their retirements and they provide exclusive tax benefits that make it easier to do so. Contributions can be made with pre-tax or post-tax dollars and can be invested in securities like stocks, bonds, and mutual funds.
One of the most appealing features of the 401(k) is the ability for your employer to match a portion of each of your contributions. Your employer might offer to match your contributions up to a certain percentage of your salary, for instance, 5%. Employer contribution matches can help increase the amount you’re contributing each period without costing you any extra money. Keep in mind all employer contributions will be made with pre-tax dollars and will be taxed as income when distributed.
Most 401(k) plans allow both pre-tax and Roth contributions. If you anticipate your income tax rate being higher in retirement than it is now, the Roth might be the wiser option for you. Conversely, if you would benefit from lowering your taxable income today by way of deduction, the traditional 401(k) might better suit your needs. The annual individual contribution limit for 401(k)s is $20,500, or $27,000 for those older than 50 in 2022. This limit applies only to the funds you contribute yourself; it doesn’t include whatever your employer decides to contribute on your behalf.
Solo 401(k)
Whether you’re a self-employed worker or you own a small business with your spouse, a Solo 401(k) offers a tax-advantaged way to save for retirement. With a Solo 401(k), you play the role of both employee and employer, which means you can make contributions for yourself and on behalf of your company. This plan brings with it a relatively high annual contribution limit of $61,000, or $67,500 if you’re old enough to qualify for catch-up contributions. Similar to a standard 401(k), the owner can choose between a opening traditional or Roth account. That way, you can either defer taxes to save money right now or receive tax-free money during retirement.
Health Savings Account (HSA)
Health savings accounts (HSAs) aren’t technically retirement accounts, but they can still prove invaluable in the pursuit of your retirement goals. The primary function of an HSA is to help people save for healthcare expenses by providing tax-advantaged growth for the investments within the account. They are known as Triple Tax Free as the funds committed to the account are tax-deductible and then grow tax-free until you need to withdraw them to cover medical costs. Withdrawals can be made at any time and are also tax-free–so long as they’re used to pay for a qualifying healthcare expense.
Fidelity projects that the average 65-year-old couple in America will need to spend approximately $300,000 on medical care over the course of their retirements, and it’s likely that we’ll see this number continue to rise. Investing in an HSA could go a long way toward lessening the financial burden of future medical expenses, and it’s the most tax-efficient vehicle for healthcare savings. For many individuals with strong cash flow, a great planning strategy is to fully fund the HSA but NOT use it for current medical expenses. This allows the HSA the ability to grow and compound tax-free for use later in life when medical expenses will likely be larger! But the benefits don’t stop there. Once you turn 65, you can use your HSA funds however you’d like—not solely on medical costs—without having to pay a penalty or fee. However, you’re still required to pay income taxes on your distributions as you would with a tax-deferred investment account like a traditional IRA. The annual contribution limit for HSAs is $3,600 for individuals and $7,200 for families.
Taxable Brokerage Account
If none of these plans sound appealing to you, or if none is sufficient to meet your retirement planning needs on its own, there’s always a taxable brokerage account. Many opt for a brokerage in addition to their tax-advantaged retirement account in order to save more or enjoy greater flexibility with their investments. Bear in mind that these accounts aren’t afforded any of the special tax breaks as the retirement accounts discussed previously, and you must pay capital gains taxes on any income you earn. They can, however, be an integral part of a retirement income strategy that pairs retirement account withdrawals which are taxed as income (unless Roth) withwithdrawals from a taxable brokerage account where the tax would only be on realized gains and that tax can be as low as 0.
Final thoughts
Remember that the contribution limits for IRAs, 401(k)s, and HSAs are independent of one another, so there’s nothing keeping you from investing in more than one of these accounts at once if you choose to. In fact, many find that some combination of the above savings plans can better suit their needs.
No matter which account, or accounts, you use in your retirement plan, consider making contributions as often as possible. It can be difficult to set aside money from each paycheck, especially early on in your career, but small investments today can add up to a more substantial sum by the time you’re ready to retire. This is the power of compound interest. Take this example – a Roth IRA funded with a yearly $6,000 contribution for 30 years with yearly growth of 8% would be valued at over $740,000!
If you’re interested in discussing your retirement saving options, reach out to a Financial Planner at Ausperity Private Wealth.
Securities offered through Sanctuary Securities Inc, Member FINRA, SIPC Advisory services offered through Sanctuary Advisors, LLC. A SEC Registered Investment Advisor. Ausperity Private Wealth is a DBA of Sanctuary Securities, Inc. and a DBA of Sanctuary Advisors, LLC. Do not transmit orders regarding your Sanctuary Securities, Inc. account(s) or Sanctuary Advisors, LLC account(s) via e-mail. Sanctuary Securities, Inc., Sanctuary Advisors, LLC, and Ausperity Private Wealth will not be responsible for executing such orders and or instructions.
This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.
Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Have you ever wondered what would happen to your digital assets when you pass away? Join us to learn some best practices with how to transition your social media, email, login info, & more!
Join us as we discuss planning for the next generation & dive into various tax-advantaged strategies to help set-up our children with their best financial life.
A backdoor Roth IRA is an informal name for a method used by high-income taxpayers to create a permanently tax-free Roth IRA, even if their incomes exceed the limits that tax law prescribes for regular Roth ownership. This tax avoidance strategy helps you if your income is too high to contribute to a Roth IRA directly, whereby you can still get your money into the account by adding a few steps to the process.
It’s usually worth the extra effort because of the exclusive tax benefits provided by Roth IRAs. Specifically, traditional IRAs and 401(k)s are taxable upon withdrawal (or tax-deferred), while Roth contributions are taxed upfront and then allowed to grow tax-free. Roth IRAs also afford their owners more flexibility when it comes to deploying their retirement cash. Traditional IRAs have what is called required minimum distributions (RMDs), which require their owners to withdraw a certain amount of cash each year once they hit the age of 72.
Similarly, if you can contribute after-tax income to your 401(k), which then may allow afford you the ability to capitalize on a game-changing retirement savings strategy known as the Mega backdoor Roth 401(k)!
How a standard backdoor Roth works:
Contribute to a traditional IRA account. If you don’t already own a traditional IRA, you’ll need to open one before you can fund it. Ensure that the contributions you make are non-deductible (i.e., post-tax funds) and that you’ve accounted for those contributions in your submission of IRS Form 8606.
Convert your contributions to a Roth IRA. It’s important that you convert your traditional IRA to a Roth IRA as soon as possible. Failing to do so could allow your non-deductible contributions to accumulate investment gains while within the traditional IRA, which you would be responsible for paying taxes on upon conversion.
Enjoy the tax protection of a Roth IRA. If you’ve executed it properly, all the taxes you owe will be paid upfront. From here onward, the funds within your Roth will grow tax-free. An added benefit to note is that your beneficiaries will receive tax-free distributions.
Who is the backdoor Roth for?
Backdoor Roth IRA conversions are for investors whose annual earnings are in excess of $144,000 (or $214,000 if you’re filing jointly with a spouse) and are therefore prohibited from making contributions to a Roth IRA. Roth IRAs were originally designed to assist low-to-middle income families in saving for retirement, but the unique tax shelter they provide makes these accounts appealing to retirement-savers of all types. If you’re not able to contribute directly to a Roth IRA because of high income, you can instead make a contribution to a traditional IRA and then convert it into a Roth—effectively bypassing the contribution restrictions.
For 2021 and 2022, the individual contribution limit for traditional IRAs is $6,000. If you’re married and filing jointly with a spouse, the limit is $6,000 per person–or $12,000 in total. Finally, the IRS allows you to contribute an additional $1,000 if you’re over the age of 50–raising the individual contribution limit to $7,000, or $14,000 if filing jointly. Simply stated, you’re able to move $6,000-7,000 per person, per year into a Roth using this legal maneuver. To maximize your retirement savings, it’s recommended that you do this each year for as long as you’re able to.
But be careful, if you already have an IRA with pre-tax money in it (from tax-deferred contributions or a rollover from an old 401(k) plan) your conversion and future retirement withdrawals will be partially taxable. This is because the IRS taxes withdrawals containing both pre-tax and after-tax dollars on a pro-rata basis which limits the ability to convert just a new non-deductible IRA contribution. For example, if you have $44,000 in a traditional IRA that has been funded with pre-tax money and then make a $6,000 after-tax contribution your total IRA will be $50,000 and ANY conversion amount or distribution will be 88% taxable!
What is a mega backdoor Roth?
In 2022, if your plan both allows you to make after-tax contributions above the $20,500 limit ($27,000 if you are 50 or older) and to transfer–or convert–those after-tax contributions to a Roth IRA or 401(k), you can get the best of both worlds. You can defer up to $20,500 ($27,000 if you’re 50 or older) by making a pre-tax contribution that also reduces your taxable income and make an additional contribution of up to $40,500 that can be transferred to a Roth IRA.
How a mega backdoor Roth conversion works
If you have maxed out your pre-tax contributions to your 401(k)–the cap is $20,500 ($27,000 if over age 50) for 2022–you may be eligible to contribute additional funds to the account in the form of after-tax dollars. Not every employer-sponsored 401(k) allows you to make after-tax contributions, though, so review the terms of your employment agreement or summary plan description before proceeding. Although you are paying taxes on this cash up-front, you’ll benefit from tax-free growth in Roth if executed properly.
The next step is to make an ‘in-service’ withdrawal or distribution. Most 401(k) plans allow participants to make distributions to a Roth IRA while still employed. It is possible to take this step after you have left your job, but it may entail paying more taxes. Just as with a standard backdoor Roth, timing is essential. After making your post-tax contributions, be sure to make your in-service distribution as quickly as possible to avoid generating any taxable returns. Recently, 401(k) plans have started allowing the Mega Backdoor Roth to occur inside the plan and will assist in moving your after-tax funds to the Roth 401(k) for you. Even better, a few providers allow an automatic conversion feature that converts after-tax assets to Roth the very next business day!
A relevant caveat is that a mega backdoor Roth involves more moving parts than a standard backdoor Roth, so do not try this without consulting a professional first. A financial advisor or tax professional should be able to simplify the process for you and a call to your 401(k) benefit center is recommended.
A Mega Backdoor Roth Example:
For 2022, the maximum amount that can be contributed is $61,000 inside a 401(k) plan for those under the age of 50. Subtract from this amount the $20,500 in pre-tax contributions plus your employer match (we are assuming a 6% match with a $150,000 salary). Total pre-tax contribution is $29,500. This leaves over $31,500 of after-tax contributions which can be converted to Roth for future tax-free growth!
Need help executing this strategy? Schedule an appointment today!
Securities offered through Sanctuary Securities Inc, Member FINRA, SIPC Advisory services offered through Sanctuary Advisors, LLC. A SEC Registered Investment Advisor. Ausperity Private Wealth is a DBA of Sanctuary Securities, Inc. and a DBA of Sanctuary Advisors, LLC. Do not transmit orders regarding your Sanctuary Securities, Inc. account(s) or Sanctuary Advisors, LLC account(s) via e-mail. Sanctuary Securities, Inc., Sanctuary Advisors, LLC, and Ausperity Private Wealth will not be responsible for executing such orders and or instructions. This e-mail message is intended only for the use of the individual or entity to which the transmission is addressed. Any interception may be a violation of law. If you are not the intended recipient, any dissemination, distribution or copying of this e-mail is strictly prohibited. If you are not the intended recipient, please contact the sender by reply email and destroy all copies of the document.
As inflation continues to eat away at consumers’ savings and purchasing power, investors are searching for new ways to insulate their assets while also earning a reliable return in a volatile market. Enter the Series I Savings Bond, a virtually risk-free investment that promises a 9.62% return through October 2022.
Series I Savings Bonds, also known as ‘I bonds,’ have become increasingly more popular in recent months, as they are specifically designed to be a hedge against inflation. Here is what you need to know about I bonds in order to determine whether or not they’re a worthwhile investment for you.
Inflation is slowly eroding your savings
If there’s one thing we know about periods of high inflation, it’s that money loses value over time. Simply stated, a dollar today is going to be worth more than that same dollar tomorrow. With inflation levels climbing above 8%, investors who leave their money in traditional savings accounts (which tend to earn close to 0% interest) will see their funds gradually diluted.
In order to protect the value of your savings from inflation, you’ll need to earn returns that are in excess of the inflation rate. Luckily, today’s inflation rates are being outpaced by I bond interest rates, which presents investors with a unique opportunity.
I bonds can protect you from inflation
Like treasuries, I bonds are backed by the full faith and credit of the U.S. government and therefore carry a next-to-zero probability of default. But, while other low-risk investments offer similarly low yields, I bonds are currently serving up a whopping 9.62% return for discerning investors.
I bond yields are calculated by combining two interest rates: a fixed rate that’s established by the U.S. Treasury and a variable rate that scales with inflation. Although the Treasury has the option to adjust the fixed rate every six months, I bonds maintain the fixed rate that they were issued under for their full maturity of up to 30 years. The fixed rate for I bonds remains at 0% for the third consecutive year.
The variable interest rate is adjusted every six months to reflect current levels of inflation. In May and November of each year, the Treasury uses the Consumer Price Index (CPI) to set a new variable rate. A higher CPI reflects higher levels of inflation, and results in the Treasury assigning a higher variable interest rate. Unlike the fixed rate–which is guaranteed over the lifetime of the bond–the variable rate is only guaranteed for six months following the bond’s issuance. Today’s variable rate (quoted semi-annually) is 4.81%.
When taken together, these two rates result in a combined interest rate of 9.62% from now until November. That’s 9.62% of risk-free profit that you can lock in over the next several months.
A couple things to consider before investing
Investing in I bonds will not be for everyone–doing so comes with a couple important caveats that could bear significant implications for your finances; particularly, in the short-term.
Annual limits
Generally, the Federal Reserve only allows individuals to buy up to $10,000 worth of I Bonds each calendar year. These bonds are available for purchase through the Treasury Direct website. There are, however, exceptions to this rule. For those interested in stashing away more funds than the annual limit allows, there are a handful of strategies that are available.
First, if you still haven’t gotten around to filing your tax return for this past year, you can elect to receive $5,000 of your refund in paper I bonds. This effectively bumps the amount of I Bonds you can buy from $10,000 to $15,000 per year, assuming you had the prescience to submit an IRS Form 8888 with your tax return.
Second, the $10,000 annual limit (or $15,000 limit, if you take advantage of the tax refund option) applies to each individual, meaning that every member of your household can purchase this amount of I bonds. Families with children can purchase I bonds on behalf of each child, but these investments must be made in custodial accounts and are treated as gifts for tax purposes.
Finally, if you own a business or a living trust, you can purchase I bonds on behalf of those entities. Whether you’re self-employed, own a family LLC, or make investment decisions for a corporation, you can purchase $10,000 of I bonds for your business. The same goes for living trusts–as long as they’re considered separate entities come tax time, you can buy I bonds for multiple trusts if you want to. Similarly to with children, the I bonds you buy for your business or trust must be held in separate accounts.
To illustrate how maximizing your I bond holdings can look in practice, consider the following example. A married couple, each with their own business and living trust, would be able to purchase up to $60,000 in I bonds, or $70,000 if they opt for additional paper bonds as part of their tax refund. If they have a child, then they’re allowed to buy another $10,000 in I bonds per year on their behalf. Although these bonds would live in a few different accounts, that’s a total of $80,000 in inflation-protected securities.
Illiquidity
I bonds are intended to be investments that are held over a relatively-longer period of time. Once you purchase an I bond, you must hold it for at least twelve months before you even have the option to redeem it. What’s more, if you cash in your bonds before you’ve held them for five years, you must surrender the last three months of interest payments. For example, if you hold an I bond for 18 months before redeeming it, then you’ll only receive the first 15 months of interest.
These holding requirements bear important implications for investors. To start, your investment will be locked-up for at least a year, which means that you won’t be able to access your funds should an unexpected cash need arise. Further, since your earnings are diminished if you cash in your bonds early, investors are more inclined to abide by the requisite five-year holding period. This illiquidity could present challenges for some, potentially forcing them to look elsewhere for inflation protection.
Be sure to factor in the above considerations when deciding whether or not it makes sense for you to put your money into I bonds.
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