Transcript
Megan (0:07)
Next up, we've got one from Brian D. He says, my wife and I are approaching the income cap for contributing to our Roth IRAs. What bucket should we invest our money into instead to prepare for starting a backdoor Roth strategy in the future?
Bo (0:24)
Love it, love it, love it, love it. All right, so this is a little bit. It's difficult to answer your specific question without knowing your account structure. I'll tell you anecdotally what we think about for a number of our clients, because what we don't want you doing is if you are someone who was contributing to a Roth on a monthly basis and you say, man, I am now at the point to where I think my income might be over the limit. And I don't want to do the thing where I put money in my Roth. I get through to the new year and then I'll get my W2. And I'm like, oh, crud, we were over the limit. So now I've got to go back in time, I've got to undo all those contributions I made. Not only have to pull up the money I put in, I have to pull out any applicable earnings. And when I pull out those earnings, they're going to be subject to ordinary income tax as well as penalty. If I'm under 59 and a half, it might be better to just not have to do that. So I'm not going to contribute monthly to my Roth anymore. So does that mean I just stop saving that money? No, not at all. Most often what we tell our folks to do is instead of dollar cost averaging inside of your Roth ira, there's nothing wrong with dollar cost averaging inside of an after tax brokerage account. So if you were saving the. I don't remember the math on my head. Is it $583? Is that what it takes to max out a Roth? I'm going off memory here.
Megan (1:36)
Yeah.
Bo (1:36)
$583 a month. Instead of doing that inside of your Roth, now you shift it to go into your after tax account and you can just buy a low cost index fund. Now the thing they have to think through is, okay, if I'm doing that, and the intent is that those dollars will ultimately flow into my Roth. Am I going to be okay triggering capital gains when I have to sell those one year from now to then fund it between January and April of next year? For most folks, if you're following the finance, Brian, can you hold the thing up? If you're following the financial order of operations and you have a fully funded emergency fund and you have a 25% savings rate. There's a good chance that you can use additional cash or additional capital to fund that. And then if you have to true up from your joint account, from your after tax account, you can do that. I just don't want to see you, oh, I can't do Roth anymore, so I'm going to shut it down and my savings rate decrease.
Brian (2:27)
No, you just hit on two big things. I love backdoor Roth conversion strategies, I really do. But don't take our excitement and enthusiasm for it and you do a transaction that's going to be a headache for you. I had a dear friend of mine who reached this was last year, reached out and said, I did that backdoor Roth contribution you mentioned on your show. And I was like, no, you shouldn't have done. Last time you and I talked, you told me you had a big IRA rollover. He goes, oh, yeah, I still got that. And I was like, well, you didn't do a backdoor Roth contribution because you didn't have the right structure. This is why guys, measure twice, cut once. I love doing backdoor conversion strategies, but you do have to have the right account structure to make this work. The government is very clear on this. If you have any IRA assets, meaning SEP IRAs, simple IRAs, you know, traditional IRAs, rollover IRAs. When you left a previous employer, you're not going to be able to do a Roth conversion strategy and let it be a tax free transaction. You can do it, but now you have to prorate or allocate your basis to figure out the taxes, which is a complete. It just adds a layer of complexity that when you watch financial content, that's not what you signed up for. The clean way you do this is that you clean out any IRAs that you have. So if you have like an IRA rollover and you make the determination that, hey, I have a great 401k with my employer, you can roll the IRA assets into your 401k. Well now qualified assets like a 5, you know, a 401k, 457, 403b, those are under different section of the tax code to where they don't count against the pro. You don't have to prorate or allocate the basis. When you do the conversion strategy from the traditional ira, you contribute to a traditional IRA and then you convert it to a Roth. All right? And since there's no income caps, they took that away around 2010. That's why anybody can do this. I mean, that's the structure here's the other thing I would caution Brian D. On is that obviously if you guys are getting in those higher income ratios, you know, $7,000 is all you can put in your Roth IRA, your spouse is going to be able to put $7,000. But I bet if you're getting to those higher thresholds, that's not maxing out your 25%. And you don't get to go to step eight or seven and eight of the financial order of operations unless you're investing 25% of your gross income. Don't skip out on after you get past doing your 401k and after you do your Roth contributions, don't forget that you can do after tax savings in like a joint brokerage account so that you can keep this savings train going. Because I just don't like it when people when you're starting out and Maybe you're making 60, 70 grand a year and your 25% is covered up by your Roth your contribution plus your employer's contribution into your 401k. But as you get older and you start reaching six figure status, don't still save like you're making $60,000. Save and invest like now you're in this six figure increase your investments and your saving strategies to correlate with your new income.