Transcript
Brian Preston (0:07)
All right, we've got Andrew B. He says, my employer has started to allow in plan Roth conversions. How does one decide how much traditional or the match to convert to Roth? Is this an example or a reason to take it to the next level?
Beau Henderson (0:22)
I'll enter the second part first. Yes, it is a time when it might make sense to take it the next level. Because this gets incredibly nuanced and incredibly complicated when you're starting to do mega backdoor Roths. And let me. Can I lay out what a mega backdoor Roth is?
Megan (0:36)
Yeah, well, you definitely need to, because I think Andrew, he's asking, he sees that somebody has made Roth conversions in plan conversions available. That tells me whoever designed your employer's plan, they were designing to add additional features. And Beau's about to go over that. But you didn't even ask Andrew what this kind of. You're asking, how do you, you know, should I take advantage of this, let BO blow your mind with this cool planning opportunity of mega backdoor Roth contribution?
Beau Henderson (1:02)
Yes. So in plan conversion is one piece of that. What it's basically saying is that you have some assets inside of your 401k that can be converted to Roth inside of the plan. Now, what most people think of when they think of Roth conversions is I take some pre tax dollars and I convert them to Roth dollars and that becomes a taxable event. A lot of folks will do that with their employer match. Maybe I'm maxing out my Roth pre tax, my Roth salary deferral and my employer match goes in pre tax and I want to convert that. Those are all taxable events. But most often when we see in plan Roth conversions inside of a plan, it's because there happen to be after tax contributions available inside of that plan. Now, what most people don't realize is when it comes to 401ks, we often think of two ways to put money in there. We can either do pre tax deferrals or we can do Roth deferrals. Well, in some plans there's actually a third option to put money in. It's called after tax deferrals. And it is not limited to the same 23,000 in 2024, 23,500 next year. It's not limited to the same salary deferral limit. So you can actually put in all the way up to the Section 415 limit, which caps at $70,000 in 2025 of after tax contributions. Well, one of the beautiful things is if you're putting after tax money into your 401k and it allows for in plan conversions, you can convert Those after tax 401k contributions that you put in to Roth. And it is a completely tax free event. It allows you essentially to do a mega backdoor Roth contribution. So a lot of folks out there have access to this, are able to do 20, 30, $35,000 Roth contributions inside of their 401k by this planning opportunity. So the question that Andrew had is, okay, I've got this going on and I have this availability. How do I know should I do after tax first? Should I do conversions first? Should I do pre tax? Most often when folks were able to save at this level and you're talking about potentially putting $70,000 of your compensation or maybe 50 or $60,000 of your compensation into a 401k, you're likely a higher income earner. Well, if you're a higher income earner, the pre tax contributions that you can put into your 401k are incredibly valuable. That tax rate, if you're in the 30% or above marginal tax bracket is so, so valuable. So it's not uncommon for someone to completely max out their pre tax 401k contributions all the way up to the 23,000 this year, 23,500 next year, and then start doing the after tax contributions. Would you agree with that? As opposed to doing it before us?