The Mega Backdoor Roth

An option within some 401(k) plans

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Overview

Contributions, on an after-tax basis, to your 401(k) can be converted to a Roth and remain in the 401(k), or possibly, be moved to an outside Roth IRA. This would provide tax-free income to be used during retirement that would supplement your taxable income since the gains on Roths are not taxed upon distribution. There are two types of Roths (and therefore two types of conversions to Roth). They are the Roth 401(k) and the Roth IRA. There are significant differences between the two.

Procedure

To accomplish this, you will have had to reach your personal limit of either $19,000 or $25,000 for the year. (For our purposes, I am citing 2019 limits.) Once this is achieved, you can make after-tax contributions to your 401(k) up to the 415(c) limit of either $56,000 or $62,000. Keep in mind, if your company also contributes to your 401(k), your after-tax contributions will be combined with your company’s contributions for the purpose of reaching the overall limit. Example: A total overall limit of $56,000 wherein you contributed the max of $19,000; the company, at that point, has contributed $10,000 to provide $29,000 in the 401(k). You can now contribute $27,000 after-tax (to bring you immediately up to the $56,000 limit). The $27,000 would go into the after-tax “bucket” which is convertible to a Roth within the 401(k) OR you can roll (the $27,000 bucket) into an outside Roth IRA (if your plan allows in-service distributions). Not all 401(k) plans allow this, so you would have to check with your provider. The 401(k) plan has to allow in-service distributions of after-tax funds prior to age 591/2 to be able to roll out these funds and also allow after-tax contributions.

Required minimum distributions (RMD)

 RMDs are required when you reach age 70 1/2 from taxable accounts: 401(k), IRA, SEP, IRA, etc. RMDs are also required on a Roth 401(k) if you have left the Roth conversion in the 401(k) at the time you reach the RMD age. RMDs are not required on Roth IRAs. Therefore, a rollover from a Roth 401(k) to a Roth IRA would make sense closer to the time you would reach RMD age, so you are not required to take distributions. (Currently, there is a bill in Congress to raise this RMD age to 72 years.)

Summary

This is called a Mega Backdoor Roth (rather than a regular Backdoor Roth) because you have the option of putting much more into an after-tax 401(k) than the $6,000 or $7,000 (2019) annual IRA limits. With a regular Backdoor Roth, you contribute the $6,000 or $7,000 to an after-tax IRA, then convert to a Roth. With a Mega Backdoor Roth, you can contribute up to the 415(c) limit after tax, within the 401(k) and convert to Roth either inside or outside of the 401(k). Anytime you convert, in either of these scenarios, you will owe taxes on the gains upon the day of conversion. These gains are added to your taxable income for that year and are taxed at your effective tax rate. Few may be interested in this option, but I want to bring it to your attention for your retirement planning. If permissible within your plan, it is a great way to build substantial tax-free income. 

ACN

SOURCEAero Crew News, June 2019
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Glenn Nevola
Current airline captain and also financial advisor specializing in providing financial assistance to fellow airline pilots in their pre and post retirement planning. Glenn Nevola has been an airline pilot since 1986 where his career started with People Express Airlines, which merged with Continental Airlines in 1987 and was then merged with United Airlines in 2010. He is currently based in Newark as a 737 captain. In addition to being a pilot, he operated the financial arm of a real estate firm that purchased, renovated, rented, marketed, bundled and sold to investors over a 12-year span. He was personally responsible for over 300 closing during that timeframe. More recently he was a former financial advisor with Morgan Stanley in NYC where he acquired his Series 7 and Series 66 licenses. He brought over to the firm a concept and business model that would assist retiring airline pilots with post - retirement wealth management. This was, in part, augmented by the fact the mandatory retirement age was recently changed from age 60 to age 65 for commercial airline pilots. When Morgan Stanley hired him, the oldest of these pilots were then approximately 63 years of age. His unique position of living in both worlds – flying and finance - provided him the ability to market to his niche in direct target marketing from one of their own. He also has skin in the game, as he is a pilot, who participates in the retirement plans on which he advises and as such is in similar models as many of his clients. As time went on at Morgan Stanley a decision was made, based on many factors such as compliance restrictions, inability to market and assist younger pilots with their desire for 401(k) management and general restrictions on building out the business model, to split off and create his own financial services firm, Flight Line Financial, LLC (FLF) – a registered investment advisor based in NJ. FLF is also licensed in NJ for insurance enabling the firm to provide annuity counseling. This created a win - win scenario for further growth by allowing FLF to focus on 2 distinct groups of pilots – younger pilots, less than age 59 ½ and older pilots over age 59 ½. For the younger group, FLF provides asset allocation strategies incorporating diversification, dollar cost averaging and rebalancing options to pilots for a flat annual fee. Also discussed with this group includes topics such as Roth vs. non-Roth, 529’s, max contribution limits, 415 (c) limits, spousal accounts and other general financial topics. For the older pilot group, FLF has affiliated with a leading wall street firm for post-retirement financial planning. Wealth management services provided include many aspects such as creation of post retirement financial distribution plan, trust and estate planning, diversification, allocation, hedged equities, bond structuring, long term care, etc. The firm FLF is affiliated with has been in the wealth management business since the 1970’s and manages over $2 billion in assets from individual investors. Glenn has the unique position of living in both worlds – flying and finance. He interacts with his target market every time he is at the airport or on a trip. In numerous businesses, owners pay substantially for leads in their specific target market, such as mailing lists, calling lists, email lists, etc. Additionally, servicing the younger pilots creates pipelines for future rollovers. Currently FLF manages approximately $250 million in assets across approximately 200 clients.

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