WEBVTT - At The Money: The Mega Backdoor Roth

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<v Speaker 1>Bloomberg Audio Studios, podcasts, radio news.

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<v Speaker 2>Tax deferred portfolio is also known as qualified accounts, have

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<v Speaker 2>become one of the most popular ways to invest. There

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<v Speaker 2>are about one hundred million households nearly seventy five percent

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<v Speaker 2>of every household in America with some sort of a

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<v Speaker 2>formal tax advantage. Retirement savings total defined contributions are nearly

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<v Speaker 2>fourteen trillion dollars. The latest edition in your Tax Deferred

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<v Speaker 2>Portfolio Choices is the Mega Backdoor Row. To help us

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<v Speaker 2>unpack all of this and what it means for your

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<v Speaker 2>retirement savings, let's bring in Dan L.

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<v Speaker 3>Rosa.

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<v Speaker 2>He's an expert in qualified retirement accounts and works with

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<v Speaker 2>clients all over the country. In full disclosure, Dan leads

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<v Speaker 2>the corporate retirement plans at my Firmer Helts Wealth Management

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<v Speaker 2>and is one of my partners. So let's start with

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<v Speaker 2>the basics. Most of our listeners are certainly familiar with

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<v Speaker 2>four oh one ks, and they're probably familiar with variations

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<v Speaker 2>such as a ROTH four oh one K or a

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<v Speaker 2>ROTH IRA. What is a Mega backdoor WROTH?

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<v Speaker 4>So a regular four one K allows you to contribute

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<v Speaker 4>up to twenty four and a half thousand dollars into it.

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<v Speaker 3>Right.

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<v Speaker 4>The mega backdoor of ROTH feature just allows you to

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<v Speaker 4>contribute above and beyond that twenty four and a half

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<v Speaker 4>thousand dollars up to potentially seventy two thousand dollars. So

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<v Speaker 4>it uses the same type of strategy that you have

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<v Speaker 4>in your regular backdoor ROTH IRA. Right, that's just a

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<v Speaker 4>way for high earners to get money into a ROTH account.

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<v Speaker 4>They're going to make a non inductible contribution to a

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<v Speaker 4>traditional IRA and then convert that to a ROTH IRA.

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<v Speaker 4>It works, it's great, but the dollar amount is pretty small, right,

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<v Speaker 4>it's seven five hundred dollars. The Mega backdoor ROTH uses

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<v Speaker 4>the same strategy, but inside of your four one K plan,

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<v Speaker 4>where the contribution limits are significantly higher.

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<v Speaker 2>So mega backdoor four oh one k ROTH sounds kind

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<v Speaker 2>of complicated, but it really seems like that's a huge

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<v Speaker 2>increase in your after tax contributions that theoretically grow tax

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<v Speaker 2>free and are withdrawn tax free. Is that right?

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<v Speaker 3>That's right.

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<v Speaker 4>It's it's a cheap when it works and your plan

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<v Speaker 4>allows it. It's a cheat code, right, There's nothing else

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<v Speaker 4>out there that's going to allow you to get that

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<v Speaker 4>much money into a qualified and that means that much

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<v Speaker 4>rock dollars into a qualified retirement account.

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<v Speaker 2>So cheat codes and back doors sounds a little shady.

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<v Speaker 2>Is this legit with the irs? Have they blessed this? Yeah?

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<v Speaker 4>Yeah, it's just the backdoor part that sounds kind of sketchy.

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<v Speaker 2>It is.

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<v Speaker 4>It is not a gray area, it is not a loophole.

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<v Speaker 4>It's completely legit. The rules are actually very much clear.

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<v Speaker 4>The real challenge is just whether or not your plan

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<v Speaker 4>allows you to use it.

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<v Speaker 2>So let's go through that. If the I R S

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<v Speaker 2>says it's kosher, I would imagine your employer or the

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<v Speaker 2>benefits provider, maybe even the custodian who who has to

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<v Speaker 2>sign off on it? Is Is it any of the

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<v Speaker 2>above or all the above whose approval is required?

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<v Speaker 3>Yeah, it's There's really nothing to do with the custodian

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<v Speaker 3>with this.

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<v Speaker 4>It's more of a plan level decision that's going to

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<v Speaker 4>be made by the employer, right. They're the ones that

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<v Speaker 4>are going to control the plan design and would ultimately

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<v Speaker 4>make the decision to offer the after tax contributions in

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<v Speaker 4>plan Wroth conversion features that make up this megabactoor Wroth.

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<v Speaker 4>The formul k provider is obviously involved and they need

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<v Speaker 4>to be able to administer this, but that's generally.

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<v Speaker 3>Not a problem.

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<v Speaker 2>Huh. So typically twenty four and a half twenty four

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<v Speaker 2>point five is a regular four oh one K. I'm

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<v Speaker 2>assuming catch ups and things like that are separate. So

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<v Speaker 2>if you could go to seventy two thousand in this

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<v Speaker 2>and it's after tax, why would the employer object? This

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<v Speaker 2>sounds like a great deal for anyone who wants to

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<v Speaker 2>throw more money into their four o one K.

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<v Speaker 4>Yeah, and this feature has gotten a lot more popular

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<v Speaker 4>in recent years, but the reality is the most likely

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<v Speaker 4>answerest to why.

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<v Speaker 3>More plans don't do it.

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<v Speaker 4>It just doesn't work for every plan after tax contributions

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<v Speaker 4>and the inplan wealth conversions do add some complexity to

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<v Speaker 4>the plan design that most importantly, they trigger additional compliance testing,

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<v Speaker 4>and that extra compliance test thing it failed can prevent

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<v Speaker 4>the whole strategy from working all together.

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<v Speaker 2>So I know our plan in our shop offers this

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<v Speaker 2>in house, and I've been taking advantage of it personally.

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<v Speaker 2>So I'm thinking about other service companies, lawyers, accountants, advisors, architects,

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<v Speaker 2>anybody that's you know, a white collar office with reasonable salaries.

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<v Speaker 2>It would seem that this should be something that all

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<v Speaker 2>those people should take advantage of Why don't all of

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<v Speaker 2>these sort of firms take advantage of it? It sounds like, hey,

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<v Speaker 2>seventy two thousand triple what you normally allow. That's seventy

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<v Speaker 2>two thousand above what your traditional for one K is giving.

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<v Speaker 2>Why wouldn't everybody jump on this?

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<v Speaker 4>Yeah, it was seventy two thousand and actually the total

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<v Speaker 4>that's you're all in that each individual can get into

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<v Speaker 4>each plan. But why don't more plans or companies use

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<v Speaker 4>this feature? Again, it just doesn't always work. So, without

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<v Speaker 4>getting too deep into the weeds on the compliance tessing side,

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<v Speaker 4>if the only individuals that are interested in using this

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<v Speaker 4>feature and contributing making these after tax contributions are the

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<v Speaker 4>owners and highest wagoarners, it's not going to work.

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<v Speaker 3>It's as simple as that.

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<v Speaker 4>So the company either has to be big enough or

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<v Speaker 4>have enough wayjarners where it's just not the top twenty

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<v Speaker 4>percent or so using it in order for.

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<v Speaker 3>It to work.

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<v Speaker 2>So what does it typically look like in a firm

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<v Speaker 2>that does this? What sort of buy in do you

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<v Speaker 2>need from management as well as the rest of the

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<v Speaker 2>staff or partnership.

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<v Speaker 4>Yeah, I mean listen as far as buying from the staff.

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<v Speaker 4>If you have a lot of employees that are contributing

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<v Speaker 4>and maxing out, right, If you have a lot of

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<v Speaker 4>people that are maxing their contributions and would do more

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<v Speaker 4>if they could, that's good sign, right, It's worth looking

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<v Speaker 4>into in that situation. But you also have to have

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<v Speaker 4>enough highly compensated individuals.

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<v Speaker 3>Right if you just have If you have.

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<v Speaker 4>Thirty people and eight of them are the big wag journers,

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<v Speaker 4>it's just again, it's not going to work.

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<v Speaker 3>It's going to be top heavy.

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<v Speaker 4>So if you have enough highly compensated individuals that are

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<v Speaker 4>interested in using this feature, there's a good shot at

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<v Speaker 4>all work.

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<v Speaker 2>So I immediately thought of professional services companies, financial advisors, attorneys, accountants, bankers, doctors, etc.

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<v Speaker 2>But you know, what sort of industries do you see

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<v Speaker 2>use this? What sort of businesses? Is this really well

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<v Speaker 2>suited for.

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<v Speaker 3>All the professionals that you just listed?

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<v Speaker 4>Tech companies, I mean, i'd say all just about all

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<v Speaker 4>of the big tech companies have this feature available. Again,

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<v Speaker 4>and I think any industry or any company where a

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<v Speaker 4>large percentage of the population would be considered highway journers,

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<v Speaker 4>meaning say over one hundred and fifty hundred sixty thousand

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<v Speaker 4>dollars a year and that are interested in making these

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<v Speaker 4>significant contributions.

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<v Speaker 3>It could work.

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<v Speaker 2>So let's assume you have a traditional four oh one

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<v Speaker 2>K and everybody is maxing out their twenty four point

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<v Speaker 2>five plus whatever catch up over fifties out there, and

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<v Speaker 2>they want to be able to save more money. What

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<v Speaker 2>is the process like converting that to a megabackdoor roth?

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<v Speaker 2>Walk us through that process.

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<v Speaker 4>Yeah, Ultimately it's going to have to come from the employer, right,

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<v Speaker 4>so whoever at the company is in charge of running

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<v Speaker 4>and administering the four to one K will need to

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<v Speaker 4>be involved in that decision. You know, if you're an

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<v Speaker 4>influential employee, of course you can try and influence and

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<v Speaker 4>push on that decision. But ultimately the plan sponsor the

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<v Speaker 4>employer will work with the four to one K provider

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<v Speaker 4>to update the plan documents add a couple of features.

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<v Speaker 4>For the megabackdoor ROTH to work. A plan has to

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<v Speaker 4>allow two things. The first is the ability to make

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<v Speaker 4>after tax contributions and the second is a way to

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<v Speaker 4>move those after tax dollars into.

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<v Speaker 3>A ROTH account.

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<v Speaker 4>Moving the after tax dollars into WRATH can happen one

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<v Speaker 4>of two ways first you have an implan WROTH conversion

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<v Speaker 4>where the after tax dollars are converted to ROTH and

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<v Speaker 4>stay in the four to one K plan. And the

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<v Speaker 4>second is an in service distribution where the after tax

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<v Speaker 4>dollars are rolled into an outside ROTH IRA mplan. ROTH

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<v Speaker 4>conversion is probably more common. It's just simpler to execute,

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<v Speaker 4>and it keeps all the money inside the plan.

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<v Speaker 2>Huh, I mean this is really attractive. I'm assuming someone

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<v Speaker 2>reaches out to HR or one of the managing directors

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<v Speaker 2>or partners or whatever the title is and says, hey,

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<v Speaker 2>this is a great opportunity. Want don't we do this?

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<v Speaker 2>Is there like an extra cost? Why would there be

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<v Speaker 2>any reluctance to do this assuming it's the sort of

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<v Speaker 2>mix of high wage employees.

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<v Speaker 4>Yeah, there is no additional costs. You could say, there's

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<v Speaker 4>a little bit of an additional headache. Right again, you're

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<v Speaker 4>adding more complexity, another layer of compliance testing.

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<v Speaker 3>So whoever you know is.

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<v Speaker 4>In charge of administering the four O one K company? Yeah,

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<v Speaker 4>maybe it amounts to a little more work, but when

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<v Speaker 4>it works, it works really well, and these significant benefits

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<v Speaker 4>far outweigh you know, the minor administrative additional administrative burden.

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<v Speaker 2>So we're talking about companies with partners and hr et cetera.

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<v Speaker 2>What about either a solo practitioner or a ten ninety

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<v Speaker 2>nine contractor. Can you do this sort of megaback door

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<v Speaker 2>roth if you're self employed?

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<v Speaker 4>Yes, absolutely, megabacdoor roth works perfectly for solo or owner

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<v Speaker 4>only four one K plans. There are no compliance tests

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<v Speaker 4>and headaches or administrative burdens when the plant only covers owners.

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<v Speaker 3>So we we're.

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<v Speaker 4>Huge fans of the megabacdoor wroth in solo formal case.

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<v Speaker 2>So let's talk about timing. How does this work? How

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<v Speaker 2>much are people converting? You know, what does this look

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<v Speaker 2>like in terms of best practices, either daily or each

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<v Speaker 2>pay period or quartterally. How often does this occur?

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<v Speaker 4>It really depends on the plan or on the plan provider.

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<v Speaker 3>Some plans only allow.

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<v Speaker 4>A certain number of conversions or distributions each year, which

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<v Speaker 4>is obviously not ideal and it really kind of pushes

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<v Speaker 4>the burden onto the participant to figure out when and

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<v Speaker 4>how to do that. Others have daily automatic roth conversions,

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<v Speaker 4>which is just awesome.

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<v Speaker 3>I've done it both ways, right, I've had the once a.

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<v Speaker 4>Year manual paper form after tax conversions and we now

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<v Speaker 4>have the daily automatic.

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<v Speaker 3>Wroth conversions with Fidelity, and it's a game changer. It's great.

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<v Speaker 4>As an employee, you don't have too much control over that.

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<v Speaker 4>It really depends on the provider. But whatever the case,

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<v Speaker 4>I certainly recommend reaching out to your four to one

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<v Speaker 4>key provider the first time you do this, the first

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<v Speaker 4>time you convert, and making sure you get it right,

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<v Speaker 4>do it.

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<v Speaker 3>The right way.

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<v Speaker 2>So you and I have talked about this in the past,

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<v Speaker 2>and you discussed automatic wroth sweeps. Is that something that

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<v Speaker 2>again gets set up by the provider or the employer

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<v Speaker 2>or the employee. How do you make sure that each

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<v Speaker 2>payroll period or in the event of any distribution or

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<v Speaker 2>yield or dividend, how do you make sure that stays

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<v Speaker 2>on the wroth side.

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<v Speaker 3>Yeah, it's a great point.

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<v Speaker 4>So that daily automatic roth sweep or automatic roth conversion

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<v Speaker 4>is awesome, but only some record keepers, only some providers

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<v Speaker 4>offer it.

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<v Speaker 3>Right.

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<v Speaker 4>So the answer, as it usually is with these types

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<v Speaker 4>of plans, as it depends right. Every plan is different,

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<v Speaker 4>every provider is different. If your plan does offer it,

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<v Speaker 4>or if you're not sure, reach out to the four

0:13:03.920 --> 0:13:06.240
<v Speaker 4>one K provider. If your plan does offer it, the

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<v Speaker 4>employee generally has to activate this daily automatic growth conversion feature.

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<v Speaker 2>All right, so I know my four oh one K

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<v Speaker 2>is a Fidelity all of these daily sweeps and other

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<v Speaker 2>things that you know, from my perspective, it was set

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<v Speaker 2>and forget, I don't have to pay much attention to it.

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<v Speaker 2>What about some of the other big four oh one

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<v Speaker 2>K provider Schwab, Vanguard, Is it possible to do it

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<v Speaker 2>with those? And do they allow for these daily sweeps

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<v Speaker 2>like what's the landscape look like out there?

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<v Speaker 3>Yeah?

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<v Speaker 4>As this feature has gotten more and more popular in

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<v Speaker 4>recent years, which it certainly has, more providers are getting

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<v Speaker 4>better at it.

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<v Speaker 3>Right five years ago, I.

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<v Speaker 4>Don't know if anyone outside of Fidelity did it now

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<v Speaker 4>if there, certainly, if your plan is big enough, you

0:13:52.559 --> 0:13:56.040
<v Speaker 4>can pretty much do whatever you want for it. I

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<v Speaker 4>think if Fidelity just happened to be the first one

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<v Speaker 4>that was really good at administering it.

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<v Speaker 3>But other providers are catching up quickly.

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<v Speaker 2>Last question. People hear this described as tax free growth forever,

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<v Speaker 2>and obviously that gets people excited, But what are the risks?

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<v Speaker 2>What scenarios? Does this not make any sense? Where are

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<v Speaker 2>you just better off investing in a taxable account?

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<v Speaker 4>Yeah, I think the excitement is warranted. I'm a huge

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<v Speaker 4>fan of the megabactoor roth feature. If your plan offers

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<v Speaker 4>it and you can afford the extra contributions, my answer

0:14:32.000 --> 0:14:32.720
<v Speaker 4>is usually do it.

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<v Speaker 3>Just keep in mind a couple of things.

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<v Speaker 4>First, if you use that in plan Wroth conversion, the

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<v Speaker 4>money stays in the plan and then follows the Wroth

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<v Speaker 4>four to H one k rules all right, So that

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<v Speaker 4>means you generally can't access that money until age fifty

0:14:48.760 --> 0:14:52.200
<v Speaker 4>nine and a half or distributable event. So I think

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<v Speaker 4>the biggest thing answer your question when does a taxable

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<v Speaker 4>account make more sense if present day liquidity is important?

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<v Speaker 2>What about out megabeck door roths. Is there the same

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<v Speaker 2>required minimum withdrawal requirements?

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<v Speaker 4>Actually, I think effective last year, the Secure two point

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<v Speaker 4>zero removed the R and D requirement from Wroth four

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<v Speaker 4>one case, so there.

0:15:17.520 --> 0:15:20.360
<v Speaker 3>Are no rm D requirements for a row for one case.

0:15:20.520 --> 0:15:24.040
<v Speaker 2>Really interesting. So if you're working in a firm, or

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<v Speaker 2>if you're a solo practitioner and you're making a decent

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<v Speaker 2>amount of money but you want to save more for retirement,

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<v Speaker 2>the megabackdoor rowth allows you to use after tax dollars

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<v Speaker 2>up to seventy two thousand to put into this account

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<v Speaker 2>that will not only grow tax free, but you can

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<v Speaker 2>withdraw a tax free whenever you want after age fifty

0:15:48.680 --> 0:15:51.400
<v Speaker 2>nine and a half, with no minimum requirements when you

0:15:51.440 --> 0:15:55.400
<v Speaker 2>turn seventy three. It sounds like a great opportunity, and

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<v Speaker 2>a lot of people just are unaware of it and

0:15:58.440 --> 0:16:01.520
<v Speaker 2>are not taking advantage of it. You should look into

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<v Speaker 2>this if you're in those circumstances and you have an

0:16:04.520 --> 0:16:08.160
<v Speaker 2>employer who will work with you to create a better

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<v Speaker 2>corporate retirement plan. I'm Barry Dults you're listening to at

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<v Speaker 2>the Money