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Is your adviser encouraging you to do an IRA rollover? Make sure they’re following this new rule

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IRA rollovers are common, whether they’re from an old 401(k) or just one account to another, but a newly implemented Department of Labor rule says financial advisers suggesting the move have some explaining to do. 

Retirement Tip of the Week: If you work with a financial adviser and they are suggesting you do an IRA rollover, a rule made enforceable July 1 says the reason must be in writing. Make sure you get that document, for your sake as well as your adviser’s. 

The key components of the rule are to review in depth then explain how this rollover best serves the client. Many financial advisers may already be doing this for their clients if they are fiduciaries, which means they are required to work in their clients’ best interests ahead of their own financial gain, but the DOL now requires it. 

The rule, known as the prohibited transaction exemption 2020-02,was passed in December 2020 and went into effect in 2021, though enforcement did not begin until February 2022. Under the rule, a recommendation for a rollover from an employer-sponsored plan to an IRA is considered a prohibited transaction if the move is not in the client’s best interest and the adviser receives compensation for it.

See: Watch out — this one mistake could cost you thousands when you rollover your 401(k) to an IRA

The mission behind this new rule is to protect investors from rolling money over from one account to another for the wrong reasons, such as a financial adviser’s monetary gain for the transfer. An extensive review, and explanation of the recommendation, will clearly outline to investors why a rollover is in their best interest – and keeps advisers and clients on the same page. 

“Rollover recommendations are a primary concern of the Department, as financial services providers often have a strong economic incentive to recommend that retirement investors roll assets out of ERISA-protected plans into one of their institution’s IRAs,” the DOL said in an April 2021 breakdown of the rule. “The decision to roll over assets from a plan to an IRA is often the single most important financial decision a plan participant makes, involving a lifetime of retirement savings.” 

Have a question about your own retirement concerns? Check out MarketWatch’s column “Help Me Retire”

For 401(k) to IRA rollovers, advisers will have to consider the alternatives to an IRA (such as leaving the money in the workplace plan), a cost comparison for both accounts, if the employer pays for any of the administrative expenses and the different types of investments, or services, provided in either account, the DOL said. Advisers will have to do extensive data gathering, including from the client as well as alternative sources, to clearly explain why this move is a good one. 

For rollovers from one IRA to another, or from a commission-based account to a fee-based one, the recommendation letter must explain the services to be provided from the new account and the long-term costs of the move, as well as “economically significant” investment features, the agency said. 

The rule applies to any registered investment advisers who offer fiduciary advice to retirement investors.

About $534 billion was rolled over from employer-sponsored plans to IRAs in 2018, according to Internal Revenue Service data cited in the Investment Company’s 2021 Fact Book. Comparatively, $70 billion was contributed to these accounts that year. 

Rollovers from an old workplace plan to an IRA can make a lot of sense. If there’s not a lot of money in the 401(k), but the individual no longer works at that job, she can roll the assets into an IRA and then continue to contribute to it so that it grows more (when people leave their jobs, they can’t keep contributing to their old 401(k) plans).  

Want more actionable tips for your retirement savings journey? Read MarketWatch’s “Retirement Hacks” column

Some people may choose to do a rollover because the fees are lower at the new account than the old one. Another reason: investment options. Investors may find they have better choices in an IRA, or a new IRA if they already have one, than their 401(k) or old account, though determining that will take a bit more research and may also depend on the investor’s needs. 

In other scenarios, keeping money in a workplace plan may be a better choice, especially for workers still at the companies offering the 401(k) plan. Aside from potentially lower fees and superior investment choices, those with active 401(k) plans may be entitled to employer matches to their contributions. These workplace plans come with other benefits, such as more stringent protection against creditors. Former employees will have to check with their companies’ rules about whether or not they can remain in the plan after they’ve left. 

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American Weed Stocks Are Cheap. They’re About to Get a Sales Bump.

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However bad the year has been for most stocks, it has been especially harsh for state-licensed cannabis sellers.

In just the past month, the


AdvisorShares Pure US Cannabis


exchange-traded fund (ticker: MSOS), which tracks America’s multistate operators—or MSOs—fell 25%, while the


S&P 500


dropped 7%.

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How Do Mega Backdoor Roths Work?

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A mega backdoor Roth is a unique 401(k) rollover strategy that’s designed for people whose incomes would ordinarily keep them from saving in a Roth Individual Retirement Account. The advantage of using a Roth IRA to save for retirement is being able to make tax-free qualified withdrawals. But not everyone can contribute to these accounts; higher-income earners are excluded. That’s where the mega backdoor Roth comes into play. If you have a 401(k) you’d like to roll over, you could use this strategy to enjoy the tax benefits of a Roth IRA without having income be an obstacle.

Make sure you’re taking advantage of every opportunity to maximize your retirement assets by working with a financial advisor.

Roth Account Basics

Before diving into the specifics of a mega backdoor Roth, there are a few things to know about Roth accounts, including Roth IRAs and Roth 401(k)s.

First, these accounts are both funded with after-tax dollars. That means when you make qualified withdrawals later, you won’t pay income tax on the money since you already paid it upfront. This is the key characteristic of Roth accounts and what makes them so appealing to investors who anticipate being in a higher tax bracket at retirement.

Next, your ability to contribute to a Roth 401(k) is not restricted by your income. But it is for a Roth IRA. For the 2021 tax year, you must be within these modified adjusted gross income limits to make a full Roth IRA contribution:

  • Single filers: MAGI of $125,000 or less

  • Married filing jointly: MAGI of $198,000 or less

  • Head of household: MAGI of $125,000 or less

You can make partial contributions above those income limits. But your ability to contribute phases out completely once your MAGI hits $140,000 (if you file single or head of household) or $208,000 if you’re married and file a joint return. For 2021, the full contribution allowed is $6,000 with a $1,000 catch-up contribution for savers aged 50 and older.

Finally, Roth 401(k) accounts are subject to required minimum distribution rules just like traditional 401(k) accounts. This rule requires you to begin taking money from your 401(k) starting at age 72. A Roth IRA, on the other hand, is not subject to RMD rules.

What Is a Backdoor Roth?

A backdoor Roth offers a work-around for people whose incomes are above the limits set by the IRS. When you execute a backdoor Roth, you roll money over from a traditional IRA to a Roth account. This way, you won’t have to pay taxes on your retirement savings in the Roth IRA when it’s time to make withdrawals. And you’re not subject to required minimum distribution rules either.

But there is a catch. You have to pay income tax on the money you roll over to a Roth account. So while you could save money on taxes in retirement, you’re not escaping the tax liability of a traditional IRA altogether.

How a Mega Backdoor Roth Works

A mega backdoor Roth is a backdoor Roth that’s designed specifically for people who have a 401(k) plan at work. This type of backdoor Roth allows you to contribute up to $38,500 to a Roth IRA or a Roth 401(k) in 2021. This is in addition to the regular annual contribution limits the IRS allows for these types of accounts. To execute a mega backdoor Roth, two conditions have to be met. Your 401(k) plan needs to allow the following:

You can ask your plan administrator whether your 401(k) meets these criteria. And if your plan doesn’t allow for in-service withdrawals or distributions, you could still attempt a mega backdoor Roth if you plan to leave your job in the near future.

If your plan meets the criteria, then you can take the next steps to execute a mega backdoor Roth. This is typically a two-step process that involves maxing out after-tax 401(k) contributions, then withdrawing the after-tax portion of your account to a Roth IRA.

Again, whether you can follow through on the second step depends on whether your plan allows in-service withdrawals. If it doesn’t, you’ll have to wait until you separate from your employer to roll over any after-tax money in your 401(k) into a Roth IRA.

You also need to watch out for the pro rata rule. This IRS rule says you can’t only withdraw pre- or post-tax contributions from a traditional 401(k). So if you’re completing a mega backdoor Roth, you couldn’t just withdraw post-tax contributions if your account holds both pre- and post-tax funds. In that case, you may have to roll over the entire balance to a Roth IRA.

Benefits of a Mega Backdoor Roth

There are three key benefits associated with executing a mega backdoor Roth. First, you can contribute significantly more to a Roth IRA upfront this way. For 2021, the contribution limit is $38,500 on top of the regular annual contribution limit and any catch-up contribution limits that may apply.

You’ll need to know the maximum amount you’re allowed to contribute to the after-tax portion of your 401(k). So for 2021, the IRS allows a maximum contribution of $58,000 or $64,500 if you’re 50 or older. You’d subtract your 401(k) contributions and anything your employer adds in matching contributions to figure out how much you could add to the after-tax portion.

Next, you can enjoy tax-free withdrawals in retirement. This is a benefit you may otherwise not being able to get if your income is too high to contribute to a Roth IRA. By reducing your tax liability in retirement, you can help your investment dollars go further. And you may have a larger legacy of wealth to pass on to future generations.

Finally, a mega backdoor Roth IRA would allow you to sidestep required minimum distribution rules. This means that you could retain control over when you choose to take distributions from a Roth IRA.

So who is a mega backdoor Roth right for? You may consider this move if you:

  • Have an eligible 401(k) plan at work

  • Have maxed out traditional 401(k) contributions

  • Are not eligible to contribute to a Roth IRA because of your income

  • Have additional money that you want to invest for retirement

  • Want to leverage the higher Roth IRA contribution limits allowed by a mega backdoor rollover

Talking to your financial advisor can help you decide if a mega backdoor Roth makes sense. And your 401(k) plan administrator should be able to tell you if it’s possible, based on your plan’s guidelines.

Mega Backdoor Roth Alternatives

If you can’t execute a mega backdoor Roth because your plan doesn’t allow it, there are other ways to increase your retirement savings. For example, you could try a regular backdoor Roth instead. This might be something to consider if you still want to enjoy the tax benefits of a Roth IRA but your plan doesn’t fit the criteria for a mega rollover. You could also elect to make Roth 401(k) contributions to your retirement plan at work. This way, you still get the benefit of contributing after-tax dollars and making tax-free withdrawals. You’d be subject to the regular contribution limits and you’d still have to take the required minimum distribution. But that may outweigh the value of tax savings in retirement.

Investing in a Health Savings Account (HSA) is another option. While these accounts are not specifically designed for retirement, they can yield multiple tax benefits. Contributions are tax-deductible and grow tax-deferred. Withdrawals are tax-free when used for eligible healthcare expenses. And at 65, you can take money out of an HSA for any reason without a tax penalty. You’ll just owe ordinary income tax on any withdrawals that are not used for healthcare expenses.

Finally, you could open a taxable brokerage account to invest. This doesn’t necessarily save you money on taxes since you’ll owe capital gains tax when you sell investments at a profit. But it could help you to diversify your investments and there are no limits on how much you can invest in a brokerage account annually.

Bottom Line

A mega backdoor Roth strategy could work well for higher-income earners who want to take advantage of Roth account benefits. There are certain rules that need to be followed to make it work, however, so you may want to talk to your plan administrator or a tax professional before going ahead. Keep in mind also that even if you can’t complete a mega backdoor Roth rollover, you still have other options for growing retirement savings.

Tips for Retirement Planning

  • If you’re saving for retirement in a 401(k) or IRA, pay attention to the fees you’re paying. For instance, check the expense ratios for each fund you’re invested in to understand how much you pay to own that fund on an annual basis. You can then compare that to the fund’s performance to determine whether the fees are justified. Also, consider any administrative fees you might be paying and how those affect your net returns.

  • Consider talking to your financial advisor about a mega backdoor Roth and whether it could be right for you. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors in your local area. You can get your personalized recommendations in minutes just by answering a few simple questions. If you’re ready, get started now.

Photo credit: ©iStock.com/designer491

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Alibaba Is Tumbling. Chinese Tech Stocks Have a New Headache.

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Chinese tech stocks were tumbling on Monday as two of the embattled sector’s leading players faced fresh fines from market regulators over disclosure rules.

China’s State Administration for Market Regulation announced Sunday a wave of penalties for improperly reporting past deals, in breach of competition law.


Alibaba


(ticker: BABA) and


Tencent


(0700.H.K.) were among the companies fined as a result.

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