Question: I am a 26-year-old pharmacist earning approximately $100,000 a year — take home pay is about $5600 a month — living in St. Louis. I contribute 4% to my employer 401l(k), which is the maximum match. I currently have about $25,000 in my savings account for emergency funds. My rent is $850/month that I split with my girlfriend, and I do not have a car payment or credit card debt. But I graduated with $148,000 in total student loans with an average interest rate of about 5-6% (though still in the interest-free period). I have been paying $4,000 per month since graduating to get the total down to $113,000 currently. I want to start saving for a down payment on a house, so I have recently decreased my student loan payment down to $2,000/month and have been putting $1,000/month in a taxable investment account and $500/month into a Roth IRA since mid March 2022. But with the recent troubles of the stock market, I have already lost some money.
I feel like the economy is declining and the housing market is in trouble, so I’m wondering if I’m doing things right? Should I keep renting instead of worrying about saving for a home at this point and just keep putting $4,000 month in loans until they’re gone? Most of my friends and family say I’m “rich” because I make six figures, but I do not feel that way given all the debt and no money saved for a home.
Answer: It sounds like you’re feeling stressed about money and questioning your decisions, so we asked financial advisers and money pros what you’re doing right and what you might want to change. And then we dive into whether it’s a good idea for you to consider a financial adviser to help you out. (Looking to hire a financial adviser? You can use this tool to get matched with an adviser who might meet your needs.)
First things first though: The reason things might feel tight is because you’re a strong saver, and for that, you deserve to be commended. However, it is important to prioritize, particularly around your personal goals.
“I would base your savings rate towards a home, and how much you can temporarily divert from the student loan debt towards a home, on how much you think the home will cost,” says Joe Favorito, certified financial planner at Landmark Wealth Management. If you believe it will cost $500,000 to buy the home you want, you’d want to put down at least 20% to avoid mortgage insurance, which means you’d need to save about $100,000 over and above your emergency fund. That’s about $2,777 per month for three years with no earnings. “Then, you want at least an additional six months of emergency funds based on what your cost of living will be when you own a home, factoring in taxes, insurance, utilities and food,” says Favorito. Ultimately, it probably does pay to redirect some of the student loan money temporarily, but as your income grows, you can always pay additional principal says Favorito. “Once you’ve secured a down payment, target at least 10% of your gross income to retirement accounts on a consistent basis,” says Favorito.(Of course, once student loan payments resume, always pay the minimum amount due.)
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But should you even be saving for a house? Well, that depends. It may feel hard to prioritize securing a long-term residence, and a home isn’t always the best investment due to the carrying costs over time. “While renting is something that might allow you to live with a positive cash flow, if your goal is to be married and raise a family, a home is a much more practical solution,” says Favorito. “Once you’ve got a fixed mortgage in place and your income grows over time, you’ll be able to catch up to some of the other savings and debt reduction goals.” That said, any money saved towards a home should be invested in cash-like investments like money markets, CDs or ultra-short term bond funds, not in anything that would introduce volatility, unless your home purchase is 7-10 years down the road.
And you may want to look at paying down your student loan like this: It’s basically equivalent to buying an investment with a guaranteed return equal to the interest rate, because they would each have about the same impact on your cash flows, says certified financial planner Eric Figueroa of Hesperian Wealth. “I can’t predict the future, but high and rising inflation, high stock market valuation, negative stock market momentum, rising recession risk and rising interest rates together seem to confirm your suspicions that the outlook for stock and bond returns is poor,” says Figueroa. Pros say, this could mean it may be a better idea to focus on paying student loan debt rather than bolstering retirement savings beyond what you already do (the match is worth getting after all). That said, with such a positive cash flow, it might be worth considering a refinance of your student loans.
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Furthermore, while interest rates are still frozen on student loans, this may be the perfect time to maintain your regular payment because all of it will come out of the principal. “If you can afford it, this is the only time you can eat into principal [soley] by just making your regular payment which will accelerate your savings,” says Figueroa.
It’s also important to understand that when you’re invested in the market, you will sustain losses at some point, and at your age, your retirement accounts should have a growth orientation. “This means a broadly diversified allocation of at least 70% in the stock market. Don’t let market volatility scare you as it pertains to long-term investing in things like your 401(k) and Roth IRAs, markets are very unpredictable in the short-term, but statistically pretty consistent in the longer-term,” says Favorito. And while it’s hard to do, Figueroa says try your best to ignore your Roth IRAs performance until you need it many decades from now. “Just keep investing in long-term assets regularly over time. You don’t need the money anytime soon, so put the money to work,” says Figueroa.
Should you hire a financial adviser to help you?
Maybe. Pros say, in your case, a flat-fee adviser (some advisers charge a flat annual retainer fee that is generally in the range of $2,000 to $7,500) or an hourly fee adviser (hourly rates are roughly $200-$400 an hour often) could be a good bet. These types of advisers could walk you through volatility, present your spending and saving priorities in a cohesive manner and develop a financial plan you could follow. (Looking to hire a financial adviser? You can use this tool to get matched with an adviser who might meet your needs.)
“An hourly or retainer-based adviser can help you set up your savings plan and put your strategy in place on more of a project basis. A retainer-fee adviser can help you set up your plan and assist with ongoing monitoring and management,” says Zack Hubbard of Greenspring Advisors. Here’s what an hourly financial adviser might cost, and here are the question you should ask any adbier you might want to hire.
Ultimately, it’s up to you. Some investors love the help of a professional, especially during times of market volatility or when they have a lot of competing financial demands, and some find that they can do it alone. Here’s what to ask an adviser you might want to hire.
- Questions edited for brevity and clarity
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American Weed Stocks Are Cheap. They’re About to Get a Sales Bump.
How Do Mega Backdoor Roths Work?
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.
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
Alibaba Is Tumbling. Chinese Tech Stocks Have a New Headache.
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.
(ticker: BABA) and
(0700.H.K.) were among the companies fined as a result.
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