The Federal Reserve wasn’t a fan. As the pandemic housing boom raged along, it pushed up prices across the economy. Higher home prices pushed up rents. Elevated homebuilding levels—which hit a 15-year high during the pandemic—put upward price pressure on everything from windows to lumber while also adding stress to an already stressed global supply chain. Not to mention, cash flowed into the economy from homeowners who tapped into that record home equity.
That’s why the central bank, who has a mandate from Congress to tackle runaway inflation, has targeted the U.S. housing market. How? It put immense upward pressure on mortgage rates. While the Fed doesn’t directly set mortgage rates, it has the levers to see that financial markets do so. Once the Fed made it clear this year what lay ahead for monetary tightening, markets quickly pushed the average 30-year fixed mortgage rate above 5%.
In June, Fed Chair Jerome Powell finally made it clear this is all by design. Powell would like to see the U.S. housing market return to a more balanced state. In his own words, he calls it a “reset.”
“I’d say if you are a homebuyer, somebody or a young person looking to buy a home, you need a bit of a reset. We need to get back to a place where supply and demand are back together and where inflation is down low again, and mortgage rates are low again,” Powell told reporters last month. “We saw [home] prices moving up very, very strongly for the last couple of years. So that changes now. And rates have moved up. We are well aware that mortgage rates have moved up a lot. And you are seeing a changing housing market. We are watching it to see what will happen. How much will it really affect residential investment? Not really sure. How much will it affect housing prices? Not really sure.”
Already, spiking mortgage rates have pushed the U.S. housing market into cool-down mode. As April and May housing data trickled in, it became clear the pandemic housing boom was fizzling out. In June and July, the pace of the cooling picked up.
To find evidence of the accelerated rate of cooling, just look at inventory data. Among the nation’s 100 largest housing markets, the median market saw inventory rise 1% between January and April, according to Fortune‘s analysis of realtor.com data. That was before spiking mortgage rates kicked off the housing correction. Among those same 100 largest housing markets, the median market saw inventory rise 50% between April and June.
Across the country, the U.S. housing market is slowing. Mortgage applications are down 17% on a year-over-year basis, according to the Mortgage Bankers Association. New home sales and existing home sales are falling sharply. Homebuilding has slowed. And more home sellers are slashing their list price.
That said, this housing correction—or as Fortune calls it, the Great Deceleration—is hardly uniform across the country. It has hit Southwest, Mountain West, and West Coast housing markets particularly hard. Among the 10 housing markets that have seen inventory levels rise the most this year, every single one is located in those regions. That group is led by Sherman, Tex. (+332% inventory); San Francisco (+285%); Santa Fe (+272%); Denver (+247%); and Austin (+220%).
The reason? Across the nation, the pandemic housing boom saw home prices become detached from underlying economic fundamentals. That detachment has been even more pronounced in markets across the Southwest, Mountain West, and West Coast. Now that mortgage rates are above 5%, buyers in those “overvalued” markets are feeling particularly squeezed. Some would-be buyers are choosing to remain on the sidelines. Others simply can’t afford a mortgage at a 5% rate.
Heading into the year, Logan Mohtashami, lead analyst at HousingWire, was already clamoring for higher mortgage rates. His thinking was that higher mortgage rates would be the only way to sideline buyers and allow inventory breathing room to climb to a healthier level. So far, Mohtashami likes what he’s seeing.
“We still have some work to do to get a balanced market. However, with higher rates, we have a shot to get back to peak inventory levels in 2019, which is a balanced market,” Mohtashami says. “All my inventory issues go away once we are back to 2019 levels, and only then can I remove the savagely unhealthy housing market theme.”
While inventory is rising quickly, it still remains far below pre-pandemic levels: Among the 917 regional housing markets measured by realtor.com, 601 markets are still at least 50% below their pre-pandemic level. Mohtashami wants to see that gap close.
For months, Moody’s Analytics chief economist Mark Zandi has been calling this slowing a “housing correction.” He doesn’t see it stopping this year. Through the summer, he expects home sales to continue falling. By this time next year, Zandi expects year-over-year home price growth to slow to 0%. That’d be quite the deceleration considering that the latest reading sits at 20.4%.
But not every housing market will be so lucky. The pandemic housing boom saw markets like Phoenix, Boise, and Las Vegas become what Moody’s Analytics deems significantly “overvalued.” Now they’re at risk of a price correction. As inventory in those places continues marching upward, Zandi predicts those significantly “overvalued” markets will see home prices fall by 5% to 10%. But if a recession actually materializes, Moody’s Analytics predicts U.S. home prices would fall by 5% while significantly “overvalued” markets, like Charlotte and Tampa, would see home prices fall by 15% to 20%.
This story was originally featured on Fortune.com
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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