Joe Anderson
ABOUT Joseph

As CEO and President, Joe Anderson has created a unique, ambitious business model utilizing advanced service, training, sales, and marketing strategies to grow Pure Financial Advisors into the trustworthy, client-focused company it is today. Pure Financial, a Registered Investment Advisor (RIA), was ranked 15 out of 100 top ETF Power Users by RIA channel (2023), was [...]

Alan Clopine

Alan Clopine is the Executive Chairman of Pure Financial Advisors, LLC (Pure). He has been an executive leader of the Company for over a decade, including CFO, CEO, and Chairman. Alan joined the firm in 2008, about one year after it was established. In his tenure at Pure, the firm has grown from approximately $50 [...]

Andi Last

Andi Last brings over 30 years of broadcasting, media, and marketing experience to Pure Financial Advisors. She is the producer of the Your Money, Your Wealth® podcast, radio show, and TV show and manages the firm's YouTube channels. Prior to joining Pure, Andi was Media Operations Manager for a San Diego-based financial services firm with [...]

Published On
April 16, 2024

Are there ever times when going all Roth isn’t the best strategy for your retirement savings? How do you determine the break-even point on doing Roth conversions? Joe and Big Al spitball on marginal vs. effective tax rates for Joseph Allen, saving to after-tax brokerage or pre-tax 403(b) for Gigi in Illinois, the arithmetic of Roth conversions for Carl Spackler in Florida, and the mega backdoor Roth for Jefe in Texas. For something completely different, we’ll wrap it up with a discussion of tax forms that need to be filed for your solo 401(k) depending on the account balance, for Smitty in The Villages. 

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Show Notes

  • (00:44) Marginal Vs. Effective Tax Rate: Going All Roth Isn’t the Best Strategy? (Joseph Allen, Wichita, KS)
  • (15:37) I’m 43 and Will Have $2.4M in Retirement. Should I Save to After Tax Brokerage or Pre-Tax 403(b)? (Gigi, IL)
  • (23:17) Is There a Break-Even Calculation for Roth Conversions? (Carl Spackler, FL)
  • (30:38) Mega Backdoor Roth: Must I Convert Traditional IRA When I Roll After-Tax Money? (Jefe, TX)
  • (36:29) Must I File Form 5500-EZ If Solo 401(k) Had No Balance at Year-End? (Smitty, The Villages)
  • (42:18) The Derails

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Andi: Are there ever times when going all Roth isn’t the best strategy? How do you determine the break-even point on doing Roth conversions? That’s today on Your Money, Your Wealth® podcast number 477, as Joe and Big Al spitball on marginal vs. effective tax rates for Joseph Allen, saving to after-tax brokerage or pre-tax 403(b) for Gigi in Illinois, the arithmetic of Roth conversions for Carl Spackler in Florida, and the mega backdoor Roth for Jefe in Texas. For something completely different, we’ll wrap it up with a discussion of tax forms that need to be filed for your solo 401(k) depending on the account balance, for Smitty in The Villages. I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.

Marginal Vs. Effective Tax Rate: Going All Roth Isn’t the Best Strategy? (Joseph Allen, Wichita, KS)

Joe: All right, here we go. We got “Dear Roth Brothers. Your friend Joseph Allen. Joseph Allen. Is he your friend? You know Joe?

Al: You know, it’s a great name. Joseph and Allen.

Joe: Yep. Wow.

Andi: That’s his point here

Joe: Oh. Then here we go. You didn’t pick up that name last time. I wrote it in.

Al: I guess we should keep reading.

Joe: You can tell we are really prepared here. “I sometimes dabble in other personal finance podcasts and came across one that made me a little angry recently as a firm Roth believer. They said the podcast was trying to showcase why going all Roth isn’t the best strategy.” All right. “Their argument is that maxing out a traditional 401(k) will end up giving you more money in retirement than maxing out a Roth 401(k) because it results in more net investable dollars. This results in more returns because you are investing pre-tax and then investing what the tax savings are elsewhere. The argument also rests in its case, saying that you currently pay the marginal tax rate as a working human, but then in retirement, you’ll be paying the effective tax rate, which will always be lower. Therefore, Roth is not essential because the taxes you pay in retirement will always be lower.”

Al: Yeah, when there’s words always and never, you know, it’s a little flawed. I mean, that does happen.

Joe: The argument rests, he’s saying, all right, well, you’re currently paying the marginal rate as a working human. You’re still paying the effective rate as a working human.

Al: Yeah, but basically they’re implying you’d be in a lower tax bracket in retirement. You’ll have more dollars because you’re paying less tax. Even though you still have to pay tax, you’re paying tax at a lower rate. This also presumes you’re saving the tax savings, which almost nobody does.

Joe: But he’s saying effective rate versus marginal rate. So when you’re working, you’re at the marginal rate, but when you’re retired, you’re going to just calculate your effective rate.

Al: Well, yeah, but that’s false. Yes, you’re right it’s a marginal rate in both cases.

Joe: Or effective rate in both cases.

Al: Or however you want to compare it, it should be apples to apples. But I think the point they’re making is that many people, even most, would be in a lower bracket.

Joe: I would agree with that 1000%. Most people will be in a lower tax bracket because most people haven’t saved.

Al: Correct.

Joe: All right. I’ll read on. Okay. “I’ve been listening to your podcast for a while and I like it much better than the other one I’m referring to.”

Al: I wonder which one it is?

Joe: Well, your name’s Joseph Allen.

Al: Yeah, right.

Joe: “And I don’t recall this argument ever being brought up. Some assumptions they make with this argument is that the person will retire before 59 1⁄2 and the person is a high earner and a high saver and they Must invest what the tax savings are in a pre-tax contribution. Obviously, if you spend the money that is saved, this doesn’t work. The analysis also uses a 4% withdrawal rate. So, as my wife and I both max out our Roth IRAs and contribute to Roth 401(k)s and are doing backdoor Roths because we don’t want to deal with the taxes in retirement and plan on retiring at age 55, does this argument have legs? This podcast ran numbers and seemed to have data to back up what you would end up with more money maxing out traditional 401(k)s than a Roth 401(k). Obviously they used a lot of assumptions and made up numbers and they didn’t add up to me. What are your thoughts about marginal and effective tax rates in retirement? Wife and I make a combined $140,000 a year and have around $106,000 combined in Roth IRAs. $40,000 in a rollover IRA that we are backdooring to those Roth accounts.” It means converting. “$46,000 in a brokerage account, $72,000 in cash. We spend around $32,000 a year and save and invest the rest. I’m 30, she’s 28. We also bought a house at the end of the year for about $300,000 and still owe $240,000 on it. Are we wrong in going all Roth? Should we contribute to traditional 401(k)s instead of Roth 401(k)s? A little ice cold Keystone Light!”

Al: Okay.

Joe: Oh, man. This guy is after my own heart.

Andi: This gets Joe so excited.

Joe: I love Keystone Light.

Al: You can picture that, right?

Joe: Oh, yeah. “Is my drink of choice.” Where does this guy live? “And my wife likes a good little vodka and Fresca.” Oh, when’s the last time you had a Fresca?

Al: It’s been quite some time.

Joe: “I drive a GMC Canyon and she drives a Hyundai Tucson.

Al: Tucson.

Joe: All right. “Thanks for all you do. Your podcast is the best out there.” Thank you, Joseph Allen.

Al: That’s very nice.

Joe: Yeah. She drinks Fresca and he’s drinking Keystone Light.

Andi: I’m sorry. I should have mentioned he’s in Wichita, Kansas.

Joe: Oh, there you go.

Al: Oh, it’s Kansas.

Joe: The flyover state.

Al: Flyover state. That’s what you call it? Got it.

Joe: Okay. So let’s break this down. Couple of things here given his income. First off, don’t listen to any other podcast.

Andi: Oh Wow.

Al: I disagree with that. You gotta listen to all sides.

Joe: I’m kidding, I think what you’re doing is right on. First of all, the marginal and effective rate. Let’s explain that first.

Al: Okay, so the effective rate is your blended rate. So in other words, you look at the taxes you paid, divide that into taxable income, that’s your effective rate.

Joe: So I made $100,000, I paid $10,000 in tax, my effective tax rate is 10%.

Al: 10%. Exactly right. Yep. 10%. That’s your effective rate. That’s blended. Let’s actually say your taxes are 20%. That would be more realistic so we can do the numbers right. So 20%, $20,000 you’ve made $100,000, 20% is your effective rate. But when you look at your income, you’re actually in the 24% bracket and that’s what’s called the marginal rate. There’s a 10% bracket, 15, 22, 24. Let’s just say you’re in the 22% bracket, just to come up with that. So in other words, some of your taxes were in the 10%, some were in the 15%, some were 22%,

Joe: 12%.

Al: 12%, Wow you’re right. Wow, I am tired today. Some were 22%, but they blend out to 20%, right? So that’s the effective rate. But what’s important when you’re talking about a Roth conversion is how much tax do you pay if you have more income? So that’s why marginal rate is important. The highest rate, that’s what you always use in this comparison.

Joe: I’ll just go with that. Okay. All right. So you’ll have an effective rate in retirement and you’ll also have a marginal rate in retirement. So if they’re comparing, well, you’re only going to pay the effective rate in retirement and not the marginal rate, they’re just playing with words here.
Second of all, so let’s say you have to think of it like this. You save $100,000, and you save it pre-tax, and that $100,000 grows, but you save, let’s just assume 25%, so $100,000 goes into the old 401(k) plan, and then you didn’t have to, it’s pre-tax, so you saved $25,000, so that $25,000 of tax savings is what they’re saying that you must save. Great. So then you put that $25,000 in a brokerage account. That brokerage account is going to have the same rate of return as your 401(k). So the $100,000, let’s say grows to $1 million. All right. Then that $25,000 is gonna grow to $250,000. That’s the same rate of return over the same time frame. Then you look at your statement and it’s like, Al, I got $1,250,000. I’m killing it. I have so much more money. All you Rothers, what did he call them? Roth brothers. You’re not getting that $25,000 savings. So you’re going to put $100,000 into your Roth plan, but you don’t get the $25,000 of savings, so you have no side account that is going to grow.

Al: Right.

Joe: So you’re comparing the $100,000 that is growing versus the pre-tax person that has $100,000 plus $25,000. On the surface, you would think, well, I would much rather have $125,000 all day growing for me because I’m going to have $1.25 million at retirement. That $100,000 grows to $1 million. Well, this is a no brainer, isn’t it?

Al: Yeah, you’re right, you’re comparing apples and oranges. The 401(k) IRA, you have to pay taxes when you pull that money out. Once you finish your example then I’m going to make mine.

Joe: What they’re missing is that, all right, that $1 million that I have to pull out, I have to pay taxes on it, right? So I pulled the money out. Let’s just assume the same tax rate. It’s 25%. So I pulled the $1 million out. I gotta pay $250,000 of taxes. And so I take the $250,000 that I saved in my brokerage account to pay the taxes to get my equal $1 million. So it’s exactly the same.

Al: You end up in the same spot.

Joe: But if I’m in the Roth, I could name 10 things that’ll be better if it’s in the Roth.

Al: Yeah, so here’s how I’m going to say it, without going through an example. I’ve run this a million times. If you are in the same tax bracket, you end up with the same amount of dollars. Same, same, same, same. But hardly, people usually are not in the same tax brackets, and there’s all kinds of other variables, just like you mentioned. So the first thing I would say is, most people, when they Put the money into the 401(k), the IRA to get a tax deduction. They do not save the tax savings.

Joe: This example said you must save it, but no one does.

Al: They spend it. So right off the bat, that’s a faulty assumption because it’s hardly ever followed. So that’s number one. Here’s another thing that is missed all the time. Let’s say you have money in a Roth and money in an IRA. And having that balance, maybe you can put your asset classes that have higher expected long term returns, like stocks, in the Roth. And maybe you put your lower expected asset growth, like bonds, maybe in your regular IRA. So yes, the stocks are more volatile. You’re gonna have years where you’re happy in the Roth and years where you’re not. But if you look out 20, 30, 40 years, you’ll be likely very happy with the stocks and the Roth. You’ll end up with a lot more because none of that is taxed.

Joe: You will also have a lot more flexibility. If everything is in your pre-tax account, I don’t know where tax rates are going to go. So you’re taking the uncertainty of taxes off the table. If you believe tax rates are going to go lower, then they go pre-tax all day long. This guy’s 30 some years old and he’s saving a ton of money. If he saved all in the pre-tax accounts. He might be in the same tax bracket or higher. You have to run the projections. Even if he was going to be in a little bit lower tax bracket, does he have the discipline to save the tax savings? If he does, well then that might be an argument.

Al: Right. Well, and here’s another factor. When you’re in your 30s, on average, you make less than when you’re, let’s say, 50, for example. So in your 30s, you know, if you kind of follow the norms, why wouldn’t you put almost all your money, if not all, in Roth? Knowing that you’re going to be in higher tax brackets later in your higher earning years. Yeah, maybe you can get a little bit more balance in, but certainly when you’re younger, I would do Roth all the time, just because of the potential higher tax brackets in the future as your salary goes up.

Joe: I want the uncertainty of taxes off the table. Alan is a CPA, so he wants to run and crunch the numbers to the penny, and I get that, and that’s why he’s my partner. But when you look at real life, And as you’re saving, out of sight, out of mind, I would just keep plowing as much money into a tax-free environment as possible. Because when you look at your balance of that $1 million in your 401(k) plan, and it’s the Roth 401(k), you’re going to say that money is all mine. I’m not a partner with the IRS here. It’s all mine. If I have money in a 401(k) plan that was pre-taxed and it’s $1 million, I’m going to be like, man, I gotta pay the piper. I gotta pay the toll for taking some of this money out. I’m not saying go 100% Roth. That’s not what I’m saying. I want you to be diversified. I want you to have money in a pre-tax account. I want you to have money in a Roth account. I want you to have money in a brokerage account to give you the most flexibility, in control over your taxes long term. So it really depends on what your tax bracket is today, how much money that you’re saving, when you want to retire and blah, blah, blah. That’s what strategy and planning is all about. But just off the surface, I think you need to do a lot more analysis on your specific situation before you kind of make these decisions.

Al: When you hear different people talking about things, if they use words like always and never, it’s pretty much always and never correct. I will say that’s when you can use that. There’s lots of examples where you shouldn’t do Roth, like let’s say you’re 64 years old, you’re making a ton of money, you’re going to retire the following year, you’re in the highest tax bracket, and then 65 to 75, before your RMD, you can do lots of Roth conversions in much lower brackets. Why not get the tax deduction right now? There’s a lot of ways. There’s a lot of times when you shouldn’t do Roth, but you just, you wouldn’t never say always and never. It makes a lot of sense to have the balance.

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I’m 43 and Will Have $2.4M in Retirement. Should I Save to After Tax Brokerage or Pre-Tax 403(b)? (Gigi, IL)

Joe: Gigi from Illinois writes in, she goes, “Hey, Andi, Joe, Big Al, quick question. I’m a high earner, diligent saver. Would it make more sense to contribute to an after-tax brokerage account or max out my pre tax 403(b)? We already maxed out the Roth 401(k) and Roth 457. Assuming the money grows for 20 years, would I be better off using a brokerage account and paying capital gains or paying ordinary income tax on the RMDs on my 403(b)?” Similar question here.

Al: Yeah, very similar. Okay.

Joe: She drives a Tesla and a 1991 mini truck, “my hubby drives a Ram, and for the record our truck beds are the same size. Drinks, IPA for him, Porter for me and a little red wine for the both of us.” Alright, details. Let’s get into the details. “Here’s our income, $400,000. Ages, 43. Side hustle, $120,000.” Alright, that’s a pretty good side hustle. “Expenses $10,000 a month. So they want to spend $120,000 a year in retirement. 401(k) $675,000, 10% Roth maxing out. 403(b) $320,000; $457,000; $220,000 plus another $40,000 in Roth. Pension is going to be $8,300 a month. Social Security, $1,500. His Social Security $3,500 combined 401(k) rollovers is $300,000, combined Roths is $135,000 and another brokerage account of about $500,000. Yes. We save more than $114,000 a year.” You go, Gigi.

Al: That’s fantastic.

Joe: Adding all this stuff up, I get like a couple million bucks.

Al: Yeah, I get a little bit more $2.4 million.

Joe: Okay, $2.4 million sounds good. “Most of that is in pre tax. $200,000 roughly in Roth, $500,000 in after tax. Outstanding debt, a little tractor loan.” Oh, I suppose if you have a tractor loan, that’s why you need a mini truck.

Al: I think so.

Joe: Yep, “20%. 2 ½ years remaining. Got a couple kids, ages 14 and 11. And let’s see, $45,000, plan to sell house one.” Okay, so, Gigi’s asking here, should we save more into the brokerage account, or should we continue to put money into a pretax account? They want to retire in 20 years, they’re 43 and they got $2.5 million. They want to spend $10,000 a month, Alan.

Al: Sure.

Joe: She’s going to have a pension of $100,000 a year. So $10,000 a month in 20 years, what, it’s going to be $200,000 a year in living expenses?

Al: Yeah, probably. And not only a pension for $100,000, but you add social security, that’s another $60,000, just right there in today’s numbers.

Joe: Right, in today’s numbers. Their fixed income is going to be pretty close to their living expenses.

Al: Yeah, and given, well I don’t know what the assumptions are here, but it may be about the same.

Joe: Right. And so they got $1.5 million already in retirement accounts at 43 years old. And they’re totally maxing out all these plans, saving $100,000 a year. Should they go brokerage or continue to go pre tax? They’re already maxing out the Roth options. So after the Roth options, should they continue to go pre tax or should they go brokerage?

Al: What do you think?

Joe: You already know what I’m gonna say.

Al: You’re gonna say brokerage.

Joe: I’m going to say brokerage account.

Al: I’m going to say let’s do some of each. You start with yours.

Joe: Here’s the deal: $1.5 million in 10 years, that’s gonna be $3 million and another 10 years that’s gonna be $6 million. So they’re gonna have $6 million in retirement accounts that they don’t necessarily need to spend. Now they’re funding these Roths. They got $200,000 in Roth and they’re going to try to fully fund those at $40,000 a year. So then they’ll have maybe $1 million, hypothetically, in Roth accounts. But the bulk of the money is going to be this giant retirement account. Then they have another $100,000 in pension. So if you look at the giant retirement account, plus $100,000 in pension, I mean, that’s all ordinary income. Social Security is going to be taxed, most of it’s going to be taxed at ordinary income. Their tax time bomb is going to be giant.

Al: It’s a big one, I agree.

Joe: I would like them to invest that into a brokerage account to get the flexibility that they would have because, I don’t know, they live on a farm and she drives a mini truck and the side hustle is $120,000. So, I don’t know, maybe they will stop their day jobs. And they want to do other things and I think the capital in a brokerage account that’s not stringent to all these rules that the IRS puts on retirement accounts gives them a lot more flexibility.

Al: That all makes sense. This is the only thing that gives me a pause. They’re already making $400,000 of income. I don’t know if the side hustle is on top of that or included, but either way, it’s a lot of income. It’s a high tax bracket. They’re probably bumping into the 32% tax bracket. So 32% tax bracket. Yeah. If I add to my pre tax, yeah, this is a tax time bomb. No question. 100% agree. I wouldn’t necessarily do that fully. I don’t know, there’s just something about paying a lot of taxes in high brackets. As a CPA that gives me a little bit of heartburn. Because of that, I probably would do some of each. How much of each? I’m not sure. I think, you know me, I’d have to run some projections to figure this out. But I would be inclined to do a little both I think. And they already have $500,000 in the brokerage, which is a great start. I would keep adding to it, but I don’t know.

Joe: I’m guessing she’s a teacher and you know, the kids are going to burn her out.

Al: Could be.

Joe: Because most people don’t have the luxury as they have in regards to retirement plans right now. Because she’s got a 403(b) and a 457 plan so she can double up on those. Then she’s going to have a giant pension when she retires. Those are really good plans. Let’s just say she maxed out the 403(b) and says, you know what, I’m not going to touch the 457. I’m going to put all that extra into the brokerage account.

Al: Well, yeah. I mean, you could do that. Here’s the other thing that gives me just a little pause. Which is, she’s, they’re 43. She wants to work 20 years. Let’s say she retired at 63, then you got 12 years to do Roth conversions, assuming current day law, which is a big assumption. I know you had to cut you off before you said that, but assuming that the laws are still the same in 20 years from now that you could do Roth conversions, they will likely be in lower brackets and have an opportunity to do some pretty big conversions.

Joe: Sure. But then they’re going to blow through all that liquidity that they have in the brokerage account.

Al: I agree, it’s a tricky one. I think for me personally, I’d be inclined to do some of both. How much would I do? I would have to give that some more thought than just a quick read.

Joe: She’s doing, I mean, the family’s doing awesome. Congratulations. You’re 43 and you’re in the top, probably 1% of individuals that have assets.

Al: Yeah. This is a 1% scenario Gigi. So good for you.

Joe: At $400,000 of income. Don’t get me wrong, it is a ton of income. So first of all, you know, you guys are doing really well from an income perspective, but the savings rate to get to $2.5 million, two homes all paid off plus a mini truck at 43. Awesome. Way to go.

Al: Yeah. It’s incredible.

Is There a Break-Even Calculation for Roth Conversions? (Carl Spackler, FL)

Joe: Let’s see. “Hi, gentlemen and Andi. Hello. Love the show. And thank you for all of your spit balling over the years. I’m going to retire early at 51. I have enough savings to make it to 59½ . At that point, I’ll have depleted my savings and therefore start pulling from my IRA accounts. I budgeted in some Roth conversions during the age 52 to 59 years, but I’ll probably still be 50% Roth, 50% traditional when I hit 59 1⁄2. I’d like to continue doing Roth conversions after age 60, but to do so, I’ll have to sell additional assets from my IRA to pay the taxes. I understand the huge benefits of conversions, but if I have less money working for me in the market in order to do the conversions, that would offset some of the future benefits of converting in the first place. Is there a breakeven analysis where I can plug in certain assumptions like rate of return and loss opportunity cost, tax pulled out of the market? I’d love to hear your spitball analysis on this topic. Gotta go. It’s my time for a shot.” I thought he said it’s my time for a shot.

Andi/Al: Yeah, you were thinking of a different type of shot.

Joe: “It’s time for my shot. I’ve got 350 yards left. Gonna hit my 5 iron. Carl Spackler.”

Al: Carl, you can hit a 5 iron more than 350, can’t you?

Joe: Oh man. I didn’t know Carl was this young. I thought Carl was crotchety old, like 70 years old.

Andi: I thought Carl was younger.

Joe: Oh really? I mean, Caddyshack reference, I think.

Andi: Yeah, he’s likely to be our age, Joe, just based on that.

Al: Yeah. I would say so.

Joe: He’s very young,

Andi: (laughs) right, exactly. Yeah. Like I said, I thought he was younger.

Joe: Yes, all right.

Al: Okay. Break-even. What’s the break-even Joe?

Joe: Well, if he’s pulling money from his retirement account to pay the tax, then you got a whole different kind of calculation. If you’re paying the tax outside of the IRA, and if you’re in the same tax bracket, there is no break even. You broke even on day one.

Al: Okay, so explain that. Why is that?

Joe: All right.

Al: Here we go.

Joe: If you keep the money in a retirement account, people say that compounding money on more dollars will give you more dollars.

Al: Which is true.

Joe: Unless it’s in a retirement account that when you pull it out, you have to pay tax.

Al: Okay. That’s also true.

Joe: So if you look at your account balance, Alan, He’s going to have $1 million in his 401(k) plan because Big Al’s got a big wallet.

Al: And so does Carl.

Joe: And then I’m going to look at my account balance, and I don’t nearly have as much money as Alan, so I look at my account balance and it says $750,000. But my dollars are all in Roth. Who has more money? That’s the question. Andi, who do you think?

Andi: I’m going to say it’s you, Joe.

Joe: Well, I think it might be the same. It’s the purchasing power of the dollar of what people need to be thinking about, not necessarily what’s on their account statement, because on their account statement in a 401(k), it’s not all theirs.

Al: Yeah, it depends on the tax bracket.

Joe: And it’s unknown.

Al: Right, which we don’t know.

Joe: It could be a lot. It could be a little. It’s unknown because we don’t know where tax rates are going to go in the future.

Al: So in your example, if the federal and state tax rates, 30%, Right? So the $1 million you pull out, you pay 30% tax, $300,000, you get $700,000. You take $700,000 out of a Roth, it’s the same number. That’s the calculation you have to think about.

Joe: Right. If I do a conversion and pay the tax, well then I get rid of the tax right now. Because I know the tax is going to come and so then it’s the assumptions of what the tax rates are going to be. It’s like buying your partnership out early, all right. And you want to do it. Sooner than later, because the more compounding effect that it has in a retirement account, more dollars are in the retirement account, and guess what? More of those dollars are going to be subject to more tax. In a very high level type of analysis, that’s what you have to be thinking about. But Carl now is doing some crazy ass planning though. He’s thinking about conversions in 12 years. Bro, just play golf and relax. I mean, you know what I mean? I could just imagine this guy’s spreadsheet. It’s like, it would be insane. I don’t know. Look, why don’t you write back when you turn 62 and say, should I do a conversion and pay the tax outta this conversion?

Al: There’s just, there’s a lot of variables.

Joe: Many.

Al: Here’s the reason why we’re punting on this. So, the first one is we don’t know what the tax rates are going to be in 12 years. We have no idea.

Joe: No idea what’s going to be in two years.

Al: We don’t know if Roth conversions will still be available in 12 years. We don’t know if, if you’re putting money into, well, right now, if you’re converting or if you’re not converting, are you spending money that you, you know, all, all these, what kind of rate of return are you getting in a Roth versus the non-Roth?

Joe: What’s your investment strategy right now? Is it all in one stock? And the thing could probably blow up. And then guess what? You might not have enough money just to live off of, let alone doing Roth conversions.

Al: You know, sometimes we say get the money to a Roth and then have your more aggressive asset classes like stocks, like blue chip stocks, S&P, or maybe small value, whatever it may be, international, whatever it may be.

Joe: Whatever it may be.

Al: Yes.

Joe: Is that the word of the day?

Al: That is. But sometimes people hear, okay, you know what? I like Apple stock, or whatever the stock of the month is, right? And they go all in and in 20 years, you might be very happy and you also might be very disappointed because you paid all this tax and Apple or Tesla or whoever Netflix, they had their run. They haven’t done very well, or maybe they even went down over 20 years and then you’re in a worse spot. So, if you want to do this, invest properly in a Roth, make sure you’re diversified with enough stocks so you’re okay.

Andi: How do you create income that will last your entire retirement, whatever it may be? As we plan today, we face a very different retirement landscape than our parents saw – we’re living longer and we may need to rely on that retirement income for much longer. Go to the podcast show notes to watch How to Create a Steady Stream of Retirement Income on YMYW TV, and download the companion Retirement Income Strategies Guide for free. Find out from Joe and Big Al how to calculate how much you’ll need in retirement, learn about fixed income sources, total return options with guest senior financial advisor Matt Balderston, and other creative approaches to generating the income you’ll need after you stop working. The Retirement Income Strategies Guide explains how to answer 5 questions you need to ask yourself before you retire, it outlines the sources of income available for you in retirement, how to maximize your Social Security benefits, and how to develop a retirement income strategy that meets your needs. Click the link in the description of today’s episode in your favorite podcast app to go to the show notes, watch YMYW TV on Creating a Steady Stream of Retirement Income, and download the Retirement Income Strategies Guide for free.

Mega Backdoor Roth: Must I Convert Traditional IRA When I Roll After-Tax Money? (Jefe, TX)

Joe: Okay. We got “Howdy Big Al, Joe, Andi,”

Al: I like the accent. Jefe from Texas.

Joe: I can’t wait to move to Texas.

Al: I know.

Andi: I think it’s actually pronounced Jefe.

Al: Jefe

Joe: Jefe or Jeffe?

Andi: Jefe.

Joe: Is it Jefe Texas or is it Jeffe from Texas?

Andi: It’s their first name.

Al: Could be if the “s” Español pronunciation would be Jefe.

Joe: Ok. “First things first. Not too many drinks,” Oh, okay “that I don’t like.” Oh, there’s not too many drinks I don’t like.

Andi: Now suddenly he’s, he’s Joe’s kind of guy.

Joe: Oh, you little sneaky little dog, you. “But my go-to at home is a little rye old-fashioned. My wife was also known as Big Al.

Andi: Jefe and Big Al.

Al: How about that?

Joe: Well, it’s not Jeffe and Big Al. “He’s not an avid drinker, but occasionally enjoys a beer, champagne, or wine. I drive a 2013 Infiniti SUV, hand me down for my wife. My wife drives a 2022 Toyota four runner. There’s a little classic Mercedes in the garage that needs a lot more attention than I want to give it. My question involves the mega backdoor Roth.” All right, super mega backdoor. The Megatron, the garage door.

Al: Yep, names we’ve come up with. You won’t find it.

Joe: You won’t get it in Wikipedia or Investopedia. “I recently started to make contributions to my 401(k) plan at work, to the after tax portion, with the idea of taking an in service distribution periodically, the plan allows it once a quarter, and then roll that into my Roth IRA at Fidelity. I have a Roth at Fidelity, currently open with a zero balance. My plan doesn’t allow for a distribution in contribution to a Roth within the plan. I currently have a small amount of traditional IRA with fidelity. Will I need to convert the existing amount in the traditional IRA to a Roth this year when I roll this after tax money into the Roth? What do I do with the small amount of gains that will be in the after tax account? My wife has a traditional IRA as well. This will not be an issue with this mega backdoor strategy.

Andi: Will this not be an issue?

Joe: Oh. “I appreciate all your spitballs and really enjoy your podcast. Keep up the great work.”
All right. So here’s the issue with Jefe. He’s got after tax dollars in a 401(k) plan.

Al: Right. Which then allows you to put those dollars into a Roth IRA.

Joe: Yeah. Or you could move it into the Roth 401(k) in plan.

Al: Yeah, in plan, you can do that. We call that mega backdoor, whatever you want to call it, but it’s an after-tax contribution to 401(k) that allows you to put into a Roth IRA or the Roth portion of your 401(k).

Joe: Roth IRA contributions are $7,000 if you’re over 50, $6,000 if you’re under. There’s income limitations to a Roth IRA contribution. There are no income limitations to 401(k) contributions. So his plan allows him to do the standard 401(k) contribution and put additional dollars in. Doesn’t get a tax benefit from it, it’s an after-tax contribution. But it allows those after-tax dollars from his contribution into that plan to then convert it to a Roth IRA. Since it’s after tax, there’s no tax on the conversion. So, He’s excited to do this. He’s getting confused with the pro-rata rules. Because he has a little amount in his IRA. He doesn’t have a balance in his Roth. It doesn’t matter. You can move it into the Roth 401(k) component in an interplan conversion in your plan. If your plan doc allows. That’s what our plan does here at our-

Al: Yeah, it does, but this says my plan doesn’t allow for distribution and contribution to the Roth within the plan.

Joe: It says, oh, okay, then move it to the Roth.

Al: Just roll it to a Roth IRA and you don’t have to touch your traditional.

Joe: There’s no pro-rata rules in the mega backdoor.

Al: No. Now you will have some, if the after taxes gain some money, there’ll be tax on that part. But the majority of it will be tax free.

Joe: So $20,000 after taxes, because he can only do it quarterly. So that $20,000 is $22,000. He moves the $22,000 into the Roth IRA, there’s $2,000 of tax to get $22,000 into the Roth.

Al: Yeah. And you just pay that out of your brokerage account or checking account, whatever it may be.

Joe: Just withhold it.

Al: Have more withholding, whatever. Yep.

Joe: All right. Their IRAs, individual retirement accounts, 401(k)s and IRAs are two totally different animals. So they’re very similar. They have different rules. They have different regulations, 401(k) rules, and IRA rules are totally separate. So he’s thinking, alright, well, since I have an IRA balance, and I move money, of an after tax component, into a Roth IRA. Is there a pro-rata issue because like the backdoor Roth Contribution or conversion has pro-rata rules. If I make an after tax Roth IRA contribution and then convert it to a Roth IRA, or if I make an after tax IRA contribution and convert it to a Roth IRA, if I have no other IRA balances, that conversion is tax free. If I have other IRA balances, I have to add up all of my IRAs and then look at the pro-rata of what I have in after tax versus pre tax, and then that’s my exclusion in regards to taxes.

Al: Well said, and the 401(k) world, as you just said, is different from the IRA world. You don’t co mingle those for purposes of the pro-rata and I forgot it.

Joe: Aggregation.

Al: Aggregation. Thank you.

Joe: You’re not aggregating 401(k) and IRA. You’re not doing pro-rata to 401(k) IRA. You’re only doing the aggregation to IRA.

Al: Yup.

Must I File Form 5500-EZ If Solo 401(k) Had No Balance at Year-End? (Smitty, The Villages)

Joe: Welcome back, Smitty. I haven’t heard from him in a while.

Al: No.

Joe: Still chilling in The Villages?

Al: Yeah, down in Florida.

Joe: “Hey, Andi, Joe and Al. I came up with something new for you guys to chew on, but first the most important stuff. I’m still driving that black 2019 Yamaha quiet tech golf cart every day here in The Villages.”

Al: Yeah, that’s pretty fine looking.

Joe: Yeah. “My recent drink of choice is tequila on the rocks.” So here we go. Here’s this question. “I’m self-employed and over the last few years I’ve been doing Roth conversions from my solo 401(k) to a Roth IRA. Ever since my balance in the solo 401(k) went above $250,000, I had to follow IRS form 5500. So he did the EZ 5500 EZ for one participant. Last year I started 2023 with a balance below $250,000 in my solo 401(k), and by the end of 2023, this balance was zero. Being that my solo 401(k) balance never touched the $250,000 or above in 2023, assuming I’m not going to be required to file the form 5500 FII. I’m not terminating my solo 401(k) as I’m still self employed in using my solo 401(k) for large contributions, then immediately rolling them to my Roth IRA. Thus leaving my solo 401(k) with a zero balance on January 1st and a zero balance on December 31st. Being I’m not terminating my solo 401(k), I’m assuming that I’m not required to file the 5500. Am I correct? However, I do assume that I would be required to file a final IRS form 5500 when I do eventually terminate the solo 401(k), correct? What do you guys think? Thank you always. Smitty.”

Al: Yeah.

Joe: Why doesn’t Smitty just open up a Roth solo 401(k), so you don’t have to do that, but then he would have to file the 5500.

Al: Still got to do it. Yeah. So let’s explain what this is. When you have a company pension plan,

Joe: Not a pension plan, a fine contribution plan 401(k).

Al: Okay. All right. Define contribution plans in a company. You have to file form 5500 in many cases, most cases. Now, if you have a solo 401(k), which is what, that just means you have a company 401(k) plan, but it’s only you, there’s a single participant. It could be you and your spouse. That would still count as a solo. But in the case of a solo 401(k), you do not have to file this IRS form 5500 unless your account balance goes above $250,000 and once it does, you’ve got to file that form. Now in this example, do you have to file it the next year because it started the year below $250,000 and it still was $250,000 the whole year that to the letter of the law, the answer is no. However, I personally would still file it because I just don’t want the IRS saying, where’s your 5500. We’re expecting it. And then you got to go through all that. So I would still file it myself. It’s pretty easy.

Joe: It’s a pretty easy form.

Al: It’s like a postcard. Smitty, go ahead and file that postcard.

Joe: He’s doing all this rigmarole with the conversions and, you know, putting all this money into it and taking it out. Just file the 5500.

Al: Just do it.

Joe: And then have a shot of tequila.

Al: Right. Yeah, you don’t really have to. I just, you know, best practice, I would do it just because I just don’t want a letter years from now with penalties. However, your statement is correct. If it’s below $250,000 for the whole year, do you have to file? Answer is no. I still would file it. In the final year of your 5500, or final year of your solo 401(k), do you have to file the 5500? Even if your balance is below $250,000, the answer is yes. It is a hassle. You have to get a federal ID number for that, but the IRS says that you have to.

Joe: All right, that’s it for us today. Thanks Andi and welcome back.

Andi: Thank you so much.

Joe: Al thanks.

Al: Yes.

Joe: I know you’re heading off again.

Al: Pretty soon. In about an hour.

Joe: All right. I’ll be here holding down the fort. We’ll see you guys next week. Show is called, Your Money, Your Wealth®.

Andi: We’ve got Moulin Rouge, the mini truck vs. a Ram truck, shooting 350 yards with a 5-iron, The Villages, and tequila in the Derails at the end of the episode, so stick around.

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Your Money, Your Wealth is presented by Pure Financial Advisors. While a Retirement Spitball Analysis from Joe and Big Al is a great starting point, a free financial assessment with the experienced professionals at Pure is a comprehensive review of your entire financial situation to uncover more strategies to help you have a successful retirement. To schedule yours, click the Free Financial Assessment banner in the podcast show notes at YourMoneyYourWealth.com or call 888-994-6257. Meet in person at any of our locations around the country, or online via Zoom. No matter where you are, the Pure team will work with you to create a detailed plan especially tailored to your retirement needs and goals.

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The Derails



Pure Financial Advisors is a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.

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