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Retiring to Bear Market: How bad is it?

Retiring is an important lifetime decision. But what is going to happen if bear market is in a full steam and the plan is to live on investment income? Potentially, Social Security can help but it may be many years ahead and it may take even longer than anticipated as the retirement age may increase in future? In this article, I try to bring together some ideas how to prepare to such a difficult situation.

Fortunately, there are different types of investment, in order of their safety:

  • US treasuries: guaranteed by government, therefore the most stable asset.
  • Certificate of deposit (CD): FDIC insured and call protected, guaranteed by the bank with federal insurance support. No growth but no risk to principal and stable interest.
  • Bonds: interest is safe as long as the borrowing institution is in business. But share price does not grow much even in a bull market.
  • Equities paying dividend: reasonably stable but may be cut or eliminated at any time. But there are companies – aristocrats which are growing dividend for many decades.
  • Growth equities: highly volatile, especially under bear market. But in a bull market, share price may experience a substantial growth.

In earlier article, buckets approach has been discussed. Indeed, it can be a great approach to retirement safety if implemented correctly. For simplicity, we can consider just two buckets: the first one to provide a stable income for living, and the second one to continue wealth accumulation. The fixed income bucket may include CD or treasury ladder, built for the next 5-10 years. The ladder is important to protect income from inflation. Right now through 2023, there are great opportunities to set it up because the rates are historically high. The accumulation bucket may include bonds and equities with interest or dividends reinvested into the same securities. Also, there can be a mix of two for example some part of dividends from accumulation bucket withdrawn for income.

The bucket approach described above is missing one principal part: what happens to the total investment balance. Most people would prefer to keep it growing, or not shrinking at least. How is it possible in bear market condition? May be not in a short term, but it can be achieved in a long term because historically after the bear market there is always a bull market. However it also depends on the type of investments being used in accumulation bucket. How to estimate and plan it well ahead of future market situation?

Let us assume we have X1 funds in accumulation bucket which are growing at Y1 interest or dividend rate. Then the annual income would be X1 * Y1. In distribution bucket, we have X2 funds growing at Y2 interest rate. The difference is that along with interest, we want to withdraw a part of principal proportional to the number of years N we want this bucket to last. The annual distribution would be X2 * Y2 + X2 / N. We want the annual distribution from accumulation bucket to be always greater than annual distribution from fixed income bucket: X1 * Y1 > X2 * ( Y2 + 1/N ).

In the formula above, it would be interesting to see the ratio between the funds in accumulation and distribution buckets, with respect to the number of years and interest (dividend) rate: X1 / X2 > ( Y2 / Y1 + 1/( N * Y1 ) ) . Taking 5% rate and 5 years as a reference for both buckets, the ratio must be greater than 5 to meet the criteria. Assuming we would need at least $40K annually or around $200K for five years to live, more than $1M would be required to have in accumulation bucket. But in a reality we may need more than $40K per year for living, and we may not have another $1M to invest. What do we do? The good news is that the above estimation is quite pessimistic.

With some effort we can raise the investment rate in accumulation bucket to 8-10%. There are some investments with return beyond 10%, but they need to be analyzed carefully as higher risk investments. But even with 8% rate, the X1 / X2 ratio drops from 5 to 3.125 which means just $625K is required to secure the annual income $40K from fixed income bucket for five years. However even more important observation is that we are missing the power of reinvestment. The formula provided works well for one year of income estimation. For the second, third year and beyond accumulation bucket would produce more income just because more shares will be added as a result of reinvestment. We can use Realty Income (O) annual distributions without and with dividend reinvestment over the last 25 years as an example (charts were produced by Portfolio Visualizer).

The other important side of reinvestment strategy is how well it works in a bear market. This is because every time the equity decline in price there is an opportunity to buy more shares for a lower price. And finally we end up with even more interest or dividend coming out. For example, AAPL with share price $174 pay dividend $0.96 per share. We can buy 5 shares with dividend $4.8 paid annually. But with share price dropped to $160, additional 0.03 shares will be reinvested rather than 0.028 with initial share price. Though it is still important to choose investments which did not reduce dividends or eliminated them entirely in past bear markets. Besides that, it is worth to mention that fixed income bucket produces the stable income regardless of market conditions. This is why the discussed two buckets strategy would perform well in a bear market when combined together.

But what about the time line? Do we want to change the buckets, when more years are spent into retirement? It appears the fixed income bucket is more important for earlier retirement years, because of the retirement date selected on the edge of bear market and the following Sequence Of Return Risk (SORR). The fixed part can be gradually replaced with Social Security and pension later into retirement. There was a great article by Kitces explaining how fixed income part can help to navigate the retirement “red” zone with extreme portfolio size volatility in early years.

Finally, a few words about the tax consideration. It is beneficial to have a fixed income bucket funded with taxable accounts, while it is more natural for accumulation bucket funds to come from retirement accounts as these funds will be used later. It would help to reduce the taxable income in early years, because of after tax money primarily used (with small addition of interest from CD or treasury ladder). Also it would help to reduce the total income in later years, because the taxable part has been already spent and most accumulation bucket funds would come from Roth IRA providing a tax-free income for life.

As a summary, these are the important actions for everyone to consider, to ensure safe retirement income in a bear market:

  • set up two buckets, one for wealth accumulation and another one to produce fixed income (wealth distribution)
  • fund the buckets properly, to make sure the total income keep growing or at least remain the same with the required distributions
  • use income bucket distributions for living, with potential mix of some dividends or interest from accumulation bucket
  • gradually replace fixed income bucket with pension and Social Security according to the plan
  • first years into retirement are the most important due to market condition on retirement date and SORR
  • allocate wealth accumulation bucket primarily for retirement accounts, while fixed income (wealth distribution) bucket for taxable accounts.

Estimated tax: what do we need to know

Working people are painfully familiar with taxes. We all know employer typically withhold some money from each paycheck. There is a federal W-4 form where employee can change the amount of money taken away from the income. The same is true for state and local taxes. It is always a good idea to carefully estimate the total annual income and withhold exactly as required, to avoid unexpected surprises in annual tax return. But what if someone retired from regular job but still has passive income such as interest, capital gain, etc.? Tax still need to be withheld regularly or estimated payment must be made as IRS does not like anyone who delay tax obligations and may impose an underpayment penalty.

What kind of penalty is in place, when individual delays tax payments? Basic requirements from IRS are defined here. IRS expect anyone to make estimated tax payment if the tax of $1,000 or more will be due at the time of annual tax return. In case of the penalty IRS require to fill the form 2210 and the penalty amount due is essentially the interest charged for every day of delay. Most states has their own requirements. For example, in California individual is expected to pay estimated tax if the tax of $500 or more will be due at the time of annual tax return ($250 if married). Federal form 1040-ES must be filed for estimated tax either by mail or online. State of California form is 540-ES and payment options are available here.

Obviously, paying estimated tax is not as hard as it sounds. But is there any way to avoid it? This is what can be done.

  • carefully study all conditions provided by IRS to escape from estimated tax payment i.e. safe harbors
  • make a correct early estimation how much tax will be due by the end of the year, and what it takes to reduce it to the degree when advance payments are not required

These are three harbors or conditions to avoid estimated tax payment covered in part I of IRS Form 2210:

  • The total tax for a current year tax return, with the exception of any refundable credits and the amount paid through withholding, is less than $1,000
  • At least 90% of the amount calculated (before subtracting withholding) has been withheld for harbor one mentioned above
  • At least 100% of the amount calculated has been withheld (110% when adjusted gross income for that year was greater than $150,000, or $75,000 if married filing separately) as a part of prior year tax return

While these harbors might be sufficient for someone, there are always situations when estimated tax still can not be avoided. The good news is that estimated tax payment may not be necessary if the total income for tax year does not exceed certain number. Manipulations to fit those numbers would be also beneficial for retirees managing their income for ACA subsidies with Roth conversions as discussed in previous article. Anyone can estimate the magic number according to his/her specific situation using for example this great calculator. In a table below, I compiled some numbers typical for retirees to have an impression when estimated tax payment can be avoided.

In this table, three types of income are considered: ordinary (interest, short term gains), capital gains (qualified dividend and long term capital gain) and social security. California’s state is used as an example of progressive tax rate, opposite to the state with no income tax such as Nevada, Washington, Texas, etc. Apparently for people who did not file for social security yet, California state tax really makes a difference. Does it mean everyone should retire in the state without income tax? Not really, because the low income numbers may play in favor for those who manage income for ACA subsidy anyway. Also, there is not much difference once the person (or couple) file for social security because California is one of the states which does not tax social security.

Overall, the income limit numbers appear to be reasonable for many people. But someone might want more money to live on. It still possible, with the use of tax-free Roth IRA distributions. The great feature of this retirement engine is that these distributions are never counted towards the taxable income, even for ACA purpose. In states like California, it is even more beneficial to fund Roth IRA as much as possible in years before the retirement using Mega backdoor Roth conversion to take advantage of low tax environment later.

Roth Conversions: Do They Make Sense?

In this article, I would like to discuss Roth conversions. Roth IRA is a powerful retirement engine which can generate a tax-free income for life. There are a few options to contribute money into Roth IRA account which can be opened with any brokerage firm or even some banks:

  • direct contribution (limited to $6K per year or $7K for those older than 50, income limit $144K for individual and $214K for couple also applies)
  • backdoor contribution (also limited to $6K and $7K per year, but no income limit)
  • mega backdoor contribution (limited to $61K per year or $67.5K for those older than 50 which include 401K pretax, after tax, employer match and any other non-elective employer contributions: no income limit)
  • Roth conversion (no limits but tax implication)

While backdoor contribution is available pretty much to everyone with earned income, direct contribution is subject to income restrictions and mega backdoor contribution must be available through the employer’s 401K plan administrator. But with backdoor, contribution limit is low. Also early in 2022, there was an attempt from US government to eliminate backdoor and mega backdoor provisions entirely. It did not succeed in Congress, but there is still a great chance the lawmakers will get rid of this back door soon.

Based on the above, the only viable option for most people to fund their Roth IRA with reasonable amount of money would be Roth conversions and this is a subject for our discussion. Under Roth conversion rule, anyone can convert some money from traditional (or rollover) IRA into Roth IRA. There are no age or amount restrictions. But if traditional IRA has been funded with pretax money, ordinary income tax is due on the entire amount being converted.

The tax implication can be a serious problem. Therefore, it is reasonable to do Roth conversions in a low tax bracket and likely with reasonably small amount of money converted each year. Many of those who retire early prefer to complete most Roth conversions before they turn 65 years old, which means health insurance from marketplace have to be purchased at the same time. ACA provide a subsidy for insurance premiums based on the income. By that reason, Roth conversions must be managed carefully to maintain the overall tax burden reasonable, in order to achieve the conversion goal.

What would be the reasonable amount of money to convert then? There is no simple answer to this question. It really depends on income (in particular, Modified Adjusted Gross Income or MAGI) and health insurance details. Insurance premium subsidies may vary substantially with the insurer, zip code and particular plan being used. I compiled a table for ACA Blue California Bronze 60 HDHP PPO plan available at major metro areas in California, as an example. For the base income, I use $20K as a reference because it is pretty much the lowest income to purchase ACA plans (Medicaid expansion which is out of the current discussion can be used by those with lower income).

In the table, the total estimated cost is the number we will be using in other calculations. For convenience, the last column has the cost with respect to $20K MAGI provided by the first row in a table. Our goal is to figure out how long it will take to offset the health care cost by Roth conversions, in particular by the gain achieved within the Roth IRA which has all converted money in it. But for that purpose, we also would like to know the total tax due to the Roth conversion, to add it up to health insurance cost. The table below represent the individual federal tax and state of California tax implied for different amount of Roth conversion while base income $20K remain unchanged. We assume the base income is long term gain and taxed accordingly. For MAGI calculation, maximum HSA contribution is subtracted from the total income because in our example we have High Deductible plan accompanied by Health Savings Account (HSA).

By combining ACA estimated cost from the first table and total tax burden from the second table, we have the total amount of money spent due to the Roth conversion (see the table below). We also want to see the same data for three years, in order to compare them with one year conversion results.

Finally, we need to calculate the return potentially generated due to the Roth conversion assuming it will be most likely anywhere between 2% and 8% annually. No tax will be paid on the return, since these funds are in Roth IRA.

What we are looking for is the number of years required for income due to the Roth conversion to cover expenses incurred due to ACA cost and taxes paid on conversion. It would be simply the total annual expense correspondent to specific amount of money being converted divided by the annual return for the rate between 2% and 8%.

As we can see from the chart, someone would need to wait somewhere from 2 to 16 years to actually enjoy the advantage due to the Roth conversion, given sharp increase in ACA premiums and taxes with the income. Obviously higher return rate makes conversions more efficient. Based on these data, it is advisable to make Roth conversion as small as possible to keep ACA premium and tax low.

Does this mean Roth conversions are not desirable at all when ACA is in picture? Of course not. The return on Roth money will grow with years to come. In fact, it is better to check cumulative return after the few years, rather than the annual return. This is a table for three years cumulative return which means annual return is reinvested to generate more income in the next year.

Once we put these data into the chart, it is clear that although the shape of the curves remain the same there is a small shift into the lower end. It will take up to 2 years to cover expenses incurred by $24,650 conversion with 8% return which does not look too long. But it is hard to achieve 8% annual return: in a real life it will be more likely in 4-5% range. Apparently more advantage will come for 4 or 5 years of cumulative return.

But would it be wise to leave income in Roth IRA, reinvest it rather than use immediately? This is actually the only option for people younger than 59.5 when the entire Roth distribution become tax and penalty free. By that reason, it makes more sense for early retirees to do Roth conversions as soon as possible to see more advantage in the future.

Dividend Investing: Smart or Stupid?

Dividend investing has always been a widely discussed topic. It gained more popularity lately, due to the current market conditions. There might be strong opinions people express in favor or against it. I wanted to focus on some basic ideas here which may help someone to make a right investment decision.

First of all, there are two investment strategies which may actually complement each other: growth and income. When it comes down to equities, investing for growth means buying and holding stock which likely will grow in price. The time of sale is up to investor. This is great, because it is possible to plan ahead for the sale event. However, growth stock may also lose its value and it is hard to predict. Therefore, the revenue stream provided by growth investments can be uneven and sometimes non-existent for a relatively long time. FAANG stock (Facebook, Amazon, Apple, Netflix, Google) would be a good example for growth investment opportunities.

Investing for income means buying and holding stock which produce income on regular basic. Some people may say there is a magic involved. Apparently, there is no magic: dividend is just a part of revenue companies pay based on their results. Investor cannot control when dividend is paid. It is up to the company to set up a schedule. As a result, investor may face severe tax implication or experience income drop at some time. Still, dividend income is much more predictable than growth income because it is paid regularly. Dividend stream can be stable even under critical market conditions, when stock market is down. AT&T can be an example of stock paying dividend for a long time.

The important number to measure investment rate of return is annual percentage yield (APY) which is the actual rate of return during the year. With respect to dividend stock, it is a dividend yield or amount of money company pay to shareholders for owning the stock. This can be a real number (dollar amount paid per share) or percentage number (amount paid per share divided by current share price). The typical dividend value can be as low as 0.1% or as high as 15%. However, most stable companies pay around 1-4% with utility and staples sector paying higher dividend while REIT (Real Estate Investment Trust), MLPs (Master Limited Partnership) and BDCs (Business Development Companies) may have even higher dividend payments, but they are also taxed at higher rates.

Individual stock is not the only way to invest. In fact, it is hard to pick the right stock which will provide a guaranteed income in the future. Mutual funds and/or ETF can bring more opportunities for inexperienced investors. Although they may not have the same benefits as stock individually selected, funds provide greater exposure to broader investments range and less risk to lose money. While ETF like VUG can be a great example for growth investment, VYM is a high yield dividend income ETF and VTI is a total market index ETF which apparently track both growth and dividend stocks. Let us compare these popular Vanguard ETFs, to understand the difference between growth and income strategies. Portfolio visualizer is a great tool to figure out what is going on with stock price, total return and income over the time.

As expected, growth ETF (in blue) show the highest return in many cases, while dividend ETF (in red) tend to have the lowest return. Total market ETF (in yellow) is in between. Again, as anyone would expect annual return is not stable and in fact exhibit substantial losses at the time of recession (2008). But we can see a quite different picture when compare the annual income rather than annual return.

As you can see, the highest annual income is provided by dividend ETF (in red), while growth ETF (in blue) demonstrate the lowest income. Total market ETF (in yellow) again is in between combining advantages of both strategies. Although the income dropped quite a bit at the time of recession 2009-2010 (more than 50% of the highest income for reported years) it remains stable across all three ETFs and to some extent repeat each other. This is because all three are index ETFs tracking a broad range of stocks.

Apparently, there are plenty of high yield dividend funds or ETF to choose from: DGRO, VIG, NOBL, HDV, SDY, VYM, SCHD. Most of them (except NOBL and SDY) are passively managed funds, which means they are not expensive to own with expense ratio close to 0. Their performance varies depend on the choice of equities selected by fund or ETF managers. While the fund with the highest dividend yield is HDV (3.55%), the fund with the lowest yield is VIG (1.53%). Lower dividend in most cases means higher annual return, but there can be exceptions. According to analysts familiar with this matter SCHD provide the best combination of return and stable income over the time. It is supported by the graph we can obtain from Portfolio visualizer.

While HDV (in yellow) indeed has the lowest (sometimes negative) annual return among these three picks, SCHD (in red) does a good job competing with VIG (in blue) for annual return and at the same time providing dividend income similar or higher than HDV.

For the tax implication, it is also important to mention that dividends can be qualified and ordinary (non-qualified). Qualified dividend along with long term capital gain carries lower tax burden, which provide an advantage to hold in taxable accounts (compared to tax deferred accounts such as IRA). Both VYM and SCHD distribute qualified dividends only.

Since there are plenty of funds and ETFs providing stable dividend yield to investor, what would be the reason to pick individual stock? As already mentioned above, dividend yield for those funds rarely exceeds 3.5%. This is because a broad range of dividend stocks are selected, at both high and low dividend yield to sustain diversification and stable value for investor. With intelligent individual stocks selection, the yield can be improved up to 4-5% and even higher in some cases. What are the criteria to pick the right stock? There are various metrics which can be explored, including the ones listed here:

  • Total return over certain time, to make sure it does not drop while dividends are being paid.
  • Sector where company operates such as telecom, energy, health care, etc. Individual stocks must be diversified across the sectors to make sure they do not underperform all together.
  • Analysts score, typically chosen as buy (strong buy), hold or sell.
  • P/E (Price-to-Earning) ratio, compared to average P/E ratio for the sector: current share price relative to the earnings per share.
  • Number of years dividend increased: there are dividend aristocrat stocks (65 as of 2021) which increased dividend during more than 25 years such as MMM, ABBV, CVX, etc.

How would the annual return and income graphs would look like for individual companies, compared to high yield mutual funds or ETFs? This is a snapshot of 25 companies paying dividends, with majority of them being dividend aristocrats.

For the annual return, we have really unstable picture compared to ETFs. Indeed, individual stocks are always more volatile than the index across a broad range of stocks. However, annual income on the second graph looks nice and consistent with total value substantially higher than ETF increasing over the time.

Which strategy works better then? There is no simple answer for this question. It depends on investment goals, time horizon and other conditions. One can choose dividend income over the growth when regular money stream is more important than the gain in value. This could be actually true for some retirees who want stability over the high return. Lately, dividend investment become more popular because of the high inflation and low interest environment which makes bond investment less attractive. After all, dividend stocks are combining the best across equities and bonds making investment revenue more predictable yet producing measurable income.

How to avoid tax when retired

2019 Weekly Planner Tax Taxes Uncle Sam Wants Your Money Funny Theme 134  Pages: 2019 Planners Calendars Organizers Datebooks Appointment Books  Agendas: Journals, Distinctive: 9781092423953: Amazon.com: Books

Paying taxes is not pleasant but important responsibility for everyone. In US, the tax code designed to take the most advantage of people working for a company in private sector. Pretty much all their income is eligible for ordinary income tax, and there is not much you can do with that. The topic become more interesting for people who own business or retired. The focus of this article is on retired folks, who collect their income from pension, retirement accounts or investment.

Indeed, retirement accounts such as 401K or IRA are designed to take advantage of lower tax rates applied when you retire. It is assumed there is no earned income anymore. Some may suggests many retired people still has a substantial tax burden and have to pay high tax. While it may be true to some extent, it is important to realize that there are legitimate ways to reduce the tax at retirement. Moreover, there are greater opportunities of doing that, compared to working years.

With respect to tax, it is important to consider the overall tax burden. Which typically include individual income tax (federal, state and local), sales tax and property tax at least. Let us focus on federal tax first. Since we assume that the retired individual does not have earned income, the following strategies can apply:

  • Use Roth IRA distributions when possible
  • Limit traditional IRA or 401K distributions or offset them by tax deductible spending
  • Make sure taxable accounts provide tax efficient income

In order to get advantage from tax-free Roth IRA distributions, it is important to have sufficient funds in it. There are multiple ways to fund Roth IRA. While direct contributions are limited by $6,000 annually (or $7,000 for those older than 50), there are backdoor Roth and mega-backdoor Roth conversions providing more flexibility. For example, conversion from employer’s after tax 401K account could reach as much as $34,500 annually. However, in case of conversion it is important to remember about 5 years rule which essentially prohibit Roth IRA gain distributions for 5 years after the conversion time.

There is an ordinary income tax always applied to Traditional IRA or 401K distributions. We cannot do much about it, but it is possible to limit amount of money converted each year to minimize tax or completely avoid it. For example, first $12,400 (single) or $24,800 (married couple) matching standard deduction can be converted without any tax withheld. Also funds coming into Health Spending Account (HSA) are tax-deductible too. As discussed in previous article health care expenses can be deducted as well after certain limit has been reached. But in certain situation too little income may actually be worse: in order to qualify for ACA subsidy for those younger than Medicare age, Modified Adjusted Gross Income (MAGI) must be at least 138% of Federal Poverty Level which is $17,609 (single) or $23,791 (couple). This link gives some idea how MAGI is calculated.

Income received from taxable accounts can be managed too. For long term capital gain (stocks sold after one year since acquisition) there is a special tax treatment: currently income below $40,000 (single) or $80,000 (couple) is actually tax-free. The same is applicable to qualified dividends available from certain stocks. Is it necessary to buy individual stock, in order to receive special tax treatment? Not at all. But everyone needs to be careful about income distributed by actively managed mutual fund or ETF, to align it with tax strategy. For example, these are year-end distributions per share made in year 2020 by Vanguard Wellesley fund: long term capital gain $0.388, short term capital gain $0.078, dividend $0.192. Apparently Certificate of Deposit or Savings account are the worst in terms of income tax: ordinary income tax is always applied.

Pretty much all remaining taxes depend on the place where we live. The high level picture on overall tax burden by state can be found for example here. The tax in the table has ranking from the highest in New York, Hawaii, Vermont to the lowest in Tennessee, Delaware, Alaska. But local tax may vary between the counties within a single state. Considering state and local income tax, it may be worth to check if there is a flat or progressive tax rate. The flat state tax rate vary from 3.07% in Pennsylvania to 5.25% in North Carolina with Indiana, Michigan, Colorado, Illinois, Massachusetts and Kentucky in between. Although reasonably small, it may be higher for low income people than in some states with progressive tax rate. The difference between the tax applied to high and low income earners may be as high as 9.3% (California), 7.2% (New Jersey) or 5.4% (Vermont). Income tax in these states starts from 1%, 1.4% and 3.35% respectively.

It is hard to manage sales tax. If it happens to be high, the only way to reduce it is to buy less. Still, there may be some strategy to help. The Payboo credit card actually pay sales tax back to buyer, when purchase happens online at their website bhphotovideo.com. It may be worth to buy expensive cell phones, tablets or computers there for those living in area with high sales tax. How about even bigger ticket items like a new car? It is possible to buy a car in one of the states without sales tax on cars and register it in other state after 90 days from purchase. Besides that, there are states with no sales tax: Alaska, Delaware, Montana, New Hampshire, Oregon. Also there are states with low sales tax, such as Hawaii, Wisconsin, Wyoming and Main.

Many retired people consider moving into states with no income tax: Washington, Nevada, Texas, Florida, Tennessee, New Hampshire, South Dakota and Wyoming. While it make sense for some, the states with no income tax often take the revenue from other sources such as sales or property tax. For example, the state of Oregon does not have sales tax but income and property tax are on the high side. Meantime the state of Nevada has no income tax and relatively low property tax, but sales tax is high. Again, it is worth to look into overall tax burden, rather than just income tax. Property tax combined with other local taxes can make retirement life miserable. Therefore, it is important to understand what tax breaks are available for retirees. The guide like this can be used as initial guess.

No tax on 401K: myth or reality?

Retirement Planning and Tax Benefits or Deductions Go Hand in Hand.

Retirement accounts such as 401K are quite popular. During the career time, anyone can put aside some money before income tax withheld. Currently, 401K annual contribution limit is $19,500 (with additional $6,500 for those older than 50), which can be combined with Heath Savings Account annual limit $3,550 (with additional $1,000 for those older than 55) for individuals and families signed up for High Deductible Health Plan. There is also traditional IRA with annual contribution limit $6,000 (with additional $1,000 for those older than 50). However, federal income tax is always due later at the time of distribution. Also, many states require paying additional tax on these distributions. For example, $100K in someone’s 401K may actually worth just $88K due to the 12% federal tax bracket. Retirement accounts are designed in assumption that the tax bracket would eventually get lower for people, when they withdraw money at retirement age. Which may not be always true, especially for those applied for Social Security Benefit later and experience Required Minimum Distributions (RMD) kicked in at 72. Essentially the tax on retirement accounts is a time bomb waiting to explode. Is it possible to withdraw money from retirement accounts and never pay tax? Actually it is possible, under certain conditions.

The reasonable first step for anyone who would like to withdraw money from 401K is to roll it over into traditional IRA. There is no tax associated with this rollover. It can be done for the entire account or part of it, even before retirement age. Though it works for former employer’s 401K only. There are multiple discussions about advantages and disadvantages of this step. In most cases, there is an advantage to keep retirement savings in traditional IRA, rather than 401K after separation from service. Also this is an important step before further actions are taken.

One way to avoid tax on IRA distribution is to transfer IRA money directly into Health Savings Account (HSA). This can be done once in a lifetime. HSA must be active (i.e. combined with qualified High Deductible Health Plan) and maintained for at least one year after the transfer is complete. HSA money spent on health care services are 100% tax-deductible. However, HSA annual contribution limit of $3,550 is still applicable. It makes such a transfer much less attractive. Also some accounts may have limited investment choices as well as other restrictions and fees.

Fortunately, there is a better way to avoid tax on IRA distributions. Medical and dental expenses which exceed 10% of annual Adjusted Gross Income (AGI) are tax-deductible when itemized deductions are used. While it is a rare case when anyone who spend more than 10% of annual income on health care during the career time, situation changes with income dropped due to the separation from workforce. This is especially useful for those who already retired but did not reach Medicare age. For example, with annual income around $20K it takes just $2,000 to become eligible for tax-free health care expenses. In fact, $2,000 may be spent just for health care insurance premiums. In this case, all actual health care expenses beyond insurance premiums become deductible. Higher health care expenses provide more tax advantage in this case.

But how does it relate to IRA distributions? Actually there is a direct link between tax- deductible health care expenses and IRA distributions. The annual amount of distribution can be adjusted to match health care expenses in excess of 10% AGI paid during the calendar year. It can be implemented even before the age of 59.5 with traditional IRA rollovers into Roth IRA: additional penalty 10% does not apply in this case. In this way, the matching part of distribution is essentially tax-free. How much money in total can be withdrawn tax-free? According to the reports, average retired American spend as much as $280K on health care alone during the lifetime. This is a decent part of 401K/IRA savings for ordinary people. Any tax-free IRA distributions are helpful to reduce RMD and eventually a tax burden during the later retirement years.

What if someone can manage to have a very low income, for example $5,000? Would this be even better, as it makes deductible any expenses beyond $500? Actually it is not. Anyone with annual income below Federal Poverty Level (FPL) which is $12,760 for individual and $17,240 for a family of 2 become eligible for free health care under ACA Medicaid Expansion. In this case, small income does not help: IRA distributions would be fully taxable, as health care expenses are non-existent or extremely low. To this extent, it is better to have higher income to take advantage of tax-free IRA distributions. But not too high, as it gradually reduce all benefits of tax-free distributions to zero. It appears the income between $17K and $25K per year is the best for that purpose.

Also another question may rise. What actually brings more advantage: reduce income to near zero and use free health care through Medicaid expansion, or maintain income in optimal range mentioned above and enjoy tax-free IRA distributions? It may appear beneficial to get health care for free. But it is for a limited time, till Social Security benefit and RMD kick in and the cost of health care would be substantially higher along with a high tax on IRA distributions. Therefore, the preference still come to the scenario of tax-free IRA distribution. The advantage would be even greater for those who live longer and therefore experience higher health care expenses.

Retirement income: chase the impossible?

Retirement may be a dream time for many people, but it comes with a challenge. Everyone still need a regular paycheck, to cover living expenses. But there is no employer anymore, who take care about it. It is better to plan for retirement income well in advance. Is it possible at all, in ever-changing world where we live? In this article, I would like to discuss buckets approach which actually can help the average retiree.

The buckets approach has been discussed lately in various forms, from two to eight buckets. The basic idea has been presented for example here. In order to sustain and even grow money in rapidly evolving market conditions, there is a need to split the entire amount of money saved for retirement into a few sources or buckets. The goal is to make sure a volatile stock price would not have a direct impact to the quality of life, and at the same time investments continue to grow and provide a reasonable return.

How much money does each bucket hold? It depends on two major factors: the amount of planned living expenses, and the worst case market recovery time. While the cost of living during retirement is different for every person, the market recovery time can be estimated from the chart below. This is a historic chart providing a composite S&P 500 index valuation over many decades. Typically, the market recovery takes a few years but sometimes it may take as long as 10 years or even longer. Therefore, in order to avoid losses it would be reasonable to assume that the most risky assets must be held well beyond 10 years.

The Bucket 1 is essentially the one which provide a regular income during the retirement years. It may include sources such as regular checking or saving account, money market account and short term CD. Money are FDIC insured and does not depend on market fluctuations. How much money do we need in this bucket? Typically, these funds need to cover 2-3 years of living expenses. For someone ultra conservative, 5 years of living expenses would be even better choice. For example, if someone’s plan is to spend $25K each year the bucket need to carry $75K to $100K. But if someone would like to withdraw $40K each year then the bucket funds would increase to $200K.

The Bucket 2 contain assets which does not require immediate access (Bucket 1 is designed for that), but still expected to hold its value well during 8-10 years between the recessions which is equivalent to $300K to $400K. It may include longer term CDs, Treasury Notes, Municipal funds or even total market stock or bond funds. While there is a risk involved, the value is expected to be relatively stable. These are after tax assets i.e. it is assumed the tax has been already paid on principal amount of money. Money in this bucket can be used to fund Bucket 1, when required.

The Bucket 3 and Bucket 4 are intended for long term investments, which are expected to grow over the retirement time. These are primarily retirement accounts (RA) which involve some tax breaks as well as additional tax burden. Bucket 3 include money in Roth accounts, which grow tax-free and can be withdrawn by anyone older than 59.5 without penalty. It makes sense to hold low cost index funds there, as well as individual REIT because of the complex taxation laws around them. Also it may be beneficial to include more risky assets into Bucket 3. Money from this bucket can be used to fund Bucket 2 or directly Bucket 1, whenever there is a need.

The Bucket 4 holds money in traditional retirement accounts such as tIRA or 401K. These are pretax money i.e. any distribution would trigger an ordinary interest tax. These funds need to be slowly converted into Roth (early Roth conversions were explained in details here), in order to avoid high tax bracket and eventually Required Minimum Distribution (RMD). Roth’s conversions can be started any time, without implications other than tax imposed on distributions. Since these funds are not supposed to be used for a very long time, the most risky assets like individual stocks can be purchased here.

All buckets and fund transfer directions between them are presented in the figure below.

Finally, a few words about the real estate. It does not make sense to include a primary home here: it is hard to consider as a source of income. However, rental income can be included into Bucket 1 as funds directly accessible to cover expenses. The rental or second home sale can also be considered as potential income which would be reasonable to include into Bucket 4, because of the tax due on this sale.

Early Roth conversions

How To Create A Roth IRA Conversion Ladder

Roth’s account is a great retirement asset, designed for our money to grow tax-free and penalty free. Indeed, there are no tax or fees on Roth distributions for those over 59.5 years old. Moreover, there are no required distributions at certain age like other retirement accounts has. It is attractive to keep retirement savings there. But there are limited options available to fund Roth IRA, and pretty much all of them involve a tax bill. We will discuss today how to lower or possibly avoid this tax all together.

First let us figure out how to contribute into Roth IRA:

  • any individual can directly contribute up to $6K ($7K for those over 50) annually if MAGI (Modified Adjusted Gross Income) is less than $124K (single) or $196K (married) as of 2020
  • rollover contributions (conversion from traditional IRA or 401K to Roth IRA) are available to individuals with any income and there is no annual limit

As you can see, there is still a way to contribute a significant amount of money into Roth IRA through a rollover. However the same annual contribution limits are applied to traditional IRA and it is hard to accumulate substantial money there. Still, Backdoor Roth is an opportunity for everyone with high income to establish Roth IRA and contribute into it: initially after tax money are contributed into traditional IRA account and then immediately converted into Roth IRA, to avoid any tax implications.

Other opportunities allow in fact to contribute unlimited amount of money into Roth IRA:

  • Former employer’s 401K rollover into Roth IRA: available to those who change employer during their career, which is the case for most people in US
  • Mega backdoor Roth: after tax 401K rollover into Roth IRA, if permitted by employer

The first option is available to anyone who left an employer which made 401K plan available to employees. We consider traditional 401K here, because Roth 401K is still rare to find. There is no annual limit on such a rollover. However, there is a tax due for the entire amount converted during the year of rollover. This is because 401K funded with money contributed before tax has been withheld. It is a two steps process: initially 401K money are converted into traditional IRA and no tax withheld, then money from traditional IRA converted into Roth IRA and ordinary income tax is due.

The second option is available with selective employers, which provide an opportunity to contribute into after tax 401K. These are after tax money subject to $63,500 annual limit (for all 401K contributions combined), and can be converted directly into Roth IRA (principal) and into traditional IRA (capital gain). Moreover, the conversion may sometimes take place for an active employee (in-service rollover). It important to mention that there is no tax due for this conversion.

Whatever option has been used, the tricky part is a conversion of pretax money accumulated in traditional IRA into the Roth IRA as both federal and state tax is due with this conversion regardless on age or other conditions. Obviously, the amount of tax depend on individual’s tax bracket in year of conversion. It may be hard to control it while being employed, especially with high compensation job. By that reason, most people postpone conversion till they retire in lower tax bracket. While in general it seems a right strategy, the following considerations are important:

  • Modified Adjust Gross Income (MAGI) is important not just to reduce the Roth conversion tax bill, but also to qualify for health care subsidies under ACA
  • Medicare premiums required for those over 65 years old also depend on MAGI
  • While Social Security benefits itself may not be taxable in most states, there will be a tax if it is combined with Roth conversions
  • Ability to postpone Social Security benefit application till 70 may temporarily reduce the tax bill but increase it later
  • Required Minimum Distribution (RMD) from pretax retirement accounts such as traditional IRA and/or 401K triggered for those 72 years old would make tax even higher

Therefore, the main question is when to start and complete Roth conversions, in order to minimize the overall tax burden? There is no simple answer to this question. It depends on many factors, including individual assets and the time of retirement. But there are simple rules which allow evaluating different strategies and come up with the best one.

MAGI is essentially a taxable income, combined with certain deductions such as Social Security benefit, individual retirement contribution and tax-exempt interest. In 2020, all individuals with MAGI between $12,490 and $49,960 or households with MAGI from $21,330 and $85,320 qualify for tax credits to lower health care premium under ACA (also known as Obamacare act). People with income lower than $12,490 are covered under Medicaid expansion available in most states. Tax credits are the highest for those with the lowest income and gradually phased out for higher income individuals or households.

Medicare premiums are also based on MAGI. Everyone is eligible for Medicare starting at 65. Standard Medicare Plan B rate (which is $144.6 a month in 2020) is available for individuals with income less than $87K and for married couples with income less than $174K. At higher income, premiums rise up to $491.60.

Social security benefits are exempt from federal tax (and from state tax in most states). However, individuals with total income greater than $25K and couples with total income greater than $32K must pay tax on social security benefit. Up to 50% of the benefit is taxed for those with annual income between $25K and $34K ($32K to $44K for couples) and up to 85% is taxed for those with income greater than the limits above. Again, MAGI is considered as a total income for this purpose.

Required Minimum Distribution (RMD) is applied to those older than 72, and with pretax money left in retirement accounts such as traditional IRA or 401K. For a tax purpose, the ordinary income tax is due on entire amount of assets converted during a tax year. The annual amount of RMD is determined as remaining eligible account balance at the end of previous tax year divided by Life Expectancy Factor. The factor is uniform and depend on age: it start with 25.6 for those 72 years old, and gradually reduced to 10.2 for those 92 years old and further down to 1.9 for 115 years old.

Let us consider an example of individual who accumulated $350K in traditional IRA and looking forward for annual Social Security benefit of $25K taken at 70. He/she has a plan to retire at 60, and do regular Roth conversions year after year until 72 with a goal to convert everything before RMD kick in. Then ideally MAGI and income tax would look like in the chart below.

The spike after the age of 69 is due to Social Security tax applied during the Roth conversions. Apparently there will be no impact on Medicare premium and tax will reset to zero once all conversions are done. But what if this individual decides to retire at 55 years old, rather than 60? The chart become a little different.

Obviously the tax bracket changed from 22% to 12% and the spike is much lower than in previous case. But what about the total tax paid during the observation time? Surprisingly, the difference is not that much: $46,128 in the first case which is 60 to 74, compared to $44,326 in the second case which is 55 to 74. Does it make sense to do such a detailed planning to save so little? Actually it does.

The difference comes from ACA subsidies, which can be estimated using this great calculator. For MAGI $30K in the first case, annual premium cap for individual is $2511 and for MAGI $24K (second case) it is dropped to $1586. This is another $1K of savings. For a couple, the difference is less impressive: $1799 compared to $1012. But this is an ideal case. To make it realistic, the following numbers need to be adjusted:

  • We assumed there is $350K saved in pretax money. But for those retired at 60 this amount would likely increase compared to those retired at 55, which means additional tax. Also, many people have accumulated more than $350K in pretax money even at the age of 55.
  • Social security benefit taken at 70 may not be $25K as assumed here. It can be less or greater, depend on the number of contribution years and compensation level.
  • It is a rare case when MAGI is exactly equal to Roth conversion each year. There might be an additional income and deductions taken. It is easier to drive tax down to almost zero in the second case through the deductions, by investing into tax exempt funds for example.
  • Health care premiums can also be driven to near zero, when retiree younger than 65 qualify for Medicaid with MAGI below 138% of Federal Poverty Level ($17,609 for individual and $23,791 for a couple in 2020).
  • Roth’s conversions can be spread beyond the age of 72, but careful RMD evaluation is required in this case.

According to the statistics, most people choose to retire at 65 or later. In this case, opportunity to reduce tax with Roth conversion is limited and high tax bracket is almost guaranteed through the rest of the life.

How to survive expat tax

Everyone must pay tax. Nothing is certain but death and taxes. US citizens must always pay federal tax, no matter where they live. Tax return may get really complicated for those living abroad, because other countries require residents to pay tax on their worldwide income too. How to handle this situation correctly? We already discussed how to prepare for long stay abroad. In this article, I wanted to focus on situation when US citizen live outside of country with all income coming from US. It is typical for retirees and possibly some other people who do not have any source of income outside of US, but by another reason decided to live in a foreign country.

Typically, anyone must stay in the foreign country for more than 180 days in a single year to be considered as a tax payer. Therefore, permanent residence permit is likely required, unless expat share a dual citizenship between US and that country. Also it is important to mention that countries in the world are not created equal. They apply different laws and rules for tax regulation:

  • Expat friendly countries with no local tax for people with US income only (most Latin America countries, for example) or no income tax at all
  • countries which require all residents to pay a local tax but has a tax treaty with US to avoid double taxation (currently more than 60 countries)
  • all other countries

If someone is lucky to live in the country like Mexico, then tax report does not look much different from the one filed within US. Federal US income tax is due on all income sources, and no local tax imposed for people with major income sources in US and no professional activities in Mexico. Even better, there is no need to report US state tax in this case unless rental property income is received. In a later case, tax implications depend on the state where property is located. Some states like Florida, Nevada or Washington does not have a state tax. There are also 10 countries position themselves as zero income tax heaven: United Arab Emirates, Oman, Bahrain, Qatar, Saudi Arabia, Kuwait, Bermuda, Cayman Islands, The Bahamas, Brunei. Of course these countries generate income from other sources, such as natural resources or extremely high living cost.

It is absolutely not in expat’s interest to live in the country which does not have a tax treaty with US. However tax rules may be regulated by country’s specific laws. Anyway, it is not a subject of our current discussion.

Situation is different for those who live in one of the countries which has a tax treaty with US. Overall, the highest tax between US and the country of residence is due in this case. In Europe, local tax is likely higher than US tax in most cases. Portugal is a nice exception, providing up to ten years of local tax break for expats living there. Living in the country with flat income tax can be an advantage when certain conditions met. Typically, it makes sense to pay US tax first and then submit a country’s specific form to local authorities to pay the rest to ensure no double taxation happened.

In order to estimate the total tax burden, we need to understand current brackets for US federal tax (ordinary income):

  • 10% for income up to $9,875 (single) or $19,750 (couple)
  • 12% for income up to $40,125 (single) or $80,250 (couple)
  • 22% for income up to $85,525 (single) or $171,050 (couple)
  • 24% for income up to $163,300 (single) or $326,600 (couple)

There is also a standard deduction $12K (single) or $24K (couple) available as a result of Tax Cuts and Jobs Act (2018). Let us compare US tax rate to another country with progressive tax rate similar to what we have in US, Spain for example. These are the individual tax brackets converted to US dollars:

  • 19% for income up to $13,966
  • 24% for income up to $22,660
  • 30% for income up to $39,487
  • 37% for income up to $67,308
  • 45% for income above $67,308

In addition to that, some regional tax rates applied. There is a married couple allowance of $3,814, in addition to $6,226 general allowance granted to the first tax payer. But these allowances can be applied to Spanish tax only. Moreover, standard or any other type of deductions we normally take in US (including multiple rental property deductions) are not applicable either. Tax exempt bond yield needs to be reported as well: it is exempt in US but must be included into the taxable income for a foreign country. Below is a graph to study the total tax paid by US citizen living in Spain with the ordinary income from US sources in range of $10K to $90K annually.

Apparently, the total tax for those live in Spain is substantially higher than in US for the income range provided. Eventually US and Spanish tax rate would get closer for high earners. But the gap will be still there. It looks like there is just one way to minimize the total tax in this case: accumulate more money in retirement accounts. Within these accounts, capital gain or ordinary income is usually not a part of any tax return except for the specific tax events triggered by pretax to after tax money transactions.

Similar situation observed for capital gain tax (please see the chart below). But the gap between Spanish and US tax become smaller and the curve for Spanish tax is almost flat now. Also the difference between red and blue curves diminish for single person earning more than $40K per year. Therefore, long term capital gain income (such as generated by the sale of stock held for more than one year) is definitely another way to reduce the total tax burden.

In fact, there is a flat income tax rate in some countries. It presents an interesting opportunity for expat who choose to live in one of these countries. Below is a chart to demonstrate a flat rate situation using Czech Republic with a tax rate of 15% for low to mid-income tax payers as an example.

Intersection of blue and green curves (around $53K) is a breaking point. On the right-hand side, total tax is limited by US tax (excluding deductions), while on the left-hand side total tax is limited by foreign tax (Czech in this case). Apparently, foreign tax has been effectively eliminated for those earning more than $53K due to the treaty with US. For expats living on a passive income from US sources, it may be wise to adjust the income to breaking point in order to simplify their tax returns and legally pay US tax only. As we already discussed in other article, taxable income can be adjusted with excessive Roth conversions of pretax money.

But the real advantage of flat tax rate would come to those who actually earn money from the foreign source either through employment or as a business owner. In this case, FEIE (Foreign Earned Income Exclusion) IRS provision allow deducting up to $105,900 of ordinary income earned from the foreign sources. This would mean a substantial US tax reduction and obviously the total tax reduction for residents of countries with a flat tax rate. In this case, greater earned income brings higher tax advantage.

The advantage also depends on what is actually a tax rate in a country of residence. While flat rates from 10% to 15% (Mongolia, Romania, Belarus, Russia, Bulgaria, Bolivia, etc.) can be attractive for most ordinary taxpayers, other countries with the rate in range of 15 – 25% (such as Belize, Estonia, Madagascar) may be a better fit for people with higher net worth and more substantial income. Overall, expat tax reporting process can be extremely complicated. In order to reduce a total tax burden, multiple sources recommend to look for assistance of tax professionals familiar with double taxation as well as with specific country’s rules and regulations.

After tax 401K: great, poor or ugly?

As most of us already know, 401K plan from employer is a great tool to reduce the overall tax burden. Pretty much every one who has 401K at workplace can stash away up to $19K (or $25K for those over 50 years old) in before tax money annually from Uncle Sam. Money can be invested and grow tax-free, until the distribution when tax is still due. At the time of distribution individual must be over 59.5 years old and in the lowest possible tax bracket, in order to enjoy the full advantage of retirement benefit. But what about after tax 401K? More and more employers offer this benefit. How does it matter? What would be the reason to shelve away more money into 401K, if tax has been already paid? Let us figure it out.

There are three types of employer sponsored 401K contributions currently allowed by IRS:

  • before tax (traditional)
  • Roth
  • after tax

The primary type is a traditional 401K as we all know about it. Money are contributed directly by employer with each employee’s pay check on a pretax basis and can be matched by employer. Upon the distribution, federal tax is always due. Also the penalty is imposed if 401K money are distributed at the age under 59.5. Better but less known way of traditional 401K distribution is rollover into the traditional IRA account, which can serve as a temporary stop on the road towards Roth IRA. Since there is a tax event generated with traditional to Roth IRA transition, it is always recommended to transfer smaller amount each year to minimize an overall tax burden. Unfortunately, traditional 401K distributions can be taken after employee’s separation only.

The second type is Roth 401K: money are still contributed by employer with each employee’s pay check but on after tax basis. There may be an employer’s match subject to the total annual limit. Upon the distribution, no tax is due on principal since the tax has been already paid. However tax is due on any earnings generated while money are invested within Roth 401K. The third type is after tax 401K account, which is treated similar to 401K Roth with respect to tax but no employer match is provided.

The main difference between Roth 401K and after tax 401K is in contribution limit:

  • total annual contribution limit for traditional and Roth 401K combined is $19K, or $25K for those over 50 and it does not include employer’s match
  • total annual contribution limit for all three types of 401K accounts including employer’s match is $56K, or $62K for those over 50

At first, it appears, that after tax accounts does not make much sense. The tax on contribution has been already paid, and the tax on earnings is due at the time of distribution. While distributions still can be scheduled at the time of the lowest tax bracket in the future, the advantage depends on earnings generated by after tax investments. Most likely the tax advantage will be less than for traditional 401K.

Situation changes when employer offer in-service distributions for after tax money. This would mean, that after tax money can be distributed while employee still work for the company. Moreover, the latest IRS regulation offer a split distribution of after tax 401K money: principal part can be rolled over into Roth IRA account, while earnings can be rolled over into traditional IRA. In this case, no tax is due at the time of distribution. Also after tax money (principal part) is available to employee at any time.

Why it matter if money are at employer sponsored 401K or personal IRA? There are a few potential advantages of personal IRA accounts:

  • lower fees and unlimited choice of funds to invest
  • less chance of changes in tax or distribution rules in future
  • money can be distributed from personal Roth IRA with no tax (both principal and earnings) when certain conditions are met and there is no required minimum distribution rule

Indeed, personal Roth IRA by design is far better in a long run than other retirement accounts. But it is important to remember Roth IRA distribution rules:

While the advantage of Roth IRA is quite clear, traditional IRA rules may not be as great. Please remember the tax is due on before tax money distribution from traditional IRA, similar to tradition Roth IRA and required minimal distribution is in effect. Also before tax money at traditional IRA dramatically complicates the procedure of backdoor Roth conversion, as presented below. But this is the only way to contribute into Roth IRA for those with adjusted gross income more than $137K (single) or $203K (couple).

Is there a better solution? Apparently, there is. Given the complexity and tax implication of traditional IRA, it is better to have regular rollovers for entire after tax 401K money into personal Roth IRA, to make sure earnings are minimal and does not trigger any substantial tax during conversion:

  • initiate contribution into employer’s sponsored after tax 401K up to the annual limit
  • choose money market or other extremely conservative investment, to make sure earnings are minimal or nonexistent
  • at the end of each month, initiate in-service distribution for entire amount at after tax 401K account into personal Roth IRA: no tax or very little tax will be due at that time
  • invest converted money into any fund of choice within Roth IRA
  • traditional or backdoor Roth IRA contribution limit remain in place, providing additional source of funding

The procedure described above is often referred as Mega Backdoor Roth conversion. In order to combine both ordinary and mega backdoor conversions and maximize the amount of money rolled over into Roth IRA, it is important to follow the diagram below while being employed at one company or changing employers during the career time. It is better to avoid any traditional or after tax 401K roll over into traditional IRA as long as you are employed, apparently in a high tax bracket and doing backdoor Roth conversions every year.

It appears after tax 401K contributions can provide a great advantage, when handled appropriately. By doing this type of conversion, anyone regardless of compensation level can break the small annual Roth IRA contribution barrier imposed by IRS. It is currently defined as $6K, or $7K for those over 50. With the help of mega backdoor conversion, total annual contributions would raise to $62K or $69K respectively. But what about Roth 401K? Due to the relatively small annual limit imposed for the traditional and Roth 401K contributions combined, it does not look as a great option. However it may be make sense to invest into Roth 401K for people in relatively low tax bracket, who expect it to grow over the time.