Dear Liz: I’m hoping to retire in three years so I’m saving as much as possible. I’m maxing out my contributions to a 403(b) retirement plan, a 457(b) deferred compensation plan and a Roth IRA. I also contribute $1,000 each month from my paycheck to an after-tax defined contribution plan offered by my employer. A representative from the plan provider told me I should move the after-tax money into a Roth IRA via monthly rollovers as that will be “more tax efficient.” It means a monthly call which I am happy to do if that is to my advantage. The rep explained it as “a backdoor Roth loophole” that allows one to contribute to a Roth IRA above and beyond the $7,000 limit. Is this advisable?
Answer: If your goal is to stuff more money into a Roth, then this could be a good way to do it.
Roths offer the option of tax-free money in retirement without minimum distribution requirements. That means you can leave the money alone to continue to grow tax free or use it to better manage your tax bill in retirement.
The ability to contribute directly to a Roth phases out with modified adjusted gross incomes of $140,000 for singles and $208,000 for married people filing jointly. People above those income limits can do a “backdoor Roth” by contributing to a traditional IRA and then converting the money to a Roth, since there’s no income limit on conversions. Taxes are owed on the portion of the conversion that represents pre-tax contributions and earnings, so this is usually a technique best used by people who don’t have big pre-tax IRAs.
The “mega backdoor Roth” puts this strategy on steroids. Instead of being held to the usual $6,000 annual IRA contribution limit (or $7,000 for people 50 and older), people make after-tax contributions of up to $58,000 a year to a workplace plan and then convert that money to a Roth IRA. The only tax owed would be on any gains the after-tax money earned between the time you contributed it and the time you converted it. You can have a big pre-tax IRA and still use this technique without that IRA triggering a lot of taxes.
While some plans require you to have left your job before you can make these rollovers, others — like yours — offer “in service” conversions that allow you to convert as you go, which can help minimize your tax bill. People who have to wait until they leave their job to convert will have to pay taxes on any gains the after-tax money has earned. Converting as you go minimizes the taxable gains and instead gets the money into the Roth so it can start growing tax free for you sooner. A monthly call seems like a small price to pay for this benefit, although sometimes the process can be automated. You might ask your employer if they could make that option available.
The $58,000, by the way, is the limit for all contributions to qualified plans. The money you contribute to your 403(b) and 457(a) is deducted from that limit, as are any matches your employer gives you. It’s typically a good idea to max out those pre-tax options, the way you’re doing, before you make any after-tax contributions.
Boosting credit scores
Dear Liz: I’m frustrated with my FICO scores. At one point they were well into the 800s and now they languish in the 720 to 730 range. I have no debt — no mortgage or car loan — and fully pay off two credit cards monthly. I have millions (fact, not bragging) in assets with no liabilities. I don’t anticipate taking any loans but it is so odd to me. Why is this?
Answer: You likely had at least one installment loan, such as a mortgage or car loan, when your scores were near the top of FICO’s typical 300-to-850 scale. You can still have good scores without an installment loan — and you do — but the highest scores require you to have a mix of credit types.
You might be able to add a few points to your scores by paying attention to your credit utilization — the less of your credit limit you use, the better. Adding another card or two may ding your scores in the short run but also could add points long term.
Or you can just be happy as you are. As long as you continue to use your cards responsibly, you’ll continue to have scores that are “pretty enough for all normal purposes” — in other words, that will get you good rates and terms should you decide to apply for additional credit.
Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.