10 Essential Money Saving Tips for 2024

10 Essential Money Saving Tips for 2024

10 Essential Money Saving Tips for 2024. It’s 2024. You turned a new chapter of your life. Here is an opportunity to make smart financial decisions and change your future. I have my list of ideas to help you care for your financial health in 2024.

Here are our 10 Essential Money Saving Tips for 2024

1. Set your financial goals

Your first Money Saving Tip for 2024 is to set your financial goals. Know where you are going. Build milestones of success. Be in control of your journey. Setting and tracking your financial goals will help you make smart financial decisions in the future. It will help you define what is best for you in the long run.

2. Pay off debt

Americans owe $17.3 trillion in debt. The average household owes  $103,358 in total debt, $6,365 in credit cards, and $23,479 in auto loans. These figures are staggering. If you struggle to pay off your debts, 2024 is the year to change your life. Check out my article How to pay off your debt before retirement. With higher interest rates than the previous decade, you can consider consolidating debt or prepaying your high-interest loans. Even a small percentage cut of your interest can lead to massive savings and reductions in your monthly debt payments.

3. Automate bill payments

Are you frequently late on your bills? Are you getting hefty late penalty fees? It’s time to switch on automatic bill payments. It will save you time, frustration, and money. You should still review your bills for unexpected extra charges. But there is no need to worry about making your payments manually. Let technology do the heavy lifting for you.

4. Build an emergency fund

Life can be unpredictable. Economic conditions can change overnight. For that reason, you need to keep money on a rainy day. Your emergency fund should have enough cash to cover 6 to 12 months of essential expenses. The Fed raising rates in 2022 and 2023 finally made it worthwhile for many of us to boost our cash savings,

Set up a certain percentage of your wage automatically in your savings account. Your rainy-day cash will hold you up if you lose your job or your ability to earn income. By maintaining an emergency fund, you could avoid taking debt and cover temporary gaps in your budget.

5. Monitor your credit score

In today’s world, everything is about data. Your credit score measures your financial health. It tells banks and other financial institutions your creditworthiness and ability to repay your debt. Often. The credit score methodology is not always perfect. That said, every lender and even some employers will check your credit score before extending a new line of credit or a job offer.

6. Review and budget your expense

Do you find yourself spending more than you earn? Would you like to save more for your financial goals? If you struggle to meet your milestones, 2024 will allow you to reshape your future. Budgeting is one of our most important Money Tips for 2024. Along with the old-fashioned pen-and-paper method, many mobile apps and online tools can help you track and monitor your expenses. Effective budgeting will help you understand your spending habits and control impulse purchases.

Here are some cost-cutting ideas for 2024:

  • Review your subscriptions
  • Cook at home
  • Make your own coffee/tea
  • Get a Costco membership
  • Shop around and negotiate for big purchases
  • Do it yourself

7. Save more for retirement

Maximizing your retirement savings is one of your most essential money-saving tips for 2024. I recommend saving at least 10% of your earnings every year. If you want to be more aggressive, you can set aside 20% or 25%. A lot depends on your overall income and spending lifestyle.

In 2024, you can contribute up to $23,000 in your 401k. If you are 50 and older, you can set an additional $7,500. Furthermore, you can add another $7,000 to your Roth IRA or Traditional IRA.

8. Plan your taxes

You probably heard the old phrase. It’s not about how much you earn but how much you keep. Taxes are the single largest expense that you pay every year. Whether you are a high-income earner or not, proper tax planning is always necessary to ensure that you keep your taxes in check and take advantage of tax savings opportunities. But remember, tax planning is not a daily race; it’s a multi-year marathon.

9. Review your investments

When was the last time you reviewed your investments? Have you recently checked your 401k plan? You will be shocked how many people keep their retirement savings in cash and conservative mutual fund strategies. Sadly, sitting in cash is a losing strategy, as inflation reduces the purchasing power of your money. A dollar today is not equal to a dollar 10 years from now. While investing is risky, it will help you grow your wealth and protect you from inflation. Remember that, repeatedly, long-term investors get rewarded for their patience and persistence.

10. Protect your family finances from unexpected events

The last three years taught us a big lesson. Life is unpredictable. Bad things can happen suddenly and unexpectedly. In 2024, take action to protect your family, your wealth, and yourself from abrupt events. Start with your estate plan. Make sure you write your will and assign your beneficiaries, trustees, and health directives.

Next, you need to review your insurance coverage. Ensure that your life, disability, umbrella, property, and other insurance are up to date and will protect your family in times of emergency.

401k contribution limits 2024

401k contribution limits 2024

401k contribution limits for 2024 are $23,000 per person, up from 22,500 in 2023. All 401k participants over the age of 50 can make a catch-up contribution of $7,500, for a total of $30,500

Retirement Calculator

What is 401k?

401k is a workplace retirement plan where employees and employers can make retirement contributions. These retirement plans can be one of the easiest and most effective ways to save for retirement. As an employee, you can automatically contribute your 401k directly through your company payroll. You can choose the percentage of your salary toward your retirement savings. Most 401k plans will provide you with multiple investment options in stocks and fixed income. Additionally, most companies offer a 401k match up to a certain percentage. In most cases, you must participate to receive your employer match.

There are three types of 401k contributions – traditional 401k tax-deferred, tax-exempt Roth 401k, and After-tax contributions.

You can select to make both types of tax-deferred and Roth contributions simultaneously. However,  the combined annual contribution amount cannot exceed your annual limit.

Tax-deferred 401k

Most employees commonly choose to make tax-deferred 401k contributions. These payments are tax-deductible. They will lower your tax bill for the current tax year. Your investments will grow on a tax-deferred basis. Therefore, you will only owe federal and state taxes when you start withdrawing your savings.

Roth 401k

Roth 401k contributions are pretax. You will pay all federal and state taxes before making your contributions. The advantage of Roth 401k is that your retirement savings will grow tax-free. If you keep your money until retirement, you will withdraw your gain tax-free. It’s a great alternative for young professionals and workers in a low tax bracket.

After-Tax 401k Contributions

Some 401k plans will allow you to make after-tax contributions. You can make these contributions if you have maximized your annual limit. Generally, after-tax contributions are made after you pay taxes on your income. Only your future gains will be taxable as ordinary income. Due to these tax complexities, after-tax contributions are more common as part of a Mega Backdoor Roth conversion.

Mega Backdoor Roth conversion

Mega back door conversion is a two-step process that allows you to make after-tax contributions to your 401k plan and immediately transfer the money to your Roth 401k account through in-service conversion.

What are my 401k contribution limits for 2024?

401k contribution limits change every year. IRS typically increases the maximum annual limit with the cost of living adjustment and inflation. These contribution limits apply to all employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Additionally, the limits apply to both tax-deferred and Roth contributions combined. 

  • Employees can contribute up to $23,000 to their 401(k) plan for 2024, a $500 increase from 2023.
  • Employees of age 50 or over are eligible for an additional catch-up contribution of $7,500 in 2024, the same amount as in 2023
  • The maximum 401k contribution limit for 2024, including employee contributions and employer match, is $69,000, up from 66,000 in 2023
  • If an employee makes the maximum allowed contribution, the company match cannot exceed  $46,,000, up from $43.500 in 2022
  • The total 401k contribution limit for 2023  from all sources, including catch-up contributions, is $76.500,000, up from 73,500 in 2022
  • The employee compensation limit for calculating 401k contributions is $345,000, up from $330,000 in 2022

Solo 401k contribution limits 2024

A solo 401k plan is a type of 401k plan with one participant. Those are usually solo entrepreneurs, consultants, freelancers, and other small business owners. Self-employed individuals can take advantage of solo 401k plans and save for retirement.

  • The maximum contribution limit in 2024 for a solo 401k plan is $69,000 or $76,500 with catch-up contributions. Solo entrepreneurs can make contributions both as an employee and an employer.
  • The employee contribution cannot exceed $23,000 in the solo 401(k) plan for 2024.
  • Self-employed 401k participants, age 50 or over, are eligible for an additional catch-up contribution of $7,500 in 2024.
  • The total self-employed compensation limit for calculating solo 401k contributions is $345,000.
  • Employer contribution cannot exceed 25% of the compensation
  • If you participate in more than one 401k plan simultaneously, you are subject to the same annual limits for all plans.

Please note that if you decide to hire other employees, you must include them in your 401k plan if they meet the plan eligibility requirements.

 

Roth IRA Contribution Limits 2024

Roth IRA Contribution Limits for 2024

The Roth IRA contribution limits for 2024 are $7,000 per person, with an additional $1,000 catch-up contribution for people who are 50 or older. There is a $500 increase from 2023.

Retirement Calculator

Roth IRA income limits for 2024

Roth IRA contribution limits for 2024 are based on your annual earnings. If you are single or a head of household and earn $146,000 or less, you can contribute up to $7,000 per year. If your aggregated gross income is between $146,000 and $161,000, you can still make a partial contribution with a lower value.

Married couples filing jointly can contribute up to $7,000 each if their combined income is less than $230,000. You can still make partial contributions if your aggregated gross income is between $230,000 and $240,000.

What is a Roth IRA?

A Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you retire, your withdrawals will be tax-free as well.

Roth vs. Traditional IRA

The Roth IRA and Traditional IRA have the same annual contribution limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax, depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints. These are some of the Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to plan your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those with 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in a Roth IRA if they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends, either.

There are no penalties if you withdraw your original investment

While not always recommended, a Roth IRA allows you to start your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say you invested $10,000 several years ago. And now the account has grown to $20,000. You can withdraw your initial contribution of $10,000 without penalties.

Diversify your future tax exposure.

A Roth IRA is ideal for investors in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, a Roth IRA adds a flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change when you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA has no minimum distribution requirements. Savers can withdraw their savings as they wish or keep them intact.

Legacy Planning

A Roth IRA is a great tool for general wealth transfer planning. If you decide to leave your Roth IRA to your heirs, they will not pay taxes on their distributions.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $6,000 in 2024, you could only contribute $6,000 to your Roth.

Last minute 401k moves to make in 2023

Last minute 401k moves to make in 2023

Last minute 401k moves to make in 2023 to boost your retirement savings. Do you have a 401k? These six 401k moves will help you grow your retirement savings and ensure that you take full advantage of your 401k benefits.

2023 has been a very choppy year for investors. Both stocks and bonds have experienced losses and large swings in both directions. As we approach the end of the year, you can take another look at your 401k, reassess your financial priorities, and reevaluate your retirement strategy. Let’s make sure your 401k works for you.

Retirement Calculator

What is a 401k plan?

A 401k is a workplace retirement plan allowing employees to build and grow their retirement savings. It is one of the most convenient and effective ways to save for retirement, as both employees and employers can make retirement contributions. You can set up automatic deductions to your 401k account directly through your company payroll as an employee. You can choose the exact percentage of your salary towards your retirement savings. In 2023, most 401k will provide multiple investment options in stock, fixed-income mutual funds, and ETFs. Furthermore, most employers offer a 401k match for up to a certain percentage. In most cases, you must participate in the plan to receive the match.

1. Maximize your 401k contributions in 2023

The smart way to boost your retirement savings is to maximize your 401k contributions each year.

Did you know that in 2023, you can contribute up to $22,500 to your 401k plan? If you are 50 or over, you are eligible for an additional catch-up contribution of $7,500 in 2023. Traditional 401k contributions are tax-deductible and will lower your overall tax bill in the current tax year.

Many employers offer a 401k match, which is free money for you. The only way to receive the match is to participate in the plan. If you cannot max out your dollar amount, try to deduct the highest possible percentage to capture the entire match from your employer. For example, if your company offers a 4% match on every dollar, at the very minimum, you should contribute 4% to get the entire match.

How to reach $1 million in your 401k by age 65?

Do you want to reach $1 million in your 401k by retirement? The secret recipe is to start early. For example, if you are 25 years old today, you only need to set aside $387 per month for 40 years, assuming a 7% annual return. If you are 35, the saving rate goes up to $820 monthly. If you start in your 50s, you must save about $3,000 a month to get to a million dollars.

401k Contributions by Age
Age | Monthly
Contribution
Yearly
Contribution
Lifetime
Contribution
25 $387 $4,644 $190,404
30 $560 $6,720 $241,920
35 $820 $9,840 $305,040
40 $1,220 $14,640 $380,640
45 $1,860 $22,320 $468,720
50 $3,000 $36,000 $576,000
55 $5,300 $63,600 $699,600

2. Review your investment options.

When did you last review the investment options inside your 401k plan? When was the last time you made any changes to your fund selection? With automatic contributions and investing, it is easy to get things on autopilot. But remember, this is d your retirement savings. Now is the best time to get a grip on your 401k investments.

Look at your fund performance over the last 1, 3, 5, and 10 years and make sure the fund returns are near or higher than their benchmark. Review the fund fees. Check if there have been new funds added to the lineup recently.

What is a Target Date Fund?

A target-date fund is an age-based retirement fund that automatically adjusts your stock and bond investment allocation as you approach retirement. Young investors have a higher allocation to equities, considered more risky assets. In comparison, investors approaching retirement receive a bigger share in safer investments such as bonds. By design, plan participants should choose one target-date fund, set it, and forget until they retire. The fund will automatically change the asset allocation as you near your retirement age.

However, in a recent study, Vanguard concluded that nearly 33% of 401k plan participants misuse their target-date funds.   A third of the people who own TDFs combine them with another fund.

Target date funds in your 401k in 2021

3. Change your asset allocation

Asset allocation tells you how your investments are spread between stocks, bonds, money markets, and other asset classes. Stocks typically are riskier but offer great earnings potential. Bonds are considered a safer investment but provide a limited annual return.

Your ideal asset allocation depends on your age, investment horizon, risk tolerance, and specific individual circumstances.

Typically, younger plan participants have a longer investment horizon and can withstand portfolio swings to achieve higher returns in the future. If you are one of these, investors can choose a higher allocation of stocks in your 401k.

However, if you are approaching retirement, you will have a much shorter investment horizon and probably a lower tolerance to investment losses. In this case, you should consider adding more bonds and cash to your asset allocation.

4. Consider contributing to Roth 401k in 2023

Are you worried that you will pay higher taxes in the future? The Roth 401k allows you to make pretax contributions and avoid taxes on your future earnings. All Roth contributions are made after paying all federal and state income taxes. The advantage is that all your prospective earnings will grow tax-free. If you keep your money until retirement or reach the age of 59 ½, you will withdraw your gains tax-free. If you are a young professional or believe your future tax rate will be higher, Roth 401k is an excellent alternative to your traditional tax-deferred 401k savings.

5. Do a Mega backdoor 401k conversion 

Mega Backdoor 401k is an acronym for after-tax Roth conversion within your 401k plan. Many high-income earners cannot make direct Roth contributions. At the same time, they may prefer traditional tax-deferred 401k contributions, which reduce their current taxes. Mega backdoor 401k allows you to get the best of both worlds. There is one caveat — your 401k plan must allow for after-tax contributions and in-plan conversions.

For 2023, the maximum 401k contributions of any kind (tax-deferred, Roth, after-tax, and employee match) is $66,000, up from $61,000 for 2022. If you’re 50 or older, the limit is $73,500, up from $67,500 in 2022. If you maximize your 401k allowance and receive an employee match, you can choose to make after-tax contributions up to the annual limit. Without any conversion, you will pay taxes on all your gains. The second step in the strategy requires an in-plan Roth conversion, which will move your after-tax money into Roth tax-exempt savings.

6. Rollover an old 401k plan

Do you have an old 401k plan stuck with your former employer? How often do you have a chance to review your balance? Unfortunately, many old 401k plans have been forgotten and ignored for years. Transferring an old 401k to a Rollover IRA can be a wise move.

The rollover is your chance to control your retirement savings. Furthermore, you will expand your investment options from the limited number of mutual funds to the entire universe of stocks, ETFs, and fund managers. Most importantly, you can manage your account according to your retirement goals.

Smart Strategies for Reducing Taxes on Required Minimum Distributions

Reduce taxes on Required Minimum Distributions

What is RMD?

Required Minimum Distributions (RMDs) are mandatory withdrawals that individuals with tax-advantaged retirement accounts like Traditional IRAs, SEP IRAs, and 401k must take after reaching a certain age. These accounts come with certain tax advantages. Typical contributions are tax-deductible. And all earnings grow tax-free.

The purpose of RMDs is to ensure that individuals eventually withdraw their retirement savings in these accounts and pay the appropriate taxes on those withdrawals.

Key points about Required Minimum Distributions:

Age Requirement: You are generally required to start taking RMDs from your retirement accounts by April 1 of the year following the year you turn 73. However, if you turned 70½ before January 1, 2020, the previous age for RMDs was 70½.

The SECURE Act of 2019 increased the RMD age from 70½ to 72 years. Eventually, the SECURE 2.0 Act of 2022 delayed the RMD age—from 72 to 73—starting in 2023. Furthermore, in 2033, the RMD age will increase to age 75.

Calculating RMDs: The IRS provides a formula to calculate your RMD for each account. Your RMD  will be based on your age, account balance, and life expectancy. The formula uses the account balance as of December 31 of the previous year.

Types of Accounts: RMD rules apply to Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans, 403(b) plans, and other tax-advantaged retirement accounts. Roth IRAs are not subject to RMDs during the original account holder’s lifetime.

Taxation: RMDs are generally taxable as ordinary income and are subject to income tax at your applicable tax rate for the year you take them.

Penalties for Not Taking RMDs: Failing to take the required distribution can result in substantial fines. The IRS imposes a penalty of 25% of the RMD amount not withdrawn. SECURE 2.0 Act dropped the excise tax rate 10% if you timely correct your RMDs within two years.

Withdrawal Flexibility: You can always withdraw more than the RMD amount. However, excess withdrawals do not count toward future RMDs.

Inherited Retirement Accounts: If you inherit a retirement account, RMD rules can vary depending on your relationship with the original account holder and the age of the deceased account holder at the time of their passing.

RMD Withdrawal strategies

As individuals approach retirement, they often face a new financial challenge – high taxes on Required Minimum Distributions (RMDs). These mandatory withdrawals from retirement accounts can lead to significant tax liabilities. However, there are several strategic approaches to minimize the tax burden from RMDs, ranging from early Roth contributions to charitable giving. Let’s explore some of these strategies and emphasize the importance of taking a comprehensive view of your retirement plan.

Early Roth Contributions

One of the most effective ways to reduce RMD taxes is by making early contributions to a Roth IRA and Roth 401. Unlike Traditional IRAs and 401(k)s, Roth IRAs allow for tax-free withdrawals in retirement. By contributing to a Roth IRA when you’re younger, you’re building a tax-free source of income for retirement. Moreover, Roth IRAs have no minimum distribution requirements during your lifetime, so you can let your investments grow tax-free for as long as you wish.

Roth Conversions

Considering a Roth conversion might be beneficial if you already have a substantial balance in your Traditional IRA or 401(k). Roth conversion involves transferring a portion of your pre-tax retirement savings into a Roth IRA. While you will pay taxes on the conversion amount, it can be a strategic move to lower future RMDs and ultimately reduce your overall tax burden in retirement. You can plan to make these conversions gradually over several years to lessen their tax impact.

Qualified Charitable Donations

Qualified Charitable Donations (QCDs) offer an excellent way to satisfy your RMD requirement while reducing your taxable income. You can directly transfer up to $100,000 per year from your IRA or 401k to a qualified charity without counting it as income. The QCD not only reduces your tax liability but also supports a cause you care about. QCDs are especially advantageous if you don’t need your entire RMD for living expenses.

Charitable Gift Annuity

A Charitable Gift Annuity (CGA) is another charitable giving option that can help lower your RMD tax burden. With a CGA, you donate a lump sum to a charity in exchange for regular fixed payments for life. These payments are typically partially tax-free, reducing your taxable income and potentially placing you in a lower tax bracket. The size of your payment depends on many factors, including your age when you set up the charitable gift annuity. Younger donors typically receive smaller amounts but for an extended period.

Take Distributions Early

Taking distributions early can be a strategic move for those who have control over their retirement accounts and aren’t relying solely on RMDs for income. By withdrawing money from your retirement accounts before age 73, you can manage your tax liability more effectively. This strategy lets you control when and how much you withdraw, potentially spreading the tax burden over several years.

Take a Comprehensive View

The key to effectively reducing the tax burden of your RMDs is to take a comprehensive view of your financial situation.

Taking a comprehensive view of your overall financial plan is paramount to ensuring a secure and comfortable retirement. It involves not only meeting the IRS requirements but also aligning these distributions with your broader financial goals and circumstances. By considering your entire financial portfolio, including other sources of income, investment strategies, tax implications, and long-term retirement objectives, you can optimize your RMD strategy. This holistic approach helps you strike a balance between satisfying regulatory requirements and making the most of your retirement savings. It also allows for modifications as your financial situation evolves over time, ensuring that your retirement plan remains flexible, robust, and tailored to your unique needs. In essence, taking a comprehensive view empowers you to navigate the intricacies of RMDs within the context of your broader financial well-being, ultimately enhancing your financial security during retirement.

Conclusion

RMDs are an inevitable part of retirement income. With the right strategies, you can significantly reduce the associated tax burden. From early Roth contributions and conversions to charitable giving options like QCDs and CGAs, there are numerous ways to optimize your retirement plan. It’s crucial to take a comprehensive view, considering all available strategies and their impact on your overall financial picture. By doing so, you can enjoy a more financially secure and tax-efficient retirement.

Consider working with a financial advisor or tax professional to create a retirement income strategy encompassing all available options. This strategy should align with your long-term financial goals, risk tolerance, and charitable intentions.

401k contribution limits 2023

401k contribution limits 2023

401k contribution limits for 2023 are $22,500 per person, up from 20,500 in 2022. All 401k participants over the age of 50 can make a catch-up contribution of $7,500, for a total of $30,000

Retirement Calculator

What is 401k?

401k is a workplace retirement plan where employees and employers can make retirement contributions. These retirement plans can be one of the easiest and most effective ways to save for retirement. As an employee, you can automatically contribute your 401k directly through your company payroll. You can choose the percentage of your salary toward your retirement savings. Most 401k plans will provide you with multiple investment options in stocks and fixed income. Additionally, most companies offer a 401k match up to a certain percentage. In most cases, you must participate to receive your employer match.

There are three types of 401k contributions – traditional 401k tax-deferred, tax-exempt Roth 401k, and After-tax contributions.

You can select to make both types of tax-deferred and Roth contributions simultaneously. However,  the combined annual contribution amount cannot exceed your annual limit.

Tax-deferred 401k

Most employees commonly choose to make tax-deferred 401k contributions. These payments are tax-deductible. They will lower your tax bill for the current tax year. Your investments will grow on a tax-deferred basis. Therefore, you will only owe federal and state taxes when you start withdrawing your savings.

Roth 401k

Roth 401k contributions are pretax. You will pay all federal and state taxes before making your contributions. The advantage of Roth 401k is that your retirement savings will grow tax-free. If you keep your money until retirement, you will withdraw your gain tax-free. It’s a great alternative for young professionals and workers in a low tax bracket.

After-Tax 401k Contributions

Some 401k plans will allow you to make after-tax contributions. You can make these contributions if you have maximized your annual limit. Generally, after-tax contributions are made after you pay taxes on your income. Only your future gains will be taxable as ordinary income. Due to these tax complexities, after-tax contributions are more common as part of a Mega Backdoor Roth conversion.

Mega Backdoor Roth conversion

Mega back door conversion is a two-step process that allows you to make after-tax contributions to your 401k plan and immediately transfer the money to your Roth 401k account through in-service conversion.

What are my 401k contribution limits for 2023?

401k contribution limits change every year. IRS typically increases the maximum annual limit with the cost of living adjustment and inflation. These contribution limits apply to all employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Additionally, the limits apply to both tax-deferred and Roth contributions combined. 

  • Employees can contribute up to $22,500 to their 401(k) plan for 2023, a $2,000 increase from 2022.
  • Employees of age 50 or over are eligible for an additional catch-up contribution of $7,500 in 2023, a $1,000 increase from  2022
  • If an employee makes the maximum allowed contribution, the company match cannot exceed  43,,500, up from 40.500 in 2022
  • The maximum 401k contribution limit for 2023, including employee contributions and employer match, is $66,000, up from 61,000 in 2022
  • The total 401k contribution limit for 2023  from all sources, including catch-up contributions, is $73.500,000, up from 67,500 in 2022
  • The employee compensation limit for calculating 401k contributions is $330,000, up from $305,000 in 2022

Solo 401k contribution limits 2023

A solo 401k plan is a type of 401k plan with one participant. Those are usually solo entrepreneurs, consultants, freelancers, and other small business owners. Self-employed individuals can take advantage of solo 401k plans and save for retirement.

  • The maximum contribution limit in 2023 for a solo 401k plan is $66,000 or $73,500 with catch-up contributions. Solo entrepreneurs can make contributions both as an employee and an employer.
  • The employee contribution cannot exceed $22,500 in the solo 401(k) plan for 2023.
  • Self-employed 401k participants, age 50 or over, are eligible for an additional catch-up contribution of $7,500 in 2023.
  • The total self-employed compensation limit for calculating solo 401k contributions is $330,000.
  • Employer contribution cannot exceed 25% of the compensation
  • If you participate in more than one 401k plan simultaneously, you are subject to the same annual limits for all plans.

Please note that if you decide to hire other employees, you must include them in your 401k plan if they meet the plan eligibility requirements.

 

10 Essential Money Saving Tips for 2023

Essential Money Saving Tips for 2023

10 Essential Money Saving Tips for 2023. It’s 2023. You turned a new chapter of your life. After experiencing once-in-a-lifetime events in 2022, here is an opportunity to make smart financial decisions and change your future. I have my list of ideas to help you care for your financial health in 2023.

Here are our 10 Essential Money Saving Tips for 2023

1. Set your financial goals

Your first Money Saving Tip for 2023 is to set your financial goals. Know where you are going. Build milestones of success. Be in control of your journey. Setting and tracking your financial goals will help you make smart financial decisions in the future. It will help you define what is best for you in the long run.

2. Pay off debt

Americans owe $16.5 trillion in debt. The average household owes  $96,000 in total debt, $6,270 in credit cards, and $17,553 in auto loans. These figures are staggering. If you struggle to pay off your debts, 2023 is the year to change your life. Check out my article How to Pay off your debt before retirement. With interest rates on the rise, you can consider consolidating debt or prepaying your high-interest loans. Even a small percentage cut of your interest can lead to massive savings and reductions in your monthly debt payments.

3. Automate bill payments

Are you frequently late on your bills? Are you getting hefty late penalty fees? It’s time to switch on automatic bill payments. It will save you time, frustration, and money. You should still review your bills for unexpected extra charges. But no need to worry about making your payments manually. Let technology do the heavy lifting for you.

4. Build an emergency fund

Life can be unpredictable. Economic conditions can change overnight. For that reason, you need to keep money on a rainy day. Your emergency fund should have enough cash to cover 6 to 12 months of essential expenses. The Fed raising rates in 2022 finally made it worthwhile for many of us to boost our cash savings,

Set up a certain percentage of your wage automatically in your savings account. Your rainy-day cash will hold you up if you lose your job or your ability to earn income. By maintaining an emergency fund, you could avoid taking debt and cover temporary gaps in your budget.

5. Monitor your credit score

In today’s world, everything is about data. Your credit score measures your financial health. It tells banks and other financial institutions your creditworthiness and ability to repay your debt. Often. The credit score methodology is not always perfect. That said, every lender and even some employers will check your credit score before extending a new line of credit or a job offer.

6. Review and budget your expense

Do you find yourself spending more than you earn? Would you like to save more for your financial goals? If you struggle to meet your milestones, 2023 will allow you to reshape your future. Budgeting is one of our most important Money Tips for 2023. Along with the old fashion pen-and-paper method, many mobile apps and online tools can help you track and monitor your expenses. Effective budgeting will help you understand your spending habits and control impulse purchases.

Here are some cost-cutting ideas for 2023:

  • Review your subscriptions
  • Cook at home
  • Make your own coffee/tea
  • Get a Costco membership
  • Shop around and negotiate for big purchases

7. Save more for retirement

Maximizing your retirement savings is one of your most Essential Money Saving Tips for 2023. I recommend saving at least 10% of your earnings every year. If you want to be more aggressive, you can set aside 20% or 25%. A lot depends on your overall income and spending lifestyle.

In 2023, you can contribute up to $22,500 in your 401k. If you are 50 and older, you can set an additional $7,500. Furthermore, you can add another $6,500 to your Roth IRA or Traditional IRA.

8. Plan your taxes

You probably heard the old phrase. It’s not about how much you earn but how much you keep. Taxes are the single highest expense that you pay every year. Whether you are a high-income earner or not, proper tax planning is always necessary to ensure that you keep your taxes in check and take advantage of tax savings opportunities. But remember, tax planning is not a daily race; it’s a multi-year marathon.

9. Review your investments

When was the last time you reviewed your investments? Have you recently checked your 401k plan? You will be shocked how many people keep their retirement savings in cash and conservative mutual fund strategies. Sadly, sitting in cash is a losing strategy, as inflation reduces the purchasing power of your money. A dollar today is not equal to a dollar 10 years from now. While investing is risky, it will help you grow your wealth and protect you from inflation. Remember that, repeatedly, long-term investors get rewarded for their patience and persistence.

10. Protect your family finances from unexpected events

The last three years taught us a big lesson. Life is unpredictable. Bad things can happen suddenly and unexpectedly. In 2023, take action to protect your family, your wealth, and yourself from abrupt events. Start with your estate plan. Make sure you write your will and assign your beneficiaries, trustees, and health directives.

Next, you need to review your insurance coverage. Ensure that your life, disability, umbrella, property, and other insurance are up to date and will protect your family in times of emergency.

Roth IRA and why you probably need one – Updated for 2022

Roth IRA

Roth IRA is a tax-exempt investment account that allows you to make after-tax contributions to save for retirement. The Roth IRA has a tax-free status. It is a great way to save for retirement and meet your financial goals without paying a dime for taxes on your investments. It offers you a lot of flexibility with very few constraints.

Roth IRA is an excellent starting point for young professionals. It can help you reach your financial goals faster. So open your account now to maximize its full potential. Investing early in your career will lay out the path to your financial independence.

1. Plan for your future

Opening a Roth IRA account is a great way to plan for retirement and build financial independence. This tax-free account is an excellent saving opportunity for many young professionals and anyone with limited access to workplace retirement plans. Even those with 401k plans with their employer can open a Roth IRA.

If you are single and earn $129,000 or less in 2022, you can contribute up to $6,000 per year to your Roth IRA. Individuals 50 years old and above can add a catch-up contribution of $1,000. If you are married and filing jointly, you can contribute the full amount if your MAGI is under $204,000.

There is a phaseout amount between $129,000 and $144,000 for single filers and $204,000 and $214,000 for married filing jointly.

2. No age limit

There is no age limit for your contributions. You can contribute to your Roth IRA at any age as long as you earn income.

Minors who earn income can also invest in Roth IRA. While youngsters have fewer opportunities to make money, many sources of income will count – babysitting, garden cleaning, child acting, modeling, selling lemonade, distributing papers, etc.

3. No investment restrictions

Unlike most 401k plans, Roth IRAs do not have any restrictions on the type of investments in the account. You can invest in any asset class that suits your risk tolerance and financial goals.

4. No taxes

There are no taxes on the distributions from this account once you reach the age of 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends, either. Roth IRA is a great saving tool for investors at all income levels and tax brackets.

With an average historical growth rate of 7%, your investment of $6,000 today could bring you $45,674 in 30 years, completely tax-free. The cumulative effect of your return and the account’s tax status will help your investments grow faster.

If you are a California resident, your maximum tax rate on ordinary income can be over 52.5% – 37%  for Federal taxes, 13.3% for State Taxes, and 2.35% for Medicare. This figure excludes Social security and self-employment tax.

The maximum long-term capital gain tax in the US is 23.68%. California residents could pay up to 13,3% on their capital gains as California doesn’t differentiate between long-term and short-term gains.

5. No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contribution (but not the return) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

6. Diversify your future tax exposure

Most of your retirement savings will likely be in a 401k plan or an investment account. 401k plans are tax-deferred, and you will owe taxes on any distributions. Investment accounts are taxable, and you pay taxes on capital gains and dividends. In reality, nobody can predict your tax rate by the time you need to take out money from your retirement and investment accounts. Roth IRA adds this highly flexible tax-advantaged component to your investments.

7. No minimum distributions

Unlike 401k plans, Roth IRA doesn’t have any minimum distributions requirements. Investors can withdraw their savings at their wish or keep them intact indefinitely.

8. Do a backdoor Roth conversion

Due to recent legal changes, investors who do not satisfy the requirements for direct Roth IRA contributions can still make investments in it. The process starts with a taxable contribution, up to the annual limit, into a Traditional IRA. Eventually, the contributions are rolled from the Traditional IRA to the Roth IRA.

9. Roth conversion from Traditional IRA and 401k plans

Under certain circumstances, converting your Traditional IRA and an old 401k plan to Roth IRA could make sense. If you expect to earn less income or pay lower taxes in a particular year, it could be beneficial to consider this Roth conversion. Your rollover amount will be taxable at your current ordinary income tax level. An alternative strategy is to consider annual rollovers in amounts that will keep you within your tax bracket.

10. Estate planning

Roth IRA is an excellent estate planning tool. Due to its age flexibility and no minimum required distributions, it is a good option for generation transfer and leaving a legacy to your beloved ones.

Charitable donations: 6 Tax Strategies – Updated for 2022

Charitable donations

Charitable donations are an excellent way to help your favorite cause, church, foundation, school, or other registered charitable institution of your choice. Americans made $484.85 billion in charitable donations in 2021, which was 4% higher than 2020. The average annual household contribution was $2,534. In 2021, the majority of charitable dollars went to religion (27%), education (14%), human services (13%), grantmaking foundations (13%), and public-society benefit (11%).

Charitable donations are also a powerful tool to reduce your overall tax liability to the IRS. By carefully following the tax law and IRS rules, you can substantially increase the impact of donations. Here is what you can do.

1. Meet the requirements for charitable donations

You can receive tax deductions for your donations as long as they meet specific requirements. Some of the most important rules are:

  • You have to give to qualified charitable organizations approved by the IRS. The charity can be public or private. Usually, public charities receive more favorable tax treatment.
  • You need to have a receipt for your gift.
  • You need to itemize your tax return.
  • Donations apply for the same tax year when you make them. For most individuals, the tax year and calendar year are the same. For some companies, their tax year may end on a different date during the calendar year (for example, November 1 to October 31)
  • All gifts are valued at fair market value. Depending on your donation, the fair market value may not be equal to the initial cash value.
  • You have to transfer the actual economic benefit or ownership to the receiver of your gift.

There are many ways to give. Some are straightforward, and others are more complex and require professional help. Each has its rules, which you need to understand and follow strictly to receive the highest tax benefit.

2. Give cash

Giving money is the easiest way to help your favorite charitable cause. IRS allows for charitable donations for as much as 50% of your aggregated gross income. You can carry over in future years any amounts of more than 50%.s. However, you must keep a record of your cash donations.

3. Give Household goods

You can donate clothes, appliances, furniture, cars, and other household items in good condition. The items will be priced at fair value. In most cases, the value will be lower than what you paid for them. This category is also subject to the 50% limit of the AGI.

Donating household items is a perfect way to clean your closet of old clothes and shoes that you haven’t worn for years. You can even donate your old car collecting dust in the garage. Moreover, if you plan to remodel a kitchen, you can give your old cabinets and appliances to charities like the Salvation Army. Remember to keep the receipts of these items in case the IRS asks you for them.

4. Donate Appreciated assets

One of the most popular tax-saving strategies is donating appreciated assets directly to charitable organizations. This approach is subject to 30% of AGI for donations given to qualified public charities. Appreciated assets can include publicly traded stocks, restricted stocks, real estate, privately held companies, collectibles, and artwork. The main caveat to receiving the highest tax benefit is giving the appreciated asset directly to charitable donations instead of selling it and gifting the remaining cash. This way, you will avoid paying a capital gain tax on the sale of your asset and deduct the full fair value of your asset.

 Let’s look at an example. An investor in a 28% tax bracket is considering donating an appreciating stock to her favorite charity. She can sell the stock and give the proceeds or donate the shares directly. The current market value of the stock is $100,000. She purchased it more than one year ago for $20,000. The total capital gain is $80,000. 

The investor is achieving three essential goals by giving the stock directly to her favorite. First, she is not paying a capital gain tax on the proceeds of the sale. Second, she can use the entire fair value of the stock (instead of the proceeds from the sale) to reduce her tax liabilities. Third, the charitable organization receives an asset with a higher value, which they can sell tax-free.

 5. Make direct IRA charitable rollover

Donations made directly from your IRA and 401k accounts are another way of reducing your tax bill. If you reached 72 (70 ½ if you turned 70 ½ in 2019), you could make up to $100,000 a year in gifts to a charity directly from your IRA or 401k accounts. Those contributions count towards the required annual minimum distributions you must take once you reach  72 or 70 ½, respectively. They also reduce your adjusted gross income. To be compliant, you have to follow two simple rules.

Your plan administrator has to issue a check payable to your charity of choice. Therefore the funds have to transfer directly to the charitable organization. If the check is payable to you, this will automatically trigger a tax event for IRS. In that case, your IRA distribution will be taxable as ordinary income, and you will owe taxes on them. The second rule, you have to complete the transfer by December 31 of the same calendar year.

6. Consolidate your donations

Tax Cuts and Jobs Act of 2017 increased the standard deduction for all individuals and families. Therefore relatively small charitable donations may not be tax-deductible at all.

Standard deduction amounts

2021 tax year 2022 tax year
Individuals $12,550 $12,950
Married couples filing jointly $25,100 $25,900
Heads of households $18,800 $19,400

If you want to increase the tax impact of your donations, you may have to consolidate the small annual contributions in a single year.

Wise 401k moves to make in 2022

Wise 401k moves to make in 2022

Six wise 401k moves to make in 2022 to boost your retirement saving. Do you have a 401k? These five 401k moves will help you grow your retirement savings and ensure that you take full advantage of your 401k benefits.

2022 has been a very choppy year for investors. Both stocks and bonds have experienced losses and large swings in both directions. As we approach the end of the year, you can take another look at your 401k, reassess your financial priorities and .revaluate your retirement strategy,  Let’s make sure your 401k works for you.

Retirement Calculator

What is a 401k plan?

401k plan is a workplace retirement plan that allows employees to build and grow their retirement savings. It is one of the most convenient and effective ways to save for retirement, as both employees and employers can make retirement contributions. You can set up automatic deductions to your 401k account directly through your company payroll as an employee. You can choose the exact percentage of your salary towards your retirement savings. In 2022, most 401k will provide you with multiple investment options in stock, fixed-income mutual funds, and ETFs. Furthermore, most employers offer a 401k match for up to a certain percentage. In most cases, you must participate in the plan to receive the match.

1. Maximize your 401k contributions in 2022

The smart way to boost your retirement savings is to maximize your 401k contributions each year.

Did you know that in 2022 you can contribute up to $20,500 to your 401k plan? If you are 50 or over, you are eligible for an additional catch-up contribution of $6,500 in 2022. Traditional 401k contributions are tax-deductible and will lower your overall tax bill in the current tax year.

Many employers offer a 401k match, which is free money for you. The only way to receive the match is to participate in the plan. If you cannot max out your dollar amount, try to deduct the highest possible percentage so that you can capture the entire match from your employer. For example, if your company offers a 4% match on every dollar, at the very minimum, you should contribute 4% to get the entire match.

How to reach $1 million in your 401k by age 65?

Do you want to have $1 million in your 401k by retirement? The secret recipe is to start early. For example, if you are 25 years old today, you only need to set aside $387 per month for 40 years, assuming a 7% annual return. If you are 35, the saving rate goes up to $820 per month. If you start in your 50s, you need to save about $3,000 a month to get to a million dollars.

401k Contributions by Age
Age | Monthly
Contribution
Yearly
Contribution
Lifetime
Contribution
25 $387 $4,644 $190,404
30 $560 $6,720 $241,920
35 $820 $9,840 $305,040
40 $1,220 $14,640 $380,640
45 $1,860 $22,320 $468,720
50 $3,000 $36,000 $576,000
55 $5,300 $63,600 $699,600

2. Review your investment options

When was the last time you reviewed the investment options inside your 401k plan? When was the last time you made any changes to your fund selection? With automatic contributions and investing, it is easy to get things on autopilot. But remember, this is d your retirement savings. Now is the best time to get a grip on your 401k investments.

Look at your fund performance over the last 1, 3, 5, and 10 years and make sure the fund returns are near or higher than their benchmark. Review the fund fees. Check if there have been new funds added to the lineup recently.

What is a Target Date Fund?

A target-date fund is an age-based retirement fund that automatically adjusts your stock and bond investment allocation as you approach retirement. Young investors have a higher allocation to equities, considered more risky assets. In comparison, investors approaching retirement receive a bigger share in safer investments such as bonds. By design, plan participants should choose one target-date fund, set it, and forget until they retire. The fund will automatically change the asset allocation as you near your retirement age.

However, in a recent study, Vanguard concluded that nearly 33% of 401k plan participants misuse their target-date funds.   A third of the people who own TDFs,  combine them with another fund.

Target date funds in your 401k in 2021

3. Change your asset allocation

Asset allocation tells you how your investments are spread between stocks, bonds, money markets, and other asset classes. Stocks typically are riskier but offer great earnings potential. Bonds are considered a safer investment but provide a limited annual return.

Your ideal asset allocation depends on your age, investment horizon, risk tolerance, and specific individual circumstances.

Typically, younger plan participants have a longer investment horizon and can withstand portfolio swings to achieve higher returns in the future. If you are one of these, investors can choose a higher allocation of stocks in your 401k.

However, if you are approaching retirement, you would have a much shorter investment horizon and probably lower tolerance to investment losses. In this case, you should consider adding more bonds and cash to your asset allocation.

4. Consider contributing to Roth 401k in 2022

Are you worried that you will pay higher taxes in the future? The Roth 401k allows you to make pretax contributions and avoid taxes on your future earnings. All Roth contributions are made after paying all federal and state income taxes. The advantage is that all your prospective earnings will grow tax-free. If you keep your money until retirement or reach the age of 59 ½, you will withdraw your gains tax-free. If you are a young professional or believe your tax rate will grow higher in the future, Roth 401k is an excellent alternative to your traditional tax-deferred 401k savings.

5. Do a Mega backdoor 401k conversion 

Mega Backdoor 401k is an acronym for after-tax Roth conversion within your 401k plan. Many high-income earners cannot make direct Roth contributions. At the same time, they may prefer traditional tax-deferred 401k contributions, which reduce their current taxes. Mega backdoor 401k allows you to get the best of both worlds. There is one caveat — your 401k plan must allow for after-tax contributions and in-plan conversions.

For 2022, maximum 401k contributions of any kind (tax-deferred, Roth, after-tax, and employee match) is $61,000, up from $58,000 for 2021. If you’re 50 or older, the limit is $67,500, up from $64,500 in 2021. If you maximize your 401k allowance and receive an employee match, you can choose to make after-tax contributions up to the annual limit. Without any conversion, you will pay taxes on all your gains. The second step in the strategy requires an in-plan Roth conversion, which will move your after-tax money into Roth tax-exempt savings.

6. Rollover an old 401k plan

Do you have an old 401k plan stuck with your former employer? How often do you have a chance to review your balance? Unfortunately, many old 401k plans have been forgotten and ignored for years. Transferring an old 401k to a Rollover IRA can be a wise move.

The rollover is your chance to control your retirement savings. Furthermore, you will expand your investment options from the limited number of mutual funds to the entire universe of stocks, ETFs, and fund managers. Most importantly, you can manage your account according to your retirement goals.

Maximizing Roth savings for high-income earners

Maximizing Roth savings for high income earners

Maximizing your Roth savings is a terrific way to save for retirement for both high-income earners and professionals at all levels. Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement.

Key Roth benefits for high earners

  • Roth IRA offers tax-free retirement growth. All contributions are pre-tax. In other words, you pay taxes before you make them. Once your dollars hit your Roth IRA, they grow tax-free.
  • You won’t pay any taxes on future capital gains and dividends.
  • Roth IRA is not subject to required minimum distributions at age 72.
  • You can always withdraw your original contribution tax and penalty-free.
  • Maximizing your Roth savings, especially for high-income earners, is an effective way to diversify your future tax exposure
  • High earners can incorporate their Roth savings as part of their estate planning strategy

How much can I contribute to my Roth IRA?

You can contribute up to $6,000 to your Roth IRA in 2022 or $7,000 if you are 50 years or older. For 2023, you can contribute $6.500 or or $7,500 if you are 50 years or older

Income limits for Roth contributions

Roth IRA contribution limits for 2022 are based on your annual earnings. If you are single or a head of household and earn $129,000 or less, you can contribute up to the full amount of $6,000 per year. If your aggregated gross income is between $129,000 and $144,000, you can still make contributions with a lower value.

Married couples filing jointly can contribute up to $6,000 each if their combined income is less than $204,000. You can still make reduced contributions if your aggregated gross income is between $204,000 and $214,000.

If you are a high earner, you will not meet the income limits to make direct Roth contributions. However, you still have some options. Here are some ideas that can help you boost your Roth savings

Speak with a financial advisor to find out what Roth strategies make sense for you

Backdoor Roth IRA for high-income earners

The Backdoor Roth IRA is a multi-step process that allows high-income earners to bypass the Roth Income limits. The strategy comes with some conditions. While the IRS has kept the rules vague, it’s easy to make mistakes while following the process. I had seen more than one client who had made some mistakes when they followed the backdoor steps.

Here are the general guidelines. Remember that everyone’s circumstances are unique, and this article may not address all of them.

Backdoor Roth IRA steps

  1. Contribute to a non-deductible IRA. Roth IRA and Traditional IRA have the same income limits. If you do not qualify to make direct Roth contributions, you don’t qualify for tax-deductible IRA savings. When you contribute to a non-deductible IRA, you are making an after-tax contribution to an IRA. Theoretically, you will pay taxes on your future gain but the original amount.
  2. Convert your contribution to a Roth IRA. In the second step of the process, you must transfer your assets from the non-deductible IRA to your Roth IRA. Your IRA administrator or financial advisor will give you the instructions and paperwork. Every broker requires a slightly different process.
  3. File your taxes and submit Form 8606. You must file form 8606 to report your non-deductible contributions to traditional IRAs. Please consult your CPA or tax accountant for the exact requirements for filling out and submitting the form. Pay attention to this form when you file your taxes using tax software.
  4. The Pro-Rata Rule. The pro-rata rule has one of the biggest implications in the backdoor process. The rules stipulate that ALL Roth conversions must be made on a pro-rata basis. In other words, if you have an outstanding Traditional RA, SEP IRA, or Simple IRA, your Roth conversion must be pro-rated between all existing IRA accounts, not just the non-deductible IRA from which you want to make the transfer. In other words, the Backdoor Roth strategy could trigger a substantial taxable event for you if you own tax-deferred IRA savings.

Roth conversion from IRA and 401k

Roth conversion involves the transfer of the tax-deferred savings in your IRA or 401k accounts into tax-exempt investments in your Roth IRA. Roth conversion can be a brilliant move for high-income earners in the right circumstances.

Your current and future taxes are critical elements of any Roth conversion decision-making. The strategy becomes viable during low tax years or whenever you expect higher tax rates in the future. Higher future tax rates make a Roth IRA more appealing, while lower future tax rates would make a traditional IRA more attractive.

With some proactive planning, Roth IRA offers substantial tax-free benefits. Due to income limits, many high-income savers end up with significant amounts in tax-deferred accounts such as 401k and Traditional IRA. These plans give you initial tax relief to encourage retirement savings. However, all future distributions are fully taxable and subject to required minimum distributions.

Learn more about Roth conversion here

Roth 401k

Most corporate 401k plans allow you to make either traditional tax-deferred or Roth 401k contributions. Roth 401k is similar to Roth IRA as both accounts are funded with after-tax dollars.

The contribution limits for 2022 are $20,500 per person. All 401k participants over the age of 50 can add a catch-up contribution of $6,500.

Roth 401k vs. Roth IRA

Roth 401k and Roth IRA are very similar, but Roth 401k has major advantages for high-income earners

  1. No income limits – Unlike Roth IRA, the Roth 401l doesn’t have income limits. Anyone eligible to participate in their company’s 401k plan can make Roth 401k contributions.
  2. Higher Contribution limits – You can save a lot more in your company’s Roth 401k plan versus a personal Roth IRA. You can save up to $20,500 in your Roth 401k and $6,000 in your Roth IRA. If you are 50 or older, you can stash $27,000 vs. $7,000
  3. Company match – You are eligible for a company match even if you make Roth 401k contributions. All employer matching contributions will be tax-deferred and placed in a separate account
  4. Investment options – Roth IRA offers a broader range of investment options vs. 401k plans with a limited list of funds.
  5. Distributions rules – Roth 401k savings are subject to required maximum distributions at age of 72. You can avoid this rule by rolling over your Roth 401k into a Roth IRA once you stop contributing to the plan.

What Is a Mega Backdoor Roth 401k?

Mega Backdoor 401k is an acronym for after-tax Roth conversion within your 401k plan. Many high-income earners cannot make direct Roth contributions. At the same time, they may prefer traditional tax-deferred 401k contributions, which reduce their current taxes. Mega backdoor 401k allows you to get the best of both worlds. There is one caveat — your 401k plan must allow for after-tax contributions and in-plan conversions. Depending on your plan design, setting up a Mega backdoor 401k can be pretty complex or relatively simple.

For 2022, maximum 401k contributions of any kind (tax-deferred, Roth, after-tax, and employee match) is $61,000, up from $58,000 for 2021. If you’re 50 or older, the limit is $67,500, up from $64,500 in 2021. If you maximize your 401k allowance and receive an employee match, you can choose to make after-tax contributions up the annual limit. Without any conversion, you will pay taxes on all your gains. Since your original contribution was after-tax, you don’t pay taxes on that amount. Furthermore, the IRS limits the compensation eligible for 401k contributions to $305,000 or 2022. Depending on your specific circumstances, the final contribution amount to your 401k plan may vary,

Here is how Mega Backdoor Roth 401k works

  1. Maximize your 401k contributions for the year
  2. Opt-in for after-tax 401k contributions. Your plan must allow for this election
  3. Convert your after-tax contributions into Roth 401k as soon as possible to avoid possible taxable gains. Some plans may allow you to choose automatic conversions versus manual.
  4. Watch your Roth savings grow tax-free

Final words

Maximizing Roth savings can be highly advantageous for high-income earners and hard-working professionals. Since Roth IRAs have strict income limits, not everyone will qualify automatically for direct contributions. You will need careful planning to maneuver all the different rules and a long-term view to enjoy the benefits of your Roth savings.

401k contribution limits 2022

401k contribution limits 2022

401k contribution limits for 2022 are $20,500 per person. All 401k participants over the age of 50 can add a catch-up contribution of $6,500.

Retirement Calculator

What is 401k?

401k plan is a workplace retirement plan where both employees and employers can make retirement contributions. These retirement plans can be one of the easiest and most effective ways to save for retirement. As an employee, you can make automatic contributions to your 401k directly through your company payroll. You can choose the percentage of your salary that will go towards your retirement savings, Most 401k will provide you with multiple investment options in stocks and fixed income. Additionally, most companies offer a 401k match up to a certain percentage. In most cases, you need to participate in the plan in order to get the match.

There are two types of contributions – traditional 401k tax-deferred and tax-exempt Roth 401k contributions.

Tax-deferred 401k

Most employees, typically, choose to make tax-deferred 401k contributions. These payments are tax-deductible. They will lower your tax bill for the current tax year. Your investments will grow on a tax-deferred basis. Therefore, you will only owe federal and state taxes when you start withdrawing your savings.

Roth 401k

Roth 401k contributions are pretax. It means that you will pay all federal and state taxes before making your contributions. The advantage of Roth 401k is that your retirement savings will grow tax-free. As long as you keep your money until retirement, you will withdraw your gain tax-free. It’s a great alternative for young professionals and workers in a low tax bracket.

What are my 401k contribution limits for 2022?

401k contribution limits change every year. IRS typically increases the maximum annual limit with the cost of living adjustment and inflation. These contribution limits apply to all employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. Additionally, the limits apply to both tax-deferred and Roth contributions combined. 

  • Employees can contribute up to $20,500 to their 401(k) plan for 2022, a $1,000 increase from 2021.
  • Employees of age 50 or over are eligible for an additional catch-up contribution of $6,500 in 2022, the same amount as  2021
  • The employee compensation limit for calculating 401k contributions is $305,000, $15,000 more than 2021
  • Companies can make a matching contribution up to the combined limit of $61,000 or $67,500 with the catch-up contribution. If an employee makes the maximum allowed contribution, the company match cannot exceed $40,500 in 2022.

Solo 401k contribution limits 2022

A solo 401k plan is a type of 401k plan with one participant. Those are usually solo entrepreneurs, consultants, freelancers, and other small business owners. Self-employed individuals can take advantage of solo 401k plans and save for retirement.

  • The maximum contribution limit in 2022 for a solo 401k plan is $61,000 or $67,500 with catch-up contributions. Solo entrepreneurs can make contributions both as an employee and an employer.
  • The employee contribution cannot exceed $19,500 in the solo 401(k) plan for 2021.
  • Self-employed 401k participants, age 50 or over are eligible for an additional catch-up contribution of $6,500 in 2021.
  • The total self-employed compensation limit for calculating solo 401k contributions is $290,000.
  • Employer contribution cannot exceed 25% of the compensation
  • If you participate in more than one 401k plan at the same time, you are subject to the same annual limits for all plans.

Please note that if you are self-employed and decide to hire other employees, they will have to be included in the 401k plan if they meet the plan eligibility requirements.

 

Roth IRA Contribution Limits 2023

Roth IRA Contribution Limits for 2023

The Roth IRA contribution limits for 2023 are $6,500 per person with an additional $1,000 catch-up contribution for people who are 50 or older. There is $500 increase from 2022.

Retirement Calculator

Roth IRA income limits for 2023

Roth IRA contribution limits for 2023 are based on your annual earnings. If you are single or a head of household and earn $138,000 or less, you can contribute up to the full amount of $6,500 per year.  If your aggregated gross income is between $138,000 and $153,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,500 each if their combined income is less than $218,000.  If your aggregated gross income is between $218,000 and $228,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

The Roth IRA and Traditional IRA have the same annual contributions limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $5,000 in 2023, you could only contribute $5,000 in your Roth

Roth IRA Contribution Limits 2022

Roth IRA Contribution Limits for 2022

The Roth IRA contribution limits for 2022 are $6,000 per person with an additional $1,000 catch-up contribution for people who are 50 or older. There is no change from 2021.

Retirement Calculator

Roth IRA income limits for 2022

Roth IRA contribution limits for 2022 are based on your annual earnings. If you are single or a head of household and earn $129,000 or less, you can contribute up to the full amount of $6,000 per year.  If your aggregated gross income is between $129,000 and $144,000 you can still make contributions but with a lower value.

Married couples filing jointly can contribute up to $6,000 each if your combined income is less than $204,000.  If your aggregated gross income is between $204,000 and $214,000 you can still make reduced contributions.

What is a Roth IRA?

Roth IRA is a tax-free retirement savings account that allows you to make after-tax contributions to save towards retirement. Your Roth investments grow tax-free. You will not owe taxes on dividends and capital gains. Once you reach retirement your withdrawals will be tax-free as well.

Roth vs Traditional IRA

The Roth IRA and Traditional IRA have the same annual contributions limits. Roth IRA allows you to make after-tax contributions towards retirement. In comparison, the Traditional IRA contributions can be tax-deductible or after-tax depending on your income. Additionally, your Traditional IRA savings grow tax-deferred. Unlike Roth Roth, you will owe income taxes on your withdrawals.

Roth IRA Rules

The Roth IRA offers a lot of flexibility and few constraints.  There are Roth IRA rules that can help you maximize the benefits of your tax-free savings account.

Easy and convenient

Opening a Roth IRA account is a great way to start planning for your financial future. The plan is an excellent saving opportunity for many young professionals with limited access to workplace retirement plans. Even those who have 401k plans with their employer can open a Roth IRA.

Flexibility

There is no age limit for contributions. Minors and retired investors can invest in Roth IRA as well as long as they earn income.

No investment restrictions

There is no restriction on the type of investments in the account. Investors can invest in any asset class that suits their risk tolerance and financial goals.

No taxes

There are no taxes on the distributions from this account once you reach 59 ½. Your investments will grow tax-free. You will never pay taxes on your capital gains and dividends either.

No penalties if you withdraw your original investment

While not always recommended, Roth IRA allows you to withdraw your original dollar contributions (but not the return from them) before reaching retirement, penalty and tax-free. Say, you invested $5,000 several years ago. And now the account has grown to $15,000. You can withdraw your initial contribution of $5,000 without penalties.

Diversify your future tax exposure

Roth IRA is ideal for investors who are in a lower tax bracket but expect higher taxes in retirement. Since most retirement savings sit in 401k and investment accounts, Roth IRA adds a very flexible tax-advantaged component to your investments. Nobody knows how the tax laws will change by the time you need to take out money from your retirement accounts. That is why I highly recommend diversifying your mix of investment accounts and taking full advantage of your Roth IRA.

No minimum distributions

Unlike 401k and IRA, Roth IRA doesn’t have any minimum distributions requirements. Investors have the freedom to withdraw their savings at their wish or keep them intact indefinitely.

Earnings cap

You can’t contribute more than what you earned for the year. If you made $4,000, you could only invest $4,000.

5 reasons to leave your robo-advisor and work with a real person

Leave your robo-advisor

Leave your robo-advisorRobo-advisors have grown in popularity in the last 10 years, offering easy and inexpensive access to professional investment management with human interaction.  Firms like Vanguard, Betterment, Personal Capital, and Wealth Front use online tools and algorithms to build and manage your investment. These digital advisors attract new customers with cutting-edge technology, attractive websites, interactive features, low fees, and cool mobile apps. The rising adoption of robo-advisors and various digital platforms allows the financial industry to become more accessible and consumer-friendly.

Unlike traditional portfolio management firms, most robo-advisors offer their automated investing service with low or no account minimums. You will answer an online questionnaire. Your answers will place you in a specific risk tier group. As a result, the robo-advisor will invest your assets according to your risk profile. The typical digital advisor offers automated portfolio rebalancing and tax loss harvesting. Some may even offer you financial planning advice for an additional fee.

If you have read one of my Investment Ideas articles (here and here), you know that I am a big believer in FinTech, mobile payments, and digitization of the financial industry. The covid outbreak created a massive tailwind for this trend to continue in the next decade. You will experience a complete digital transformation in all aspects of your financial life.

With all that in mind, why someone like yourself will decide to abandon their digital advisor service? So here we go.

Receive personalized advice

Life changes. Often you will be at crossroads in your life trying to make important financial decisions. You will need to talk to someone who understands your situation and can give you personalized advice with your best interest in mind. Unfortunately, digital advisor services rarely, if never offer personalized advice. Algorithms cannot understand your emotions and feelings.

Surely, you can do the research and the hard lifting yourself. There is nothing more rewarding than reaping the benefits from your hard work. However, there is nothing wrong with asking for help. You do not have to do it alone. Working with a fiduciary financial advisor who understands your circumstances will save you time and grievance. Moreover, it will save you and make you money in the long run. And most importantly, it allows you to enjoy what matters most to you.

Build a relationship

Finding a good financial advisor is like finding a personal doctor or a hairstylist who cuts your hair just the way you wanted. Would you ask a robot to cut your hair? Then, why would you leave your wealth and retirement savings to an algorithm? Having a trusted relationship with a fiduciary financial advisor will give you access to objective, unbiased, and reliable financial advice when you need it most. Your financial advisor can point your financial blind spots and recommendations on how to resolve them before they escalate.

I frequently work with clients coming from large robo-advisors. Almost always, their biggest complaint is that they were not able to get answers to their questions. They were calling customer service, waiting in line, and speaking with a complete stranger on the other side.

Building wealth is a marathon, not a race. Why not working with a trusted partner who understands your unique needs and has your best interest in mind.

Invest with purpose

Have you asked yourself, does your investment portfolio represent your philosophy and values?

For many of you, investing is a way to make a meaningful impact on your favorite causes.

Furthermore, most robo-advisors offer a limited number of generic ETFs in various asset classes. However, they do not provide a way to customize your investments according to your core values.  The only you can achieve your purpose is through a customized investment portfolio that represents what you believe.

Impact Investing

Impact investing is about MAKING A DIFFERENCE. It is a philosophy that seeks to achieve sustainable long-term returns by investing in companies that create positive and measurable social, governance, and environmental impact. If you are an impact investor, your goal is to invest your money in areas that match your core beliefs and values.  By choosing the path of impact investing, you will provide the necessary support to address the world’s most urgent challenges in areas such as sustainable agriculture, clean energy, gender equality, social justice, food conservation, microfinance, and affordable access to housing, healthcare, and education.

Thematic investing

Thematic investing is a path to achieve higher long-term returns by investing in specific economic and secular trends caused by structural shifts in our society. It is about CHANGE. The thematic investing strategy relies on megatrends that are changing the way we live. Several of my favorite trends include climate change and renewable energy, 5G and cybersecurity, digital payments and e-commerce, blockchain and digital revolution, the rising power of women, and population growth.

Have a plan

Life is complicated.  As a result, your circumstances will change. You will start a new job, move to a new place. Start a family. Buy a new house. Exercise those stock options that you received when you started your last job. Above all, you must prepare for everything that life has to give.

Once you do the groundwork, it’s easier to update your plan than create a new one from scratch every time your life changes. Your plan will make you feel confident when making complex financial decisions about your future.

According to Vanguard itself, working with a financial advisor can bring you up to 3% average additional return. The advisor alpha comes from value-added services such as behavioral coaching, tax-smart investing, asset allocation, and rebalancing.

Get a customized tax strategy.

Let’s admit it. The US has one of the most complex tax systems in the world. We all get tangled with terms such as AMT, marginal tax bracket, capital gain tax, 401k, step-up basis, tax-deferred and exempt income. With the ever-rising budget deficit, there is no doubt that your taxes will only go higher. Paying taxes is part of life but managing your future tax bill is your responsibility.

One popular way to measure the efficiency of your tax strategy is your tax alpha. Tax Alpha is the ability to achieve an additional return on your investments by taking advantage of all available tax strategies as part of your comprehensive financial planning. Unlike robo-advisors,  our firm can offer a wider range of tax planning tools that can help you realize higher long-term after-tax returns.  For instance, for us, achieving Tax Alpha is a process that starts on day 1.  As a result, we will craft a comprehensive strategy that will maximize your financial outcome and lower your taxes in the long run.

Effective Roth Conversion Strategies for Tax-Free Growth

Roth Conversion

Roth conversion of your tax-deferred retirement savings can be a brilliant move. Learn the must-know rules and tax implications of Roth Conversion before you decide if it is right for you.

Retirement Calculator

What is a Roth Conversion?

Roth Conversion is the process of transferring the full or partial balance of your existing traditional IRA into a Roth IRA. The conversion effectively moves tax-deferred retirement savings into tax-exempt dollars.

A critical downside of Roth conversion is that you need to pay income taxes on the converted amount. For that reason, it is beneficial to have additional taxable savings to cover the tax cost of the conversion.

Unfortunately, not everybody is the right candidate for Roth conversion. Consider your specific financial and tax circumstances before moving forward.

Watch your tax bracket

A crucial element of any Roth conversion decision making is your taxes. The strategy becomes feasible during low tax years or whenever you expect higher tax rates in the future. Higher future tax rates make a Roth IRA more appealing, while lower future tax rates would make a traditional IRA more attractive.

Consider your investment horizon

Generally, you will achieve a higher benefit if you perform your conversions earlier. Your Roth IRA will have time to grow tax-free for longer and will offset the cost of paying taxes upfront. 

Roth IRA 5-year rule

When you do a Roth conversion, you need to be mindful of the 5-year rule. The rule requires that 5 years have passed since your first Roth contributions before taking penalty-free withdrawals of your tax-free earnings.

You can still withdraw your original contributions at any time. However, your earnings are subject to the 5-year minimum restriction. If you do not meet the minimum 5-year holding period, your profits can be subject to ordinary income tax as well as a 10% penalty for early withdrawal.

Furthermore, each separate Roth conversion has a five-year limit. The Five-Year clock begins ticking on January 1st of the year when you make the conversion.

The advantages of Roth conversion

Converting your tax-deferred dollars to Roth RIA can have several financial and estate benefits.

Your money grows tax-free

Savings in your Roth IRA grow tax-free. As long as you meet the 5-year rule, you will not owe any taxes on your distributions. Roth IRA contributions are pre-tax. You are paying taxes beforehand but do not owe taxes on any future earnings.

In comparison, contributions to Traditional IRA are typically tax-deductible. When you take distributions from Traditional IRA, you have to pay ordinary income taxes on your entire withdrawal amount. 

Tax Diversification

If your future tax rate is uncertain for various reasons, you may want to diversify your tax risk through Roth conversion. You will benefit from holding both tax-deferred and tax-exempt retirement accounts. Tax diversification gives you more flexibility when it comes to future retirement withdrawals and tax planning. 

Asset Location

Asset location is a tax-optimization strategy that takes advantage of different types of investments, getting different tax treatments. Investors who own a variety of taxable, tax-deferred, and tax-exempt accounts can benefit from asset location. By doing Roth conversion, you can determine which securities should be held in tax-deferred accounts and which in Roth accounts to maximize your after-tax returns.

No Required Minimum Distributions

Traditional IRA rules mandate you to take taxable required minimum distributions (RMDs) every year after you reach age 72.

Alternatively, your Roth IRA does not require minimum distributions at any age. Your money can stay in the account and grow tax-free for as long as you want them.

Leave behind a tax-free legacy

The Roth IRA can play a crucial role in your estate planning. Your heirs who inherit your Roth IRA will receive a tax-free gift. They will be required to take distributions from the account. However, they will not have to pay any income tax on the withdrawals if the Roth IRA has been open for at least five years. Roth IRA is especially appealing if your heirs are in a higher tax bracket than you.

Keep Social Security income tax and Medicare Premiums low

Another hidden benefit of the Roth conversion is it could potentially lower your future social security income tax and Medicare Premiums.

Up to 85% of your Social Security checks can be taxable for individuals earning more than $34,000 and families receiving more than $44,000 per year.

Your Medicare Plan B premium will be calculated based on your reported income-related monthly adjustment amount (IRMAA) 2 years prior to your application. Even a dollar higher can push in a higher premium bracket,

Roth Conversion Strategies

With some planning, Roth IRA offers substantial tax-free benefits. Due to income limits, many retirement savers end up with significant amounts in tax-deferred accounts such as 401k and Traditional IRA. These plans give you initial tax relief to encourage retirement savings. However, all future distributions are fully taxable.

The Roth conversion may help you reduce your future tax burden and unlock some of the befits of Roth IRA. Here are some of the strategies that can be helpful in your decision process.

  

End-of-year Roth conversion

The stability of your income can be critical to your success. Each conversion must be completed by the end of each tax year. If your income is constant, you can process the conversion at any time. If your income is less predictable, your only choice will be to make your conversions towards the end of the year when you will have more visibility on your earnings.

Conversion during low-income years

The Roth conversion is generally more attractive during your low-income years when you will be in a lower tax bracket. The additional reported income from the conversion will add on to your base earnings. If you do the math right, you will be able to maintain your taxes relatively low. Analyze your tax bracket and convert the amount that will keep in your desired marginal tax rate.

Conversion during a market downturn

Another popular strategy is performing Roth conversion during a market downturn. A Roth conversion could become appealing if your Traditional IRA is down 20% or 30%. At the same time, you have a long-term investment horizon and believe that your portfolio will recover the losses over time.

Your largest benefit will come from the potential tax-free portfolio gains after the stock market goes higher. With this approach, your underlying taxes take a lower priority versus the ability to earn higher tax-free income in the future. However, you still need to determine whether saving taxes on future gains provides a higher benefit than paying higher taxes now.

Monthly or quarterly cost averaging

Timing the stock market is hard. The cost averaging strategy removes the headache of trying to figure out when the stock market will go up or down. This approach calls for making planned periodic, monthly, or quarterly, conversions. The benefit of this method is that at least part of your portfolio may benefit from lower stock values. It is a way to hedge your bets on surprising stock market moves. If your portfolio goes higher consistently throughout the year, your earlier conversions will benefit from lower stock values. If the stock market goes down in the second half of the year, your later-in-the-year conversion will produce a higher benefit.

Roth Conversion barbelling

This strategy makes sense if your annual income is variable and less predictable. For example, your income fluctuates due to adjustments in commissions, bonuses, royalties, or other payments. With barbelling, you perform two conversions per year. You make the first conversion early in the year based on a projected income that is at the high end of the range. The second conversion will occur towards the end of the year, when your income becomes more predictable. If your income is high, you may convert a much smaller amount or even nothing. If your earnings for the year are at the lower end of expectation, then you convert a larger amount.

Roth Conversion Ladder

As I mentioned earlier, each Roth conversion is subject to its own 5-year rule. The 5-year period starts on January 1st of the tax year of your Roth conversion. Every subsequent conversion will have a separate 5-year holding period.

The Roth Conversion ladder strategy requires a bit of initial planning. This approach stipulates that you make consistent annual conversions year after year. After every five years, you can withdraw your savings tax-free from the Roth IRA. In effect, you are creating a ladder similar to the CD ladder.

Keep in mind that this strategy only makes sense under two conditions. One, you can afford to pay taxes for the conversion from another taxable account. Second, your future taxable income is expected to increase, and therefore you would be in a higher tax bracket.

Conclusion

Roth Conversion can be a great way to manage your future taxes. However, not every person or every family is an ideal candidate for a Roth conversion. In reality, most people tend to have lower reportable income when they retire. For them keeping your Traditional IRA and taking distributions at a lower tax rate makes a lot of sense. However, there are a lot of financial, personal, and legacy planning factors that come into play. Make your decision carefully. Take a comprehensive look at your finance before you decide if Roth conversion is right for you.

New Year Financial Resolutions for 2022

New Year Financial Resolutions for 2022

New Year Financial Resolutions for 2022. It’s 2022. You turned a new chapter of your life. Here is an opportunity to make smart financial decisions and change your future. We have our list of ideas that can help you.

Here are your New Year Financial Resolutions for 2022

1. Set your financial goals

Your first  New Year Financial Resolutions for 2022 is to set your financial goals. Know where you are going. Build milestones of success. Be in control of your journey. Setting and tracking your financial goals will help you make smart financial decisions in the future. It will help you define what is best for you in the long run.

2. Pay off debt

Americans owe $14.3 trillion in debt. The average household owes  $145,000 in total debt, $6,270 in credit cards, and $17,553 in auto loans. These figures are insane. If you struggle to pay off your debts, 2022 is your year to change your life. Check out my article How to Pay off your debt before retirement. With interest rates staying at record low levels, you can look into consolidating debt or refinancing your mortgage. Take advantage of these low-interest options. Even a small percentage cut of your interest can lead to massive savings and reductions in your monthly debt payments.

3. Automate bill payments

Are you frequently late on your bills? Are you getting hefty late penalty fees? It’s time to switch on automatic bill payments. It will save you time, frustration, and money. You should still review your bills for unexpected extra charges. But no need to worry about making your payments manually. Let technology do the heavy lifting for you.

4. Build an emergency fund

Life can be unpredictable. Economic conditions can change overnight. For that reason, you need to keep money on a rainy day. Your emergency fund should have enough cash to cover 6 to 12 months of essential expenses. Start with setting up a certain percentage of your wage automatically going to your savings account. Your rainy-day cash will hold you up if you lose your job or your ability to earn income. By maintaining an emergency fund, you could avoid taking debt and cover temporary gaps in your budget.

5. Monitor your credit score

In today’s world, everything is about data. Your credit score measures your financial health. It tells banks and other financial institutions your creditworthiness and ability to repay your debt. Often. The credit score methodology is not always perfect. That said, every lender and even some employers will check your credit score before extending a new line of credit or a job offer.

6. Budget

Do you find yourself spending more than you earn? Would you like to save more for your financial goals? If you are struggling to meet your milestones, 2022 will give you a chance to reshape your future. Budgeting should be your top New Year Financial Resolutions for 2022. Many mobile apps and online tools alongside old fashion pen-and -aper to track and monitor your expenses. Effective budgeting will help you understand your spending habits and control impulse purchases.

7. Save more for retirement

One of your most important New Year Financial Resolutions for 2022 should be maximizing your retirement savings. I recommend saving at least 10% of your earnings every year. If you want to be more aggressive, you can set aside 20% or 25%. A lot depends on your overall income and spending lifestyle.

In 2022, you can contribute up to $20,500 in your 401k. If you are 50 and older, you can set an additional $6,500. Furthermore, you can add another $6,000 to your Roth IRA or Traditional IRA.

8. Plan your taxes

You probably heard the old phrase. It’s not about how much you earn but how much you keep. Taxes are the single highest expense that you pay every year. Whether you are a high-income earner or not, proper tax planning is always necessary to ensure that you keep your taxes in check and take advantage of tax savings opportunities. But remember, tax planning is not a daily race; it’s a multi-year marathon.

9. Review your investments

When was the last time you reviewed your investments? Have you recently checked your 401k plan? You will be shocked to know how many people keep their retirement savings in cash and low-interest earning mutual funds. Sadly, sitting in cash is a losing strategy as inflation reduces your purchasing power. A dollar today is not equal to a dollar 10 years from now. While investing is risky, it will help you grow your wealth and protect you from inflation. Remember that time and time again; long-term investors get rewarded for their patience and persistence.

10. Protect your family finances from unexpected events

The last two years taught us a big lesson. Life is unpredictable. Bad things can happen suddenly and unexpectedly. In 2022, take action to protect your family, your wealth, and yourself from abrupt events. Start with your estate plan. Make sure that you write your will and assign your beneficiaries, trustees, and health directives.

Lastly, you need to review your insurance coverage. Ensure that your life, disability, and other insurance will protect your family in times of emergency.

5 smart 401k moves to make in 2021

5 smart 401k moves to make in 2021 to boost your retirement saving. Do you have a 401k? These five 401k moves will help you grow your retirement savings and ensure that you take full advantage of your 401k benefits.

After a very challenging 2020, 2021 allows you to take another look at your 401k, reassess your financial priorities and .revaluate your retirement strategy,  Let’s make sure that your 401k works for you.

Retirement Calculator

What is a 401k plan?

401k plan is a workplace retirement plan that allows employees to build and grow their retirement savings. It is one of the most convenient and effective ways to save for retirement as both employees and employers can make retirement contributions. You can set up automatic deductions to your 401k account directly through your company payroll as an employee.  You can choose the exact percentage of your salary that will go towards your retirement savings. In 2021, most 401k will provide you with multiple investment options in stocks, fixed-income mutual funds, and ETFs. Furthermore, most employers offer a 401k match up to a certain percentage. In most cases, you need to participate in the plan to receive the match.

1. Maximize your 401k contributions in 2021

The smart way to boost your retirement savings is to maximize your 401k contributions each year.

Did you know that in 2021, you can contribute up to $19,500 to your 401k plan? If you are 50 or over, you are eligible for an additional catch-up contribution of $6,500 in 2021. Traditional 401k contributions are tax-deductible and will lower your overall tax bill in the current tax year.

Many employers offer a 401k match, which is free money for you. The only way to receive it is to participate in the plan. If you cannot max out your dollar contributions, try to deduct the highest possible percentage so that you can capture the entire match from your employer. For example, if your company offers a 4% match on every dollar, at the very minimum, you should contribute 4% to get the full match.

How to reach $1 million in your 401k by age 65?

Do you want to have $1 million in your 401k by the time you retire? The secret recipe is to start early.  For example, if you are 25 old today, you only need to set aside $387 per month for 40 years, assuming a 7% annual return. If you are 35, the saving rate goes up to $820 per month.  If you have a late start, you need to save about $3,000 a month in your 50s to get to a million dollars at the age of 65.

401k Contributions by Age
Age | Monthly
Contribution
Yearly
Contribution
Lifetime
Contribution
25 $387 $4,644 $190,404
30 $560 $6,720 $241,920
35 $820 $9,840 $305,040
40 $1,220 $14,640 $380,640
45 $1,860 $22,320 $468,720
50 $3,000 $36,000 $576,000
55 $5,300 $63,600 $699,600

2. Review your investment options

When was the last time you reviewed the investment options inside your 401k plan? When is the last time you made any changes to your fund selection? With automatic contributions and investing, it is easy to get things on autopilot. But remember, this is d your retirement savings. Now is the best time to get a grip on your 401k investments.

Look at your fund performance over the last 1, 3, 5, and 10 years and make sure the fund returns are close or higher than their benchmark. Review the fund fees. Check if there have been new funds added to the lineup recently.

What is a Target Date Fund?

A target-date fund is an age-based retirement fund that automatically adjusts your stock and bond investments allocation as you approach retirement. Young investors have a higher allocation to equities which are considered more risky assets. In comparison, investors approaching retirement receive a bigger share in safer investments such as bonds. By design, plan participants should choose one target-date fund, set it, and forget until they retire. The fund will automatically change the asset allocation as you near your retirement age.

However, in a recent study, Vanguard concluded that nearly 33% percent of 401k plan participants misuse their target-date fund.   A third of the people who own TDFs,  combine them with another fund.

Target date funds in your 401k in 2021

So if you own one or more target-date funds or combine them with other equity and bond funds, you need to take another look at your investment choices.

3. Change your asset allocation

Asset allocation tells you how your investments are spread between stocks, bonds, money markets, and other asset classes. Stocks typically are riskier but offer great earnings potential. Bonds are considered a safer investment but provide a limited annual return.

Your ideal asset allocation depends on your age, investment horizon, risk tolerance, and specific individual circumstances.

Typically, younger plan participants have a longer investment horizon and can withstand portfolio swings to achieve higher returns in the future.  If you are one of these, investors can choose a higher allocation of stocks in your 401k.

However, if you are approaching retirement, you would have a much shorter investment horizon and probably lower tolerance to investment losses. In this case, you should consider adding more bonds and cash to your asset allocation.

4. Consider contributing to Roth 401k in 2021

Are you worried that you would pay higher taxes in the future? The Roth 401k allows you to make pretax contributions and avoid taxes on your future earnings. All Roth contributions are made after paying all federal and state income taxes now. The advantage is that all your prospective earnings will grow tax-free. If you keep your money until retirement or reaching the age of 59 ½, you will withdraw your gains tax-free. If you are a young professional or you believe that your tax rate will grow higher in the future, Roth 401k is an excellent alternative to your traditional tax-deferred 401k savings.

5. Rollover an old 401k plan

Do you have an old 401k plan stuck with your former employer? How often do you have a chance to review your balance? Unfortunately, many old 401k plans have become forgotten and ignored for many years.

It is a smart move to transfer an old 401k to a Rollover IRA.

The rollover is your chance to gain full control of your retirement savings. Furthermore, you will expand your investment options from the limited number of mutual funds to the entire universe of stocks, ETFs, and fund managers. Most importantly, you can manage your account according to your retirement goals.

Successful strategies for (NOT) timing the stock market

Timing the stock market

Timing the stock market is an enticing idea for many investors.  However, even experienced investment professionals find it nearly impossible to predict the daily market swings, instant sector rotations, and ever-changing investors’ sentiments. The notion that you can perfectly sell at the top of the market and buy at the bottom is naïve and oftentimes leads to bad decisions.

The 24-hour news cycle is constantly bombarding us. The speed and scale of information could easily bounce the stock market between desperation, apathy, and fear to euphoria, FOMO, and irrational exuberance.

In that sense, the market volatility can be unnerving and depressing. However, for long-term investors, trying to time the market tops and bottoms is a fool’s errand. Constantly making an effort to figure out when to get in and get out can fire back. There is tremendous evidence that most investors reduce their long-term returns trying to time the market. Market timers are more likely to chase the market up and down and get whipsawed, buying high and selling low.

The hidden cost of timing the stock market

There is a hidden cost in market timing.  According to Fidelity, just missing 5 of the best trading days in the past 40 years could lower your total return by 38%. Missing the best 10 days will cut your return in half.

Source: Fidelity
Source: Fidelity

For further discussion on how to manage your portfolio during times of extreme market volatility, check my article on “Understanding Tail Risk

Rapid trading

Today’s stock market is dominated by algorithm trading platforms and swing traders with extremely short investment horizons.  Most computerized trading strategies hold their shares for a few seconds, not even minutes. Many of these strategies are run by large hedge funds. They trade based on market signals, momentum, and various inputs built within their models. They can process information in nanoseconds and make rapid trades. The average long-term investors cannot and should not attempt to outsmart these computer models daily.

Reuters calculated that the average holding period for U.S. shares was 5-1/2 months as of June 2020, versus 8-1/2 months at the of end-2019. In 1999, for example, the average holding period was 14 months. In the 1960s and 1970, the investors kept their shares for 6 to 8 years.

Timing the stock market
Timing the stock market

 

The market timing strategy gives those investors a sense of control and empowerment, It doesn’t necessarily mean that they are making the right decisions.

So, if market turmoil gives you a hard time, here are some strategies that can help you through volatile times.

Dollar-cost average

DCA is the proven approach always to be able to time the market.  With DCA, you make constant periodic investments in the stock market. And you continue to make these investments whether the market is up or down. The best example of DCA is your 401k plan. Your payroll contributions automatically invest every two weeks.

Diversify

Diversification is the only free lunch in investing. Diversification allows you to invest in a broad range of asset classes with a lower correlation between them.  The biggest benefit is lowering the risk of your investment portfolio, reducing volatility, and achieving better risk-adjusted returns.  A well-diversified portfolio will allow your investments to grow at various stages of the economic cycle as the performance of the assets moves in different directions.

Rebalance

Rebalancing is the process of trimming your winners and reinvesting in other asset classes that haven’t performed as successfully.  Naturally, one may ask, why should I sell my winners? The quick answer is diversification. You don’t want your portfolio to become too heavy in a specific stock, mutual fund, or ETF. By limiting your exposure, you will allow yourself to realize gains and buy other securities with a different risk profile.

Buy and hold

For most folks, Buy and Hold is probably the best long-term strategy. As you saw earlier,  there is a huge hidden cost of missing out on the best trading days in a given period. So being patient and resilient to noise and negative news will ultimately boost your wealth. You have to be in it to win it.

Tax-loss harvesting

If you are holding stocks in your portfolio, the tax-loss harvesting allows you to take advantage of price dips and lower your taxes. This strategy works by selling your losers at a loss and using the proceeds to buy similar security with an identical risk-reward profile. At the time of this article, you can use capital losses to offset any capital gains from the sale of profitable investments. Furthermore,  you can use up to $3,000 of residual capital loss to offset your regular income. The unused amount of capital loss can be carried forward in the next calendar year and beyond until it’s fully used.

Maintain a cash reserve

I advise all my clients to maintain an emergency fund sufficient to cover at least 6 months worth of expenses. An emergency fund is especially critical If you are relying on your investment portfolio for income. The money in your emergency fund will help you withstand any unexpected market turbulence and decline in your portfolio balance. A great example would be the rapid market correction in March 2020 at the onset of the coronavirus outbreak. If you needed to sell stocks from your portfolio, you would be in tough luck. But if you had enough cash to keep afloat through the crisis, you would have been in a perfect position to enjoy the next market rebound.

Focus on your long term goals

My best advice to my clients who get nervous about the stock market is to focus on what they can control.  Define your long-term goals and make a plan on how to achieve them. The stock market volatility can be a setback but also a huge opportunity for you. Follow your plan no matter what happens on the stock market. Step back from the noise and focus on strengthening your financial life.

Understanding Tail Risk and how to protect your investments

Understanding tail risk

What is Tail Risk?

Tail Risk is the possibility of suffering large investment losses due to sudden and unforeseen events. The name tail risk comes from the shape of the bell curve. Under normal circumstances, your most likely investment returns will gravitate in the middle of the curve. For long term investors, this will represent your average expected return. The more extreme returns have a lower probability of occurring and will taper away toward the end of the curve.

Understanding tail risk
Source: Pimco

The tail on the far-left side represents the probability of unexpected losses. The far-right represents the most extreme outcomes of substantial investment gains. For long-term investors, the ideal portfolio strategy will seek to minimize left tail risk without restricting the right tail growth potential.

Why is tail risk important?

Intuitively, we all want to be on the ride side of the bell curve. We want to achieve above-average returns and occasionally “hit the jackpot” with sizeable gains.

In real life, abrupt economic, social, and geopolitical events appear a lot more frequently than a rational human mind would predict. Furthermore, significant market shocks have been occurring about every three to five years resulting in “fatter” tails.

Also known as “Black Swans, they are rare and unique. These “one-off” events impose adverse pressure on your investment portfolio and create risk for outsized losses. Tail risk events bring a massive amount of financial and economic uncertainty and often lead to extreme turbulence on the stock market.

The Covid outbreak, Brexit, the European credit crisis, the collapse of Lehman Brothers, the Enron scandal, the US housing market downfall, and the 9/11 terrorist attacks are examples of idiosyncratic stock market shocks. Very few experts could have predicted them. More notably, they caused dramatic changes to our society and our economy, our consumer habits, and the way we conduct business.

Assessing your tail risk exposure

Retirees and those close to retirement, people who need immediate liquidity, executives, and employees holding a large amount of corporate stock are more susceptible to tail risk events. If you fall into one of these categories, you need to review your level of risk tolerance.

Investing is risky. There are no truly risk-free investments. There are only investments with different levels of risk. It is impossible to avoid risk altogether. The challenge for you is to have a reasonably balanced approach to all the risks you face. Ignoring one risk to help you prevent another risk does not mean you are in the clear.

Winners and losers

It is important to remember that every shock to the system leads to winners and losers. For example, the covid outbreak disproportionately hurt leisure, travel, retail, energy, and entertainment businesses. But it also benefited many tech companies as it accelerated the digital transformation. As bad as it was, the global financial crisis damaged many big and small regional banks. But it also opened the door for many successful fintech companies such as Visa, Mastercard, PayPal, and Square and exchange-traded fund managers like BlackRock and Vanguard. The aftermath of 9/11 drove the stock market down, but it led to a boost in defense and cybersecurity stocks.

Know your investments

The first step in managing your tail risk is knowing your investments. That is especially important if you have concentrated positions in a specific industry, a cluster of companies, or a single stock. Black Swan events could impact different stocks, sectors, and countries differently. For instance, the Brexit decision mostly hurt the performance of the UK and European companies and had no long-term effect on the US economy.

Know your investment horizon

Investors with a long-term investment horizon are more likely to withstand sudden losses. The stock market is forward-looking. It will absorb the new information, take a hit, and move on.

I always give this as an example. If you invested $1,000 in the S&P 500 index on January 1, 2008, just before the financial crisis, you would have doubled your money in 10 years. Unfortunately, if you needed your investment in one or two years, you would have been in big trouble. It took more than three years to recover your losses entirely.

Diversify

Never put all your eggs in one basket. The most effective way to protect yourself from unexpected losses is diversification. Diversification is the only free lunch you will ever get in investing. It allows you to spread your risk between different companies, sectors, asset classes, and even countries will allow your investment portfolio to avoid choppy swings in various market conditions. One prominent downside of diversification is that while you protect yourself from the left tail risk, you also limit the right tail potential for outsized returns.

Hold cash

Keeping cash reserves is another way to protect yourself from tail risk. You need to have enough liquidity to meet your immediate and near-term spending needs. I regularly advise my clients to maintain an emergency fund equal to six to twelve months of your budget. Put it in a safe place, but make sure that you still earn some interest.

Remember what we said earlier. There is no risk-free investment – even cash. Cash is sensitive to inflation. For instance, $100,000 in 2000 is worth only $66,800 in 2020. So, having a boatload of cash will not guarantee your long-term financial security. You must make it earn a higher return than inflation.

Furthermore, cash has a huge opportunity cost tag. In other words, by holding a large amount of money, you face the risk of missing out on potential gain from choosing other alternatives.

US Treasuries

US Government bonds have historically been a safe haven for investors during turbulent times. We have seen the demand for treasuries spiking during periods of extreme uncertainty and volatility. And inversely, investors tend to drop them when they feel confident about the stock market. Depending on their maturity, US treasuries may give you a slightly higher interest than holding cash in a savings account.

While offering some return potential, treasuries are still exposed to high inflation and opportunity cost risk. Also, government bonds are very sensitive to changes in interest rates. If interest rates go up, the value of your bonds will go down. On the other hand, when interest rates go down, the value of your bonds will decrease.

Gold

Gold is another popular option for conservative investors. Similar to treasuries, the demand for gold tends to go up during uncertain times. The faith for gold stems from its historical role as a currency and store of value. It has been a part of our economic and social life in many cultures for thousands of years.

As we moved away from the Gold standard, the Gold’s role in the economy has diminished over time. Nowadays, the price of gold is purely based on price and demand. One notable fact is that gold tends to perform well during periods of high inflation and political uncertainty.

In his 2011 letter to shareholders of Berkshire Hathaway, Warren Buffet described gold as an “asset that will never produce anything, but that is purchased in the buyer’s hope that someone else … will pay more for them in the future…..If you own one ounce of gold for an eternity, you will still own one ounce at its end.”

Buying Put Options to hedge tail risk

Buying put options om major stock indices is an advanced strategy for tail risk hedging. In essence, an investor will enter into an option agreement for the right to sell a financial instrument at a specified price on a specific day in the future. Typically, this fixed price known as a strike price is lower than the current levels where the instrument is trading. For instance, the stock of XYZ is currently trading at $100. I can buy a put option to sell that stock at $80 three months from now. The option agreement will cost me $2. If the stock price of XYZ goes to $70, I can buy it at $70 and exercise my option to sell it at $80. By doing that, I will have an immediate gain of $10. This is just an illustration. In real life, things can get more complicated.

The real value of buying put options comes during times of extreme overvaluation in the stock market. For the average investor, purchasing put options to tail risk hedging can be expensive, time-consuming, and quite complicated. Most long-term investors will just weather the storm and reap benefits from being patient.

Final words

Managing your tail risk is not a one-size-fits-all strategy. Black Swam events are distinctive in nature, lengh, and magnitude. Because every investor has specific personal and financial circumstances, the left tail risk can affect them differently depending on a variety of factors. For most long-term investors, the left tail and right tail events will offset each other in the long run. However, specific groups of investors need to pay close attention to their unique risk exposure and try to mitigate it when possible.