Episode #4 – ROTH vs. Pretax: Which Money Move Maximizes Your Wealth?

Welcome to the Millennial Money Moves Podcast. On this episode, Blake and I are diving deep into the different kinds of retirement money available to you.

We hope this episode gives you a better understanding of whether pre-tax or Roth money is best for you in your financial future. This content is purely educational, and is not intended to be financial advice or financial planning.

Please consult your professional financial advisor or tax professional to receive tailored advice to your personal situation. Babin Wealth Management is not responsible for action taken by listeners based on educational content provided.

If you would like to receive personal financial advice, please reach out to Babin Wealth Management directly at babinwealth.com. Let’s make moves. Welcome everybody to another episode of the Millennial Money Moves podcast.

I am your host, Sean Babin. And with me, as always, my guy, Blake Bandani.

The one and only. What’s going on, baby?

Good to see you, buddy.

Always.

All right, man. So today we are going to do what I’m calling the great debate. We’re going to talk about pre-tax versus Roth money.

And you’ve got, in one corner, me, all Roth. And in the next corner, we got Blake, all pre-tax. So, I love this dichotomy here.

It’s kind of perfect versus both of us believing 100% in one or the other. Now we’ve got either sides of the aisle here.

Who knows? Maybe I’m all Roth after this conversation. We’ll see.

I mean, I hope I bring some sort of logical explanation to why I do it or why I have clients do it.

And you pick up a thing or two, but yeah, that’s what we’re hoping for all the listeners as well.

Let’s get into it.

All right, man. So let’s start with just discussing what is pre-tax, what is Roth.

And for the listeners out there, you’re going to hear these two words a lot in this episode, so we got to make sure that it’s cleaned up at the start, so you have a full understanding going forward.

Right on, Sean. And I think when you hear the term pre-tax and Roth, it kind of self-explains what they’re saying in those terms.

So pre-tax, meaning that the deductions you take in a 401k perspective, is going to be pre-income tax, meaning that you are not taxed on that money, and it can go into your 401k account.

The Roth itself is saying it’s actually going to be money that’s already taxed, so you pay those applicable taxes, and then that amount that you’re deducting is now going into the investment account for you, or your 401k account post-tax or

after-tax. I get hesitant to say after-tax, because we’re going to get into it, is there’s also another deduction called an after-tax deduction. But technically again, kind of like what the terms say. Pre-tax, think pre-income tax.

You’re not paying income tax on that today. Roth, whether it’s a 401k or IRA, which you’ll get into, means post or after-tax.

Yeah, perfect. Well said. I mean, it’s just deciding, do you want to pay taxes now with the Roth and let it grow tax free and come out tax free?

Or do you want to take that income deduction by deferring the taxes on it and later on, when you take it out in life, get taxed on it at that point?

But both grow in the market tax free. So let’s check that box off on the commonality perspective, that they’re both tax free growth.

Correct.

And so when Blake’s talking about tax free growth, the opposite of that is if you have a taxable account, individual account, a joint account, a trust account, every year you’re getting a 1099 for the dividends, interest, capital gains that get

recognized to you and you’re paying taxes each year. So in a 401k or the IRAs, individual retirement account vehicles, if you’re doing pre-tax or Roth, you’re deferring all that taxation until, you know, in the pre-tax, you’re deferring it till the

end when you take it out. And in the Roth, I think the beauty of it is, you don’t pay any taxes on the dividends, interest, capital gains. And that’s why I think I love it so much.

So count types that you can have this money in is we’ve already hit on it, but we just want to make it clear again is these are for those retirement accounts. So your 401k is where you get the option to choose tax deferred or Roth money.

And then in those individual retirement accounts, IRAs, you also have the choice to do a traditional IRA, which is that tax deferred or a Roth IRA, which is the tax free.

Bingo.

And we talked on it a little bit last time, but let’s refresh some people. The listeners was kind of the maxes you can put into these accounts.

Yeah.

Because the max doesn’t change based on if you’re doing one or the other. It’s still the same max whether you’re doing Roth or pre-tax. And so in that 401k, if you’re under 50, you can do $23,500 a year.

And then in an IRA, Roth or traditional, you can do, if you’re under 50, $7,000 a year to those as well. Remember, you can do both. You can absolutely max out a Roth 401k and a Roth IRA or vice versa.

But then to your point as far as separating the two, right?

There’s a 401k deduction and then there’s an individual retirement account deduction.

The nice thing to always keep in mind is if you are being offered a 401k or a retirement plan with your organization or company, you’re allowed to do those limits no matter how much money you make.

When we start talking in terms of the IRA side of things, those limits stay, but you may not get the tax favoritism if you make too much money. Is that fair to say?

Absolutely. Yeah. The IRA deductibility faces out pretty quickly.

It does.

There’s two components of that.

One, how much you make and if you’re covered by a retirement plan at your place of work.

But then, so question for you, Sean, and you’ve seen this more than I have, but if you are in that income range and you have a 401k, you can still max out the 401k limit and you could still get the IRA. Is that fair to say?

Yeah, you can. And that’s when we have conversations of, you know, if you make too much to… Let’s say you’ve maxed your 401k out and you’re looking for more ways to save.

And we talk about an IRA, an individual retirement account with that $7,000 max. That’s when we have the conversation of, is a traditional IRA even worth it to you? Meaning, why contribute to a traditional IRA if you’re not gonna get the deduction?

And so, there’s ways around Roth IRAs. The income limits on a Roth IRA is, you know, it’s about $145,000 for a single filer, and I believe about $230,000 for joints.

So the $145,000 to about $230,000, depending on your situation, whether it’s joint or single, if you’re over those, then you won’t get the favoritism of the deduction, right?

Yeah. So here’s the number. So no, Roth IRAs have no deductions.

Because you’re not getting any tax favors?

Correct.

But they have income caps. So if you’re single and you make over $150,000, this is as of 2025, you technically cannot contribute to a Roth IRA.

Got it.

And if you’re married filing jointly and you jointly make over $236,000, you cannot contribute to a Roth IRA.

Got it.

But if you don’t have an IRA, now we’re getting tricky, now we’re having fun, you can do what’s called a backdoor Roth contribution, where you put money into an IRA, which has no income limit, and you immediately convert it to a Roth IRA.

So those are what I do with clients who make too much money to, one, contribute to a Roth directly, and two, again, make too much money where they don’t even get the deductibility of contributing to an IRA.

So why not have it grow tax free if you’re not taking the deduction?

Well said. I guess, so as we let off with the agenda, why I’ve always kind of leaned on doing pre-tax, again, that’s pre-income tax, I think is based on my tax situation. I typically take the standard deduction.

I don’t get to itemize. So anything I can do to reduce my tax bill, I’m going to take advantage of. So you think about that.

If you max out and do the $23,500, let’s say I made $100,000, per se, or whatever we want to get. I like $100,000 because it’s easy to think about.

I just reduce my adjustable gross income that’s going to get taxed on $23,500 from that $100,000 amount. So I see that as a huge advantage for me when I have to pay Uncle Sam every year.

Yeah, and I agree but disagree.

Let me hear it.

So when I look at a client and we’re recommending pre-tax or Roth, it for me, in my opinion, is all about the income tax bracket you’re in. And can we change that or are you stuck in it? And so that’s the whole debate.

Do you want to pay taxes now or do you want to pay taxes later on in life? So sometimes I like removing the variability of the future if you’re in a tax bracket that makes sense.

And that is the whole point of it is when would you, would you like to pay taxes at this rate or would you like to defer to the future and potentially pay? It could be lower, could be higher. We don’t know, that’s the whole point.

So when I’m talking to clients, we look at their tax rates and today we’re gonna just talk about the federal tax brackets. Every state’s a little different. Obviously if you’re in California or New York then you’re gonna throw another 9%.

Sorry guys.

Yeah, it’s a different conversation.

I was just coming from California.

Cause yeah, if you’re in those high tax states, sometimes it obviously makes even more sense to defer versus letting California take 9% to 10% of everything you make.

And if you’re in a zero income tax state or a low one, then that even makes it even clearer if you should pay taxes now or later as well. So we’re just gonna look at the Fed level today.

And if you’re in a state with a high one and you wanna talk about your options, don’t hesitate to reach out to us. And that’s when we can get some more individualized personal financial planning for you.

And real quick, if you live in Texas or Florida or Nevada, lucky you.

Yeah, hey, Arizona’s not that bad.

Arizona’s pretty low.

2.5% flat.

Shout out to Arizona. Let’s talk federales and let’s pick your brain on it, Sean, because I know you do this conversation a lot with your clients. I don’t do it as much.

I always like listening to you on it.

So this isn’t fun to just talk about. It’s easier to view, but hey, we’re doing a podcast, so here we go.

Stay with us.

So we’re gonna talk about tax rates for single filers and married filing jointly. So the federal tax brackets start at 10% and it goes 10% to 12% to 22% to 24% then 32% and 35% and finally 37%. There’s a big jump when you go from 24% to 32%.

That’s an 8% jump. So when I look at historical tax rates and the current tax code, these are very low rates comparative to history. And let’s do a little history lesson right now.

I mean, come on.

So in 1913 is when the 16th Amendment came out and gave Congress the authority to levy taxes on its citizens.

Pre-1913, for 126 years, there was no federal tax rates for American, or US citizens.

Can we go back?

Well, I think that’s kind of what politically they’re kind of trying to do. Because back in the day, that’s what tariffs paid for. Tariffs paid for everything that was going on in this country, and the citizens of America didn’t pay taxes.

I thought that was cool, just having the history of like…

Absolutely.

They’re kind of relatively new. 1913. You know, 112 years.

So that was interesting to me. And so tax rates have been all over the place since that time. They’ve gone as…

If we’re looking at the highest marginal tax bracket, which right now it’s 37%, you know, and when World War II broke out in kind of the late 1940s, they went as high as 94%. Imagine getting taxed on 94% of your income.

Like, what’s the point of making money at that point?

No taxation without representation. That’s what I’m thinking.

And the highest marginal tax rate hovered around 90% until about 1964. And then it’s come down slowly. It was pretty much at 70% from 1965 to 1980.

And then it came down again to about 50% in the mid 1980s. And then in the last 20, 30 years, it’s kind of hovered around that 40%.

So this is what I use when I’m telling people about, you know, where we stand historically in taxes and whether we should pay taxes now or not.

And when we’re looking at the tax tables, like if you are making as a single filer less than $197,000 in a year for 2025, you’re in the 24% tax bracket or kind of, or lower. That’s the top.

And if you’re married filing jointly, making less than $394,000 in a year, you’re below that 24, you’re in the 24% tax bracket. So how we look at it is I think the 24% and 22% tax bracket is a perfect place to pay taxes.

Because one, that’s only a 2% difference, and two, they’re very low historically, kind of averaged out. So that’s again, my recommendation, that’s how I rationalize the numbers. It’s rationalized paying taxes.

It’s looking at the numbers now, and seeing where you’re in, and does it make sense to pay those taxes based on how much you’re making today?

So if I heard you correctly, if you’re in that, we can call it a sweet spot, why not pay and do a Roth today, is what I’m hearing from you. Is that fair?

Nailed it, absolutely. Exactly what I’m trying to say.

Now what if you can do the 401k deduction, and you can get into that lower tier, and get out of the 22? I don’t think, I don’t know, you gotta remind me of the numbers.

I don’t know if 23.5 can move that needle, but if you’re married, and two of you do 23.5, can you get out of the 22 bracket with that lowering your adjusted income?

You have to, it’s, no.

No, okay.

To stay out of even the 22% and stay in the 12% tax bracket, married filing jointly, you have to make less than 96%.

Oh, okay, that’s a tough one to get to. If you’re teetering on the 22, 24, you’re not gonna be able to get to, okay.

And so if you’re single, you have to make $48,000 or less a year to stay below 22%. So basically, there’s like this tight gap right there between making, as a married couple, about 100 grand to almost 400 grand is a very tight tax table, tax rate.

So I basically sit there and tell a client, do you think taxes will be higher or lower in the future in 30 years from now? And again, it is a guess. It is absolutely a guess.

No one has a crystal ball. But when you can remove variability from the future, I love that. And you can look at paying taxes now, historically low tax rates.

That’s when I go, maybe we should at least, at the bare minimum, do 50-50 if you’re in these tax brackets.

Those tiers.

Meaning you could do half Roth and half pre-tax to kind of do like a nice hedge. I think a nice split between those creates what’s called tax diversification.

Meaning, you’ve paid some taxes now, you haven’t paid some taxes now, and then in retirement, if taxes are at 35% or go crazy high, then you take out that Roth money first, and you leave the tax deferred till later.

If for whatever reason we get back to a 0% tax rate because tariffs went so well for us, guess what? Then all that tax deferred money comes out tax free at that point. I mean, whatever that low tax rate is.

So basically why I have all my Roth money is because I’m in those tax brackets.

When I do get over the 24 into the 32 and 35 and 37, those are going to be when I flip the switch from Roth to deferred because those are a lot higher than that 24 and 22% number. So that’s how I look at it. Let me hear your thoughts.

Yeah, and that’s totally fair.

And I can’t argue anything on that aspect. Where I come in with my thoughts is, I mean, except for a couple of weeks ago, when the Trump administration is talking about getting rid of the IRS, maybe pre-income tax looks pretty good now.

But regardless of that, right, taxes are always going to be here. That’s part of what made our country and keeps our country running.

My ultimate theory, and that was all great points, Sean, is this, is that when I get to retirement, and I’m more of a modest guy, I don’t think I’m going to need a, you know, what’s the golden number for retirement is replace 70 to 80% of your income

to have a sound retirement. I still think I’m going to make the most money from a tax on paper perspective in the next 10, 15, 20 years.

So even if the tax tiers make sense, I’m still going to be making more income than I hopefully again, life changes, but then I have to pull out on retirement.

So even though I’ve deferred the income tax today, and who knows what happens with taxes, when I start cashing in on that money, and I’ve also been been pretty good with saving, so I’m hoping that I only have to do the required minimum distribution,

RMD, we’ll get into that. But if I don’t have to touch this money as much, and I’m not making as much on paper in retirement, why wouldn’t I take advantage of the no tax on the higher income I made currently? Stephen, does that make sense?

Absolutely, that’s exactly what I’m talking about, but I personally believe it’s worth paying taxes in the lower tax rates while you’re cruising through them.

So, you’re getting started, first job, second job, you’ve been in the workplace for four or five years, maybe you’re making 100, 150, kind of moving up that ladder.

That’s when, in my opinion, everybody should be doing Roth money, because they’re not making over 400K or 250K quite yet to be in those higher tax brackets.

And then when you do kind of start moving through the tax brackets and you are making a lot of money, that will set up, like I said, a nice hedge between Roth and deferred money.

And also, man, there’s just this beautiful concept of having tax-free money. I love looking at my accounts, knowing that no one can touch that. That is all mine.

Well, let’s not deceive our listeners.

There is the five-year rule for Roth.

I meant no one can touch that from a tax perspective. When I go to retire and take that Roth money out, it’s tax-free. And when we’re talking to clients about retirement, why we love having the split or at least 50-50, I think, is the bare minimum.

I’ll lean more Roth depending on your income than deferred, but let’s just call 50-50 split. So in retirement, you need your monthly income, you’re taking your draws.

Yeah, you’re going to take from that tax-deferred bracket, meaning you’re going to be paying taxes then on that. But let’s say you want to go on that vacation. Let’s say your kid is getting married.

Let’s say you want to help your kid with a down payment for their house. That’s when you dip into this Roth money. Like, let’s say you go and need 40 grand to put on a down payment or 50 grand to buy a car.

That’s when you pull from that Roth bucket and it doesn’t affect your taxes. It’s so pretty to see play out in actual people’s retirements because they’ll call and say, hey, Sean, kids getting married. I want to help them with the wedding.

I need 20 grand. Boom, send it to them. They’re not getting a 1099 at the end of the year to owe taxes on the 20 grand versus if they had all tax deferred money and they needed to tap into it, they would be getting taxed on that 20 grand.

It’s fair.

I got nothing to say against that. What’s the old adage? No one likes change.

I think I kind of just started doing pre-tax as my deduction and I just never really made the effort to look more into it.

But I would agree with you and I will bend the knee in the sense that it’s probably smart to build a little bit of a Roth bucket without a doubt.

Yeah, because what’s fascinating is you get to retirement and let’s say you’ve got that we’re just going to use a million dollars, a million dollars saved in the 401k.

And you look at it, again, using tax rates as of today, about 25 to 30 percent of that number isn’t yours. That’s the government. So really, you’ve got about 750,000 to 800,000 of that is yours.

And I don’t know, that’s again, if you’re in the lower tax rate and you’ve played the tax rate game and it’s beneficial to you, great. But I like removing the variability of taxes in the future. It’s hard to think taxes will be lower than this.

If they are, great. We’ll all be happy and loving life. And I’ll just be the idiot who can pay taxes.

Most likely not gonna happen though.

And then, like I said, as you’re kind of building your wealth or starting out, I think until again, this is all my opinion, and until you hit that 32% tax bracket, which is what it currently is, it’s a beautiful time to pay taxes.

Can we coin that beautiful time to pay taxes?

Beautiful time to pay taxes.

Yeah, said no one ever.

But I think also is the key to this conversation is I’ve been stuck on my ways, as I’ve mentioned in previous podcasts, I’ve been more on the 401k side of things, not on an individual level.

Although with the industry I’m in, I keep up, but I think it speaks to why working with a financial advisor is so key.

Yeah, because people that have done what you are doing their whole career will come to me and I’ll show them how much in taxes I can save by doing what’s called Roth conversion.

Let’s get into it.

So, you’re in your 40s, 50s, you’ve got all this money in tax-deferred, and you’ve done a really good job at savings. So, what happens is Blake alluded to a thing called RMDs or required minimum distributions.

This is the IRS coming and knocking on your door and saying, hey Blake, you haven’t paid taxes on this tax-deferred money.

Time to pay up.

We are gonna start forcing you to take out a certain amount each year, and as time goes on, as you get older, that amount becomes larger. So currently, the RMD age is 73. It looks like until they change it, which I’m sure they will.

Next year.

It becomes 75 in 2033.

Okay.

So they’re pushing it out.

Yep.

But the factor stays the same, meaning it’s getting bigger.

So you have less, you don’t have to start it as early, but they’re gonna make you take out more, quicker.

So what happens to people who have done a really good job savings, and they don’t need all their money, like let’s say they’re going to pass away with a certain amount and not going to use it all, is at some point, these RMDs come knocking, and you

You have to.

You have to.

And so what I get clients, it’s like I can visually show them that, hey, here’s your tax bill gonna be, and it pushes them into the highest tax rates, in today’s. All we can do is use today’s tax rates to model that out.

And it says, look, you’re per the IRS is gonna make you take out 300,000 that year. And let’s say you got a pension or something else coming in.

I add some quick.

Boom. Now you’re in the 400, you’re making 450 and you’re in the high, one of the highest tax brackets. So again, another strategy for a reason to why you want to have a nice balance of both is because of those, those RMDs become nasty.

But if you need all the money, then that’s the thing. And you want to know this now when you’re in your 30s and 40s, what am I on pace for? What am I, what am I, am I going to need all this money?

Am I doing a good job savings or bad job savings? And if you’re going to need all that money, then the RMDs won’t be the big thing for you. But it’s people who have done a really good job saving, where those RMDs will potentially crush them.

And meaning in a tax, tax world, they’re going to be paying more taxes than they need to. And so what we start doing is converting some of the tax deferred money to Roth, systematically through the years.

Meaning we keep them in that 22 to 24% tax bracket. Don’t blow that up. Don’t blow that up, but maybe we convert 50 grand or 100 grand a year until they have a nice split or we get it all to Roth.

And I’m currently, that’s what I’m doing with my parents because I’ve showed them the analysis of, hey, if we do this, it’s gonna save them over $600,000 in taxes over their lifetime.

The government is listening, Sean. I just want you to know that.

They know all about the Roth conversions. But the government loves it because now they’re getting the money every year and they’re paying the taxes now, and it grows tax free.

So you mentioned it. So is it, it’s different in the 401k, not the actual idea behind it, but like converting it.

Would you say it’s working with you pretty simple, like maybe simple is not the best word, but like pretty convenient to do the conversion?

Just like systematically.

To actually accomplish that and do the actual conversion while working with you, is it?

Yeah, it takes a day.

Right on.

Yeah. Yeah, we just pick out a number. We obviously, that comes with our whole tax planning aspect is, we do tax planning at the end of each year, and then at the beginning of each year is when we do our conversions.

So yes, it’s understanding how much you’re making now. Do you have that tax problem later on in life?

And also, if we’re talking to states, your kids will greatly thank you if they inherit Roth money versus tax deferred money, because what’s crazy now is if you inherit tax deferred money, you get 10 years to liquidate that account.

In those 10, so does it have to be equal over the 10?

You can do it all day long.

However you do it.

You can wait till the very last day of the 10th year. So what happens is, again, this is from the grave problem. Like it depends on how you want to set your kids up or not.

But your kids have basically inherited a tax bomb. Granted, it’s money they wouldn’t have had otherwise. We can get it all into that.

It’s a good problem to have.

A good problem to have.

But yeah, so now they have to strategically either take that money out over a 10 year smoothly, maybe play that tax break. Anyways, versus you inherit a Roth IRA, you still have the same 10 years, which is whatever.

It means you gotta get it out of the Roth, but it all comes out tax free. So it can’t grow tax free, continually. And you can’t have these legacy Roth accounts, is the reason why they did that, why they give you that 10 year period.

But again, they should be kissing your feet if you are willing to pay the taxes for them on your behalf, and they don’t inherit that big tax bomb.

So those are the things like why I’m kind of passionate about the Roth is cause it’s on the planning aspect of it. There’s some really cool things you can do with it in regards to saving taxes for yourself and later on in life.

And it’s a good thing, obviously, for people to inherit on that side.

And just to highlight from a 401k perspective, you’re not always allowed to do an in-plan Roth conversion. It’s gotta be allowed by your retirement plan. It’s gotta be written in what we call plan documents.

So if you have a 401k, you may wanna check first, reach out to us if you can even do it. But I bring that up because hopefully you don’t have other advisors listening, but Sean did give me this tidbit. Unfortunately, I didn’t take it.

What do they say? You can take the horse to the water, but you can’t make them drink it. But a great time, outside of what Sean just laid out, to think about a Roth conversion is in a really down market year.

Think about it, right? Your 401k account’s been pre-taxed, the market’s down 15%. Everyone kind of panics, but moves are made in down markets.

One being, if the plan allows for it, convert some of that money to Roth when it’s down 15%. Pay the tax on the amount that’s already down 15%.

Anyways, then what you started with, convert it to Roth, and then if you’re still in the age where you’re not looking at that money for another 20 years, guess what?

You just got that investment gain and converted it into Roth, and you won’t have to pay tax on that money anymore. It was a flawless idea, Sean.

Again, I didn’t take the advice, but next time we’re in a market that’s going to be down, I’m absolutely going to look into that.

You have to stomach that problem at that time. It’s tough.

Worth it. Wish I did it.

Absolutely, because yeah, all the growth that comes back. Again, the market has always come back. There’s never been a straight line.

There’s never been a period where it stays down, goes down, never comes back.

So in those moments where, like Blake said, market’s down 20%, 15%, and you do that conversion, and then when it does flip around, all that growth is now in the tax-free portion. And that’s a beautiful thing.

Beautiful. And why didn’t I listen? I don’t know, viewers.

I don’t like change.

Yeah, and it’s also like…

But that’s a Millennial Money Move.

It can come and go pretty quickly.

Doing stuff like that, if it’s applicable to your situation, crazy not to do it.

Yeah, and you don’t get to pick the bottoms of anything. So maybe it’s down 15% and you do it, then it goes down another 10, and you’re like…

It’s still gonna pay off.

And maybe you do more. But again, to come up with the amount that you do is all based on your taxes. Staying in those brackets, making sure that you don’t just go convert $200,000 of your IRA, your 401k to the raw portion of your 401k.

What’s this tax bill, Sean?

You said I should do this.

And now you put yourself in the 35% or 32% tax bracket, because typically in a conversion, and now we’re getting really into it, the best thing to do is have the cash to pay the tax bill versus taking it out of your account, because you’re reducing

your overall balance that grows tax free. So you want to pretty much have the cash to be able to pay that tax bill in April.

So again, it’s well said, and conceptually hopefully makes sense to you guys, but you wanna have a plan to be able to do that and know how much you wanna do.

I love it.

Because you always love it at the moment, and then everyone gets a little upset come February, March, when they’re doing their taxes, and they go, what’s this 1099 for? Why do I owe $15,000?

I thought this was a good idea.

Yeah, exactly.

But it is, especially if you don’t need to touch that money in the next 15, 20 years.

Yep, no, that was a great point, man. That was a-

I got it from you. I just-

Yeah, and I’m glad you brought it up on the pod, because you look for those opportunities. So why we do it just the beginning of the year is because having a crystal ball would be great, but we don’t.

And so we just systematically, every January and February, we’re doing the conversions with our clients because we can’t wait for- we can’t time anything, so we just do it.

But you ever get caught in a COVID type environment where the market’s down 35 percent, or 2022 where the market went down for nine straight months, ended the year down 20 percent?

Those are the times where we’re calling people saying like, hey, can you afford to do $30,000 or 50 grand from your IRA to your Roth? Even if it’s 10 grand, something’s better than nothing.

Bingo. Great stuff. I don’t know, Sean, I think I got to re-evaluate if I got to do some Roth moving forward, and I think that’s the move.

Maybe just a little bit.

Said an appointment, let’s go over it. We’ll run some analysis for you.

Fair enough.

But I think that leads into, we talked again, pre-tax versus Roth, what that implies, it’s not just 401k, it’s IRAs, depending on income limits, converting, doing Roth conversions, backdoor Roth, but then you heard, I don’t know how long ago, it

first hit the market, but mega backdoor Roth. And I think that leads us into what we had mentioned earlier in this session that we want to talk a little bit about after tax.

This is new. I feel like it’s come on the scene in the last maybe four or five years.

I remember getting asked about it in my mass mutual days, and that’s like 2018. So that’s almost seven years ago. Ouch.

But I get hesitant when I talk about it because it’s like, well, you already said Roth is after tax.

It gets confusing.

It gets confusing. But from a 401k perspective, to keep it high level, we talked about pre-tax deduction and a Roth. But there is another additional money source that you can do as a payroll deduction if it’s allowed called an after-tax deduction.

Okay, so stay with me here. Assume you make $200,000 and you max out your 401k, whether it’s pre-tax or Roth, I won’t be offended, $23,500. $200,000 income, you’ve deferred $23,500, and your company matches you up to 4%, okay?

Well, if you do the math quickly, you just put in $23,500, you’re gonna get a 4% match of your $200,000 salary, so that’s $8,000. Sean had to put the fingers up for me, but I had that one, Sean. That puts you in right around $30,000, $32,000, right?

You are technically allowed by the IRS in 401k qualified retirement plans to do $70,000 total. Now you have to get creative, and this is where talking with me can help, especially if you’re a business owner.

So out of the total limit of $70,000 that you can put into these vehicles, you’re only at about $32,000. Well, what about that other $38,000? Well, that’s where after tax can come into play.

And if you have the wiggle room from your paycheck, you can actually do what’s called an after tax deduction for another $38,000.

It’s your own personal money, it’s not an employer contribution you are withholding, and it is already going to be paying tax on it. It does have different tax implications than Roth.

That money you do pay gains tax on, so as it grows, you will have to pay tax, but it allows you to get to that magical IRS number of $70,000. Keep in mind, if you’re over age 50, it’s up a little bit more than that, another $7,500.

But pause there, that’s powerful, right? I did $2,300, $500, I got my 4% match, and now I’m doing another $38,000 in a post-tax, aka after-tax money source. Huge.

Where the mega backdoor Roth came into place, you check the boxes, the plan allows it, and you can do some after-tax, you can actually now convert that after-tax into, you guessed it, Roth.

And if you do it in time before there’s crazy market gain, you may have very little capital gains tax, convert that to Roth, and now that’s in that Roth bucket growing tax rate. So now you just put another $38,000 into a Roth bucket.

Yeah, it’s incredible.

It’s gotta make sense.

It has to. I mean, obviously you have to be able to, you want to max out your 401k first.

Of course.

Because it’s the same kind of thing. And then, yeah, it’s again, it’s for those highly compensated employees that have maxed out maybe that whole tax deferred portion because they’re making a lot of money.

And then they’re like, excuse me, they max it out come September or even earlier. And then they’re like, hey, I’ve got four or five months left in the year and I want to keep contributing at this pace. Okay, we have after tax?

Yeah, let’s do that. And then we get to the end of the year and we convert that straight to a Roth to avoid like Blake said, the cap gains. If you just leave it in that after tax bucket, you will get taxed on the gains as they come.

So the whole point is convert that to Roth immediately, get it in a tax free account that grows tax free, isn’t taxed each year like an after tax portion is.

Coined mega backdoor Roth. Mega backdoor Roth.

Yeah, I’m glad we hit on that because we’ve kind of alluded to that in the prior couple episodes. We definitely needs its own five, six, seven minutes to discuss because it is a complex one, but it’s a tough one to get to.

It is.

You’ve got to really have an income problem, which I think we’d all love to have.

Great problem to have.

And you want to be savings too. We talked about that savings rate, 12 to 15% of your gross. What’s the point of making $400,000 a year if you’re spending 395 of it?

What do you got to show for yourself at the end of the day? So, yeah, I love that point on the after tax. And it’s something that you’re seeing a little more frequently.

And so think of this as you’re making money.

If there’s any listeners out there who are maxing out their 401Ks with a couple months to spare at the end of the year, and you still want to contribute your normal paycheck deduction, see if your plan has that after tax portion.

So here’s what I found that’s a little annoying. Talk to me on a plan design aspect of, typically you have to go in there and elect it. Like once you max out your, whether it’s Roth or tax deferred portion of your 401K, it just kind of stops.

But you actually physically need to go in there and elect the after tax portion, right?

Just like you did with your pre-tax or Roth deduction.

And you can, if you’re good with your numbers and you look at the beginning of the year, you can already set, if the plan allows for it, have an after tax deduction amount start going from the beginning of the year.

You don’t have to necessarily wait to max it out.

True, you can’t, absolutely.

And now, you know, so.

If you’re maxing your 401k out and you’re like, wait, I can do more, that’s all you can take away from it. Hit us up.

Beautiful.

We’ll help you out.

We did our job.

Yeah.

Great stuff, Sean. I still think I’m going to go pre-tax, but Roth conversion. I am.

I didn’t sell you on any of this stuff.

Even the RMDs taking out money tax-free in retirement. Like you want to go buy a boat, you want a car, you want a second home. And that all comes out tax-free versus, let’s say you need 100 grand and tax rates are at 25% for you.

If I want a boat, I’m going to save up for a boat.

All right.

I just, all right.

I know. I know. All right.

Well, I guess I didn’t do my job.

No, I think at the end of this, everyone’s going to flip.

You’re going to see a huge influx of Roth deductions.

Again, I think it’s the coolest thing in the financial world to be able to save tax-free money, grow tax-free, or sorry, it grows tax-free and comes out tax-free. You’ve paid the taxes, you’re done with it.

And so, like I said, in the middle of the episode of looking at your account on a Roth level, all that money is yours.

Looking at your account on a pre-tax level, whatever your tax rate is, 25 plus state, whatever the case might be, let’s say it’s 25 percent, 25 percent of that account is not yours, it’s the government’s.

So, yeah, it’s putting in the work now if it makes sense. Again, it’s all just a tax bracket game, in my opinion. It’s, are you in a low one relative and you should pay now?

Then great.

If you’re like, no, I’m going to do nothing in retirement, I barely need anything to live off of, so right now I’m just going to defer and slowly take money because I’m not going to make more than, you know, not need 10 grand a month, so, you know,

$120,000 a year. Boom. Okay, great.

It’s all the other fun stuff that comes in retirement, the traveling, the second homes, the cars, the weddings, the boats that people don’t think about when they have all tax-deferred money and they have no Roth money to dip into.

And the RMD bomb.

The RMD bomb is crazy.

I never thought about that once.

In our analysis, we show people there are certain years where they are literally in the 37% tax bracket, just because of the RMD hit.

And so, like I said, I’ve showed many clients and prospects that you can save them five, six, seven hundred thousand dollars in taxes over their lifetime, if done early enough.

And early enough meaning start converting money in your 40s and 50s so that it grows nicely for the next 20, 30 years. And you can make up for that tax hit that you take.

Great stuff, Sean, as always, man.

Yeah. Good conversation. The great debate.

Tell us what you think.

Yeah.

I appreciate you guys.