Microsoft Mega Backdoor Roth Conversion 2020
Lars Phillips | March 26, 2020
In this article we are going to talk about the Microsoft Mega Backdoor Roth Conversion which is available to Microsoft employees in 2020, and talk about how to convert funds in your Microsoft 401k to Roth in 2020.
As of 2020, Microsoft employees have some very interesting corporate benefits available to them like Restricted Stock Units (RSUs), the Employee Stock Purchase Program (ESPP), BrokerageLink, and the Deferred Compensation Plan (DCP) if you are level 67 or above. The Microsoft Mega Backdoor Roth Conversion is clearly one of the more powerful and also one of the more underutilized benefits available to you as a Microsoft employee.
In this article you will learn:
✔ What the Microsoft Mega Backdoor Roth Conversion is
✔ How to convert After-Tax dollars in your Microsoft 401k to Roth in 2020
✔ A sample situation in which the Mega Roth strategy is used to execute a Roth conversion for an employee who wants to convert from a 401k to a Roth
✔ What the benefits are of doing a Microsoft Mega Roth Conversion
✔ The difference that using a Microsoft Mega Back Door Roth Conversion can make in your finances
✔ How companies such as Microsoft and many others are giving their employees the option to participate in this Mega Backdoor Roth Conversion strategy
✔ How to take advantage of the Microsoft Mega Backdoor Roth 401k Conversion benefit if it is available to you through your employer sponsored 401k plan
✔ What to do if you want to convert to Roth within your Microsoft 401k
✔What some of the other major Microsoft benefits are, such as the Microsoft Deferred Compensation Plan and the Microsoft Employee Stock Purchase Plan, and how to use them alongside the Microsoft Mega Backdoor Roth Conversion.
✔A timeline for using many of the benefits available to you as a Microsoft employee
The math behind the Microsoft Mega Backdoor Roth Conversion 2020
So let’s get into the good stuff and crunch some numbers here regarding the Microsoft Mega Backdoor Roth Conversion.
As of 2020, if you are under 50, you can contribute $19,500 to your 401k. If you’re over 50, you get to put in an extra $6,500 for a total of $26,000. Both of these numbers have increased by $500 from 2019 to 2020.
Now, you also probably know that Microsoft is going to match 50% of that original $19,500. Microsoft is going to put $9,750 into your 401k if you are maxing it out. Now what you might not know, though, is that the federal limit for total dollars going into a 401k in 2020 is $57,000. This is an increase of $1,000 from 2019. In addition, as we talked about earlier, you can contribute an extra $6,500 if you are over 50.
What this means is that there is a difference of $27,750 between what you and Microsoft originally contribute, and what the IRS allows. Now, what’s so cool is that Microsoft lets you make an after-tax contribution to your 401k to make up this difference. And then on a daily basis it automatically converts these dollars to Roth. So let’s think about this aspect of the Microsoft Mega Backdoor Roth Conversion. for a second. I, Lars Phillips, can contribute $6,000 to a Roth IRA on an annual basis outside of my 401k. Microsoft employees can contribute over four and a half times to a Roth as I can just by utilizing this feature within their 401k.
Why the Microsoft Mega Backdoor Roth Conversion makes a difference
Why is leveraging the Microsoft Mega Backdoor Roth Conversion important? If you’re saving money above and beyond your 401k, you’re probably saving into a taxable account. When we think of a taxable account, we think of an individual account, a joint account, a community property account, etc.
Well, within your taxable account you’re going to have investments and those investments are going to kick off interest income, dividends, capital gains, all of which are taxable each and every year. There can be a pretty substantial tax drag on performance, especially when you think about this compounded year after year.
In a Roth, on the other hand, same interest, same dividends, same capital gains, that’s all tax free. And so, if you continue to pour money into a Roth account, you do this each and every year, all of a sudden you’ve got a really nice nest egg of tax free dollars built up in your portfolio.
Why should you use the Microsoft Mega Backdoor Roth Conversion?
This gives you a ton of flexibility down the road to manage distributions in retirement. This way, you don’t necessarily have to take from your IRA where income is going to be taxable. Or, you don’t have to take all of your money from a taxable account where hypothetically down the road you’ve got some pretty big capital gains that have built up over time. If you plan correctly, you can really save a lot of money from a tax perspective in retirement, particularly if you are thinking about where you are pulling different assets from.
Other Microsoft benefits
As mentioned, the Microsoft Mega Backdoor Roth Conversion benefit is just one of the many Microsoft benefits that Microsoft employees can take advantage of. There are several others, outlined here in brief is an explanation of the Microsoft Deferred Compensation Plan and the Microsoft Employee Stock Purchase Plan.
Microsoft Deferred Compensation Plan 2020
In this section you will learn how to leverage the Microsoft Deferred Compensation Plan, and you will also learn how the Microsoft Deferred Compensation Plan works.
Who is eligible for the Microsoft Deferred Compensation Plan?
The Microsoft Deferred Compensation Plan is available to Microsoft employees level 67 or above. This is also important if you’re Level 65 or 66 and you think you’re going to be promoted to a level 67 at anytime in the future.
How does the Microsoft Deferred Compensation Plan work?
A deferred compensation plan works very much like a pre-tax 401k plan to reduce your taxable income. Any amount you contribute to a deferred compensation plan reduces your taxable income dollar for dollar. These contributions can be invested for growth and used down the road for income in retirement.
Here is the annual timeline of financial events for Microsoft employees who participate in the Microsoft Deferred Compensation Plan. Starting each May, Microsoft employees get to make the Deferred Compensation election for your cash bonus in September of the following year. So for May 2020, the election is being specified for the bonus to be paid in September of 2021. You are allowed to defer up to 100% of your cash bonus, whereas you can only defer 75% of your salary. Remember that any deferred compensation election you make this year will affect your deferrals and taxable income for next year.
In November 2020, along with making your annual benefits election, you have a one-month window to make your Deferred Compensation election for your 2021 salary. At the end of May, and again in August, November, and next February, you have stock grants vesting. 22% of those shares are withheld for taxes, and you receive the remaining 78% of the vesting shares in your Fidelity or Morgan Stanley account. However, you can change this withholding percentage if you feel you’re not withholding enough and you’re having a large tax bill at the end of each year.
How can you leverage the Microsoft Deferred Compensation Plan?
Most people have their salary and their bonus directed to their bank account, and they use this to fund their ongoing expenses. They also commonly allow for all of their stock awards to accumulate in an investment account and hold those shares of stock for the long term. Given the benefits Microsoft offers, we would encourage you to flip this. You should direct the majority of your salary into investment accounts such as Deferred Compensation or your 401k. In order to cover living expenses, you should sell shares of stock as they vest, so you don’t run into capital gains tax issues.
Microsoft Employee Stock Purchase Plan 2020
The Microsoft Employee Stock Purchase Plan is a benefit that lets Microsoft employees purchase Microsoft stock at a discount to its stock price. Much like your contributions to the Microsoft 401k, your contributions come from payroll deductions. However, unlike with the Microsoft 401k, contributions to the Microsoft Employee Stock Purchase Plan are made on an after-tax basis.
How much can you contribute to the Microsoft Employee Stock Purchase Plan?
You can deduct up to 15% of your salary, or up to $25,000 per year.
How does the Microsoft Employee Stock Purchase Plan work?
Your contributions are placed into an account, and shares are purchased at the end of each quarter for 10% below the market price. You are allowed to sell these shares immediately, and we recommend that you do so in order to limit your exposure to the fluctuations of the Microsoft stock price.
Here is a timeline of events for the Microsoft Employee Stock Purchase Plan. During each quarter, your payroll deductions move into a money market account, until the end of the quarter. At the end of each quarter, you actually purchase the Microsoft shares at a 10% discount, and then are free to sell them. If you are thinking about leveraging the Microsoft Deferred Compensation Plan and the Microsoft Employee Stock Purchase Plan along with the Microsoft Mega Backdoor Roth Conversion, it would be wise to do so in accordance with a comprehensive financial plan that takes all elements of your financial situation into account.
Getting the most out of your Microsoft Mega Backdoor Roth Conversion
If you’re a Microsoft employee who wants to start taking advantage of the Microsoft Mega Backdoor Roth Conversion, or any of the other benefits offered in the Microsoft employee benefits plan, please feel free to schedule a quick phone call by using the link below.
This content is for illustrative purposes only. Individual situations may vary. Please consult your tax advisor to determine if the scenarios discussed in this article are right for you. Investment Advisory services offered through Avier Wealth Advisors. Avier is not affiliated with Microsoft.