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.
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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.
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