What is a Mega Roth IRA for Merck Employees?

The enormous entryway Roth IRA is a strategy Merck's 'highly compensated employees' (HCEs) can use to increase retirement savings and shield investment growth from retirement taxes.

According to a recent study conducted by the Employee Benefit Research Institute (EBRI) in 2022, it was found that individuals aged 60 and older who have a Mega Backdoor Roth IRA in place tend to have higher retirement savings and potentially enjoy a more tax-efficient retirement. The study revealed that retirees with a Mega Backdoor Roth IRA were able to maximize their after-tax contributions, resulting in a substantial increase in their Roth assets and potential tax-free growth over time. This strategic approach can be particularly beneficial for Merck workers in their 60s who are looking to optimize their retirement savings while minimizing their tax burden.

Let's begin with the fundamentals.

Retirement Savings 101

When you choose to make Roth contributions, you will deposit after-tax dollars into your account. This means that you will pay taxes on the money in the year it is earned, and you will not receive any tax benefits for your contribution.

In exchange, you will not owe taxes on your contributions or future withdrawals. In addition, as long as your Roth contributions have 'matured' for at least five years, any earnings they generate will not be subject to taxation. (However, if Merck made any contributions, you will still be required to pay taxes on those contributions when you withdraw, as you will not have already paid taxes on them. Merck's contributions are always traditional, tax-deductible contributions.)

Limits for 2022 have changed since last year. A person under the age of 50 is eligible to contribute $20,500 to their 401(k). People aged 50 and older may contribute an additional $6,500 annually in catch-up contributions to their 401(k), for a total of $27,000. Limits for total employee and employer contributions have also increased over the past year and now stand at $61,000 (or $67,600 for individuals aged 50 and older).

Some company 401(k) plans permit after-tax contributions, creating a 'mega backdoor' through which you can invest up to an additional $40,500 in your Roth IRA or Roth 401(k).

We'll explain how it works and whether or not it's a good move for you, but you should be aware that this is complex and advanced financial planning with the potential for unexpected tax bills; you should absolutely consult an expert on this one.

Is a Mega Backdoor Roth Possible?

There are two prerequisites; if you are uncertain about either, contact HR or the administrator of your Merck plan.

1. You must be able to make after-tax contributions to your 401(k). Not all 401(k) plans permit contributions after taxes. Quick vocab lesson: After-tax contributions are a distinct category from pre-tax and pre-tax contributions. (We've previously mentioned how after-tax and post-tax were once confused.)

2. In addition, your 401(k) plan must permit in-service withdrawals and Roth conversions. In-service withdrawals (also known as in-service distributions) allow you to transfer funds from your 401(k) to a Roth IRA while you are still employed by Merck. In-plan conversions allow you to convert your after-tax 401(k) contribution to Roth dollars.

Mega Backdoor Roth IRA Pros

• Due to the dollar quantities involved, this strategy can significantly impact your overall retirement savings and tax-free Roth asset pool. Even if Merck only allows this for a few years, it may still be worthwhile if it makes sense given your overall financial situation.
• If the entire massive backdoor Roth strategy is well-planned, it can be relatively simple for an individual to implement.

Mega Backdoor Roth IRA Cons

• Most individuals lack the flexibility to leverage this strategy's benefits, particularly on an after-tax basis.
• Even if individuals have the ability to implement this strategy, it may not be effective at the plan level. Your Merck-sponsored 401(k) plan must satisfy a number of testing requirements. This includes the participation of 'highly compensated employees' or HCEs in comparison to 'non-highly compensated employees' or NHCEs. Logic dictates that if only HCEs make after-tax contributions, the plan may be required to return a portion of the contributions to HCE participants if it fails the test.

How a Mega Backdoor Roth Works

The precise limit on a contribution plan such as a 401(k) is quite high: $61,000 (or $67,500 for those 50 and older) in 2018. This maximum number is comprised of the $20,500 (or $27,000) employee elective deferral amount, as well as any matching contributions from Merck, profit-sharing, and your after-tax contributions.

Using the massive backdoor strategy, you transfer all of your after-tax 401(k) contributions to a Roth IRA or to Roth dollars within your 401(k) before the funds can earn investment returns. Due to IRS nondiscrimination tests, there are also situations in which a company's highest-earning employees cannot contribute the maximum amount after taxes. If withdrawn from a Roth-style account, the money will grow tax-free rather than tax-deferred, meaning neither you nor your beneficiaries will owe taxes on the earnings. Pretty cool.

In-service withdrawals or conversions are one of the requirements, as speed is crucial. You do not want to wait until you depart Merck to transfer that sum of money.

NOTE: If you leave it in your 401(k) as an after-tax contribution, it will accrue taxable earnings the entire time.

Manually completing the process is difficult, and we are here to help.

Consider a scenario in which a missed in-service withdrawal or in-plan conversion has accrued earnings. Certainly not the end of the universe. The IRS confirms that you can transfer the contribution portion to a Roth IRA and the gains portion to a traditional IRA, which requires some effort but preserves the favorable tax status of your contribution.

Calculate Your After-Tax Contribution Amount

You'll note that we repeatedly refer to 'up to $40,500' in additional contributions; this is because each individual's amount after taxes may vary. To make up the difference between the standard employee contribution amount of $20,500/$27,000 and the maximum limit of $61,000/$67,500, you must account for any Merck matching and profit-sharing along the way.

Let's examine a few straightforward scenarios.

Henry, 57

Age-based maximum cap: $67,500

Salary: $100,000

Profit-sharing: 25% of compensation

At 56, Henry has greater potential. Henry has capacity for after-tax contributions of $15,500 if he contributes the maximum $27,000 and receives the maximum $25,000 from his employer.

Nancy, 44

Age-based maximum cap: $61,000

Salary: $100,000

Up to 3 percent of remuneration is matched by the employer

If Nancy contributes the maximum of $20,500 and her employer matches $3,000, she has capacity for $37,500 in after-tax contributions.

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Age-based maximum: $67,500 for Jason (60 years old).

Maximal annual contributions to both his 401(k) ($27,000 in 2022) and IRA ($7,000 in 2022). He wants to save even more by contributing to a mega backdoor Roth IRA, but he also wants to know the utmost after-tax contribution he can make to his 401(k) plan. If his total annual employer contributions are $10,000 in 2022, Jason can contribute up to $30,500 after taxes this year. John would transfer his after-tax contributions to his Roth 401(k) or Roth IRA, allowing him to deposit an additional $30,500 in a Roth account with tax-free growth, assuming his 401(k) plan has the necessary provisions.

Some 401(k) plans limit the amount of after-tax contributions, so even if you have the ability to contribute more, you may not be able to. There are also situations in which a company's highest earners cannot maximize their after-tax contributions due to IRS nondiscrimination tests. These tests are designed to ensure that those earning the most are not saving at a higher rate than the rest of the organization.

And it bears repeating that after-tax contributions are not deductible, and if left in the 401(k) plan rather than being transferred into a Roth-style account, the earnings could be taxed upon withdrawal.

When to contemplate a mega backdoor Roth 401(k)

Mega backdoor Roth IRAs are an intriguing option for high-income Merck employees seeking additional retirement and higher savings options. It is worthwhile to consult a financial planner if:

• You've exhausted out your personal 401(k) contributions. This precedes that. When you've reached your contribution limit and still have more money to save, you can contemplate a mega backdoor strategy.
• You desire to save additional funds for retirement. Mega backdoor Roth IRAs are an excellent method to save money each year. Still, there are a variety of additional financial strategies to consider, such as time horizon and liquidity.

Conclusion

Imagine stumbling upon a well-hidden vault filled with confidential financial strategies. Just as this vault holds exclusive insights, a Mega Roth IRA presents a valuable opportunity for high-income Merck employees approaching retirement. By strategically leveraging after-tax contributions, they can amass a wealth of tax-free growth and earnings within their Roth IRA. Just as the secure vault ensures the protection of valuable assets, the Mega Roth IRA safeguards their retirement funds, providing a prosperous and secure future for those who delve into its specialized knowledge.

Source:

1. What to do with an Early Retirement Ebook
2. RSUs Essential Facts (Schwab.com, 2022)
3. The Mega Backdoor Roth Too Good To Be True?' (Forbes.com, 2022)
4. Social Security Ebook
5. Lump Sum vs. Annuity Ebook
6. 401(k) Rollover Strategies Ebook
7. Closing the Retirement Gap Ebook

How long must Merck workers maintain the withdrawals?

The payments must continue for a minimum of five years or until you reach age 59 and a half, whichever is lengthier.

How frequently must Merck employees make withdrawals?

Merck employees are required to accept the payments on an annual basis.

Can Merck workers initiate 72(t) payments from their 401(k)?

The 72(t)-payment plan is applicable only to the IRA or IRAs from which the initial payment was calculated. Depending on your requirements, you can split your IRA into two IRAs prior to establishing a 72(t)-payment plan. One IRA can be used to calculate and withdraw 72(t) payments, while the other remains available for non-72(t) purposes.

How do Merck employees determine payment amounts?

Three methods have been approved by the IRS for calculating 72(t) payments. The required minimum distribution (RMD) method, the amortization method, and the annuity factor method are these methods. The RMD method will initially generate lesser payments than the other two methods. Although other methods of calculating the payments are not strictly prohibited, it would be exceedingly risky to use a method that has not been approved by the IRS. Generally, you should consult a tax or financial advisor when calculating your 72(t) payments.

After beginning 72(t), can Merck employees alter their method?

You can transition from the amortization or annuity factor method to the RMD method. This is a one-time, irreversible change, and the RMD method must be used for the remainder of the schedule.

Can Merck workers cancel their 72(t) payments?

If you do not adhere to your 72(t)-payment plan or if you modify the payments, the 10% penalty exemption will no longer apply. Even worse news: the 10% penalty will be reinstated retroactively for all distributions taken prior to age 59 1/2.

Can Merck employees take 72(t) additional withdrawals in the event of an emergency?

A supplemental withdrawal is regarded as a change to the payment schedule. Any change in the account balance that is not the result of regular gains and losses or 72(t) distributions will also be regarded as a modification and will trigger the 10% penalty. This indicates that neither rollovers nor contributions can be used to fund an IRA. You cannot convert or rollover your 72(t) payments.

Conclusion

In the realm of financial strategies, Merck employees nearing retirement can approach the 72(t) rule with the finesse of a seasoned conductor leading an orchestra. Similar to how a conductor carefully orchestrates the harmony among musicians, understanding and implementing the provisions of the 72(t) rule requires meticulous planning and coordination. By conducting their financial moves with precision, these employees can navigate the complexities of early withdrawals from their retirement accounts, ensuring a harmonious balance between accessing funds and avoiding penalties. Just as a conductor guides a symphony to create a masterpiece, a well-executed 72(t) strategy can lead to a harmonious and secure retirement journey.