The other day I was reading through some updates to my employers benefits and I realized I missed a change to my benefits that I can leverage. The problem is to do so I need additional funds. As of this writing we have already maximized almost every benefit we can, leaving little in the way of salary to take advantage of more advantaged spaces. But this got me thinking, perhaps I can still take advantage without requiring a pay raise. That led to this post regarding employer benefits and the fungibility of money.
Our History with Maximizing Employer Benefits
Over the last decade I have been pretty good at maximizing my employer benefits. We have done 401K maximization, HSA, and even dependent care flexible spending accounts. Sure for a while we did not do things like Employee stock purchase plans, but I didn’t have the funds to support those things (or so I thought). With a pay raise this year we took advantage of this opportunity, but recently I’ve come to realize due to the fungibility of money we could have leveraged this opportunity all along.
So we have established I can cover 401k, HSA, dependent care flexible spend, and employee stock purchase plan contributions with my salary. So what triggered the opportunity I am concerned my funds cannot support? In January my employer quietly changed their 401K rules to support after tax contributions and in service rollovers.
The Mega Back Door Roth, After Tax 401K Rollovers
Basically what this change in rules does is allow us to put money into our 401k after tax above and beyond the 18K a year limits. The limits instead become $54K. This 54K includes your after tax contribution, before tax (18K) normal contribution, and any employer match. Even with my employers generous 6K contribution this leaves me with 30K in potential contributions.
The second important rule change for my plan is the in service rollover. Because of this ruling and various IRS rules I can take this after tax contribution and once per year roll it directly into a ROTH IRA. This essentially extends my ROTH IRA savings opportunity from 5500 a year to 5500+ those additional contributions. (A note you would really need to have this rollover provision, otherwise the after tax earnings would be taxable at ordinary income rates. That would be bad since normal capital gains rates are typically lower than ordinary income) In my case if I can find a way to fund it they have opened a door to a total of 35.5K in Roth contributions a year. Knowing how much I favor tax advantaged accounts, you know I want to be all over this opportunity. But where to get the funds?
Money is Fungible, it’s all in your head
For years I have been a big proponent that Money is Fungible. What this means is each unit or individual dollar is interchangeable. The division of funds into multiple accounts or even buckets is largely a scheme of our mind. So for example if say you save 50% of your earnings there are multiple ways to do so. You could save the money from your side hustle and spend the money from your job. Or you could subdivide both equally. Whichever tact you choose the division is basically mental. I.E. it does not change the end funds, just potentially you psychologically.
How to utilize the fungible property of money
The above has interesting ramifications for finding funds to contribute to an Employee stock purchase plan or other short term investments. So in the case of the Employee Stock Purchase Plan (ESPP) I can contribute money up to 10 percent of my income a year. Depending on your plan a few times a year the money spits out with a 15% discount on price in the form of company stock. Previously we also held a Dependent Care flexible spending account that spits out once a year tax free. In both cases when the money came out in the past we use to apply it to savings or mortgage.
A different way to look at short term employee benefits
The thing about both options, the ESPP and Dependent Care Flexible spending account, is they are both short term advantaged accounts. In the case of the Flexible spend I have to get the money out this year to ensure I get the money income tax free. For the ESPP I might be able to hold my company stock and pay taxes later, but I do not recommend this (a post for another day). Instead it is also sold the same year, basically at vesting. It’s easy to miss the implications, but here is where money being fungible comes in.
Short Term Advantage funds no different from Savings or Future Income
Think about it, the money in your ESPP or Flexible spending account is no different than new money coming out of your paycheck. Nor is the money going into the ESPP and Flexible spending account any different then the money you just withdrew from these plans. The only difference is the Flexible spend account guarantees you a tax savings return of your marginal tax bracket and ESPP probably guarantees you something like a 15% return. So ultimately you want to find a way to capture this regardless of whether you have the funds. So what do you do?
A perpetual motion machine, funding itself
Well since the money is no different, essentially the question becomes is the 15% or tax bracket return a higher return then you can get elsewhere? If yes then the best course of action is to invest in them. But How? Easy, max out these plans. Pull the money your paycheck will be reduced by out of savings and live off it for one round of these plans. From then on you can live off the proceeds of each cash out while pocketing the 15% into other investments or areas. So essentially if you can manage your money you can contribute to these accounts with no net impact to your finances after the initial seeding of the plan.
So how will we fund at least some of the Mega Back Door Roth
Back to my Mega Back Door Roth idea. We stopped our Dependent Care Flexible Spending Account this year due to eligibility concerns that are now changing. We also ramped up our ESPP contributions this year. So the ESPP contributions are already to a self sustaining level. While we do have the excess savings space to cover the restart of the flexible spending account, it is probably better to fund this amount by seeding from savings to kick start the process. As noted once started it can otherwise fund itself. As such we now have one requirement, to set aside these funds in a sort of perpetual motion machine to fund itself.
The ramification is the same funds we would have used to fund ESPP and Flexible spend can now be used to fund the After Tax 401K Roth IRA funding. Essentially we can increase our tax advantage space and employee benefits without getting a pay raise due to the power of money being fungible. Pretty cool huh? Will it cover the full 30K? Probably not. But it will start us down that path.
Have you ever taken advantage of the Fungibility of money? Are you taking advantage of the Mega Back door Roth? ESPP?