Retirement savings accounts, such as 401(k)s, 403(b)s and 457s, have long been the primary savings vehicles for individuals in the U.S. Traditional pension plans have largely disappeared and the burden is on most Americans to save for a desired lifestyle that exceeds what Social Security benefits can provide. So, what if you could help your clients unlock hidden opportunities within their retirement plans that can not only boost the amount they can save, but also reduce their future tax outlays?
I’ve written previously about this strategy: making after-tax contributions to a 401(k) plan that are then converted to either a Roth within the 401(k) plan or a Roth IRA outside of the plan. Known as the Mega or Super Roth strategy, it still remains underutilized although it’s been legal now since 2014.
Make hay while the sun shines
If your client can afford this strategy and their plan allows for it, the time to start is now. Democrats have tried to eliminate this generous strategy, but so far have not been successful. President Biden’s fiscal year 2024 budget request would limit the amount taxpayers with incomes over $400,000 can hold in tax-favored retirement accounts like mega Roths or backdoor IRAs, but that proposal is seen as having little chance of passing. Congress is expected to vote on the budget by September 30, but Republicans may move spending bills earlier.
A backdoor Roth IRA is a similar strategy to a Super/Mega Roth; it also provides high-income earners with a way to skirt income limits and get money into a Roth vehicle. People sometimes consider the Super/Mega Roth strategy to be a backdoor, too. But a Super/Mega Roth strategy always begins with a company retirement plan. In contrast, the backdoor Roth IRA strategy is done outside of retirement plans.
Although the Mega/Super Roth strategy will not necessarily be around forever, high earners can continue to take advantage of its current availability.
I’ll share some examples on how it can help clients this year.
First, cover the basics
Before getting into the hidden opportunities of Super/Mega Roth’s, let’s first look at the obvious: Are your clients taking full advantage of their company’s match?
They may be forfeiting this opportunity if they are not making regular contributions that last throughout the full calendar year. In most cases, 401(k) and other defined-contribution plan participants are allowed to contribute up to $22,500 if they are under the age of 50 by Dec. 31, 2023, or up to $30,000 if they are age 50 or older by that date. Total contributions from employer and employee may not exceed $66,000 for those under age 50 by Dec. 31, 2023.
For example, let’s say Lisa, age 40, earns $125,000 a year (approximately $2,400 a week) and contributes 25% to her 401(k). Her company matches 100% of that contribution up to 6% of her total income. By September she will reach the maximum amount — $22,500 — that the IRS will allow her to contribute this year.
The maximum combined contribution for employee and employer contributions is $66,000. But once her contributions stop going into the plan, so do the company contributions. Lisa is much better off contributing 18% of her $2,400 paycheck ($432) for the full calendar year, instead of 25% ($600) so that her company contributes $144 per week ($2,400 x 6%) for the full year instead of only during three-quarters of the year.
True-up match
The only exception to this would be if the company does what is called a true-up match — catching up on employees’ contributions the year following their missed contributions. While this is nice, it isn’t ideal; the preference is to dollar-cost-average into the market and have the company match those contributions earlier in the year rather than catch up later.
Don’t forget to advise your clients to re-adjust retirement contributions at the beginning of each year based on their goals, income and yearly limits.
What about retirement-account superpowers?
The Mega or Super Roth is essentially the following:
- The participant makes regular contributions to a retirement plan, and their company may match those contributions. These can be done pretax (allowing participants a tax deduction now) or as Roth contributions (allowing participants tax-free distributions in the future) if the plan permits.
- The participant makes additional after-tax contributions to the plan. (After-tax contributions are generally not matched by employers, so its extra important to take steps to maximize company matches in Step 1.)
- The participant converts the after-tax contributions to a Roth within the plan or possibly converts to a Roth IRA outside of the plan. More on those strategies later.
Note that not all plans allow for Roth contributions, after-tax contributions or even conversions from after-tax to Roth. To determine if this strategy is possible, it will be necessary to find out what the plan rules are. Asking the retirement plan provider or the retirement plan administrator the right questions can help determine what a plan will and will not allow.
Who benefits from a Mega/Super Roth?
Participants who are most likely to use the Mega/Super Roth strategy fall into three categories:
Super Savers. These are the clients who have savings in their blood. They are always looking for ways to optimize their savings and the Mega/Super Roth is a great way to do it, especially since regular Roth IRA contribution limits are set at $6,500 in 2023, plus a catch-up contribution of $1,000 per year for those age 50+ by December 31. (Note that Roth IRA contributions are subject to income limits.)
Empty Nesters. These parents have finished raising children who’ve successfully launched into adulthood — or at least moved out of the house. They are ready to kick their savings into a higher gear and sprint to retirement.
High Income Earners. High earners can’t put away as big a percentage of their income as lower income earners. Executives, doctors, lawyers and other high earners can use the Mega/Super Roth strategy to shelter more of their income so they can maintain the same standard of living in retirement that they enjoyed while working.
Note that all plans must satisfy testing requirements that confirm highly compensated employees (HCEs) do not disproportionately benefit from retirement plan contributions. Each participant is subject to these rules, and they may end up over-contributing to the plan, in which case they will get refunded without any tax penalty.
Real-World Scenarios
Let’s see how the Mega/Super Roth could help people in different categories contribute more this year to their retirement plans and boost their future tax savings.
John and Terry – Empty Nesters
John, 58, and Terry, 60, are married and would like to retire in five years. They prioritized their children’s needs as they were growing and supported them through college. John and Terry are ready to play catch up with their own retirement and have dreams of traveling and perhaps even owning a condo in a warm-weather locale. They are ready to commit to aggressive savings goals.
Their combined annual income is $300,000 ($150,000 each), which includes their base pay plus expected bonuses. John’s company allows pretax and Roth 401(k) contributions but does not allow after-tax contributions; therefore, he will not be allowed to do a Mega/Super Roth. John decides to max out his contribution to his 401(k) in pretax dollars. Terry has the option to do the Mega/Super Roth in her 401(k), but the plan will only allow her to do an “in plan” conversion. Here is what their savings could look like this year:
John’s pretax 401(k) contributions ($22,500 + $7,500 catch up) = $30,000.
John’s company will match 100% of his contributions up to 4% of his salary ($150,000 x .04) = $6,000. Between John and his company, the total contributions into his 401(k) will be $36,000, well below the total limit.
Terry is going to max out her pretax contributions just as John did at $30,000 ($22,500 + $7,500 catch up contributions.)
Terry’s company will match 100% of her contributions for the first 4% of her salary and 50% of the next 4% of her salary, meaning that they will match a total of 6% of her income = $9,000.
How much more can Terry contribute to the after-tax bucket and convert to the Roth in her 401(k), which will allow her to max out her contributions? Use this worksheet:
| A. Total Contributions Allowed in 2023 | $73,500* |
| B. Terry’s Pretax Contributions: | $30,000 |
| C. The Company Match: | $9,000 |
| D. Line A minus B minus C = | $34,500 |
For a couple previously not allowed to contribute to a Roth IRA because their income exceeded the annual limit of $228,000 in 2023, $34,500 is a huge sum to be able to contribute after tax and then convert to a Roth for one tax year. Even if they were eligible to contribute to a Roth IRA (based on income), they would cap out at $15,000 in contributions. This is more than double that amount.
Gary and Diane – Super Savers
Gary and Diane met at work and still work for the same firm. They are in their early 30s and they have always aimed to retire early. They are willing to forgo spending now so that they can reach their savings goals earlier. This year, Gary will earn $155,000 and Diane will earn $110,000. They both believe that taxes will rise in the future and last year they put all their 401(k) contributions into the Roth within their plans. Because their income was over $214,000 in 2022, they didn’t qualify to make Roth IRA contributions.
This year, Gary and Diane are working with a financial advisor who ran a financial plan for them. The advisor determined the couple would be best off, based on the planning assumptions, to put half of their contributions into a Roth within their 401(k) plans and half into a pretax bucket within these plans. Here is the breakdown of how that looks for them:
Gary earns $155,000. His company matches 5% of his income. How can Gary contribute to a Roth if the income limit for 2023 for married filing jointly is $228,000?
| A. Total Contributions Allowed in 2023 | $66,000 |
| B. Gary’s Contributions: | $22,500* |
| C. The Company Match: | $7,750 |
| D. Line A minus B minus C = | $35,750 |
Gary is allowed to contribute an additional $35,750 to the after-tax portion of his 401(k) and convert that to the Roth within his plan.
Diane earns $110,000 and the company’s match is 5%. How can Diane contribute to a Roth if the income limit for 2023 for married filing jointly is $228,000?
| A. Total Contributions Allowed in 2023 | $66,000 |
| B. Diane’s Contributions: | $22,500* |
| C. The Company Match: | $5,500 |
| D. Line A minus B minus C = | $38,000 |
Diane is allowed to contribute an additional $38,000 to the after-tax portion of her 401(k) and convert that to the Roth in her plan.
Notice that not only do they have the opportunity to contribute $73,750 ($37,500 for Gary and $38,000 for Diane) into a Roth this year, but because they contributed some of their funds pretax, they have lowered their total income threshold to the point that they can also contribute $6,500 each into a Roth IRA if they wish. (Their income is $155,000+$110,000, less the $22,500 they each contribute combined to the pretax portion of their 401(k)s, less their standard deduction for 2023 of $27,700 equals $214,800. The income limit starts at $218,000, so they can make the full Roth IRA contributions, if desired.)
Gary and Diane need to continue to make sure they are contributing enough pre-tax funds to their 401(k)s to qualify for the Roth IRA in future years.
Drs. Fred and Frankie – high-income earners
Drs. Fred and Frankie met when they were in residency together. They are heart specialists and are high-income earners. Fred works as a cardiologist for a private practice and earns $300,000 per year. The private practice does an automatic 3% match of his salary regardless of whether he puts money into his 401(k) or not. Frankie works as a cardiothoracic surgeon for a hospital and contributes to a 403(b) account. She will earn $340,000 this year and is entitled to a pension; therefore, the hospital does not contribute to her 403(b) account.
Fred and Frankie are both are in their late 50s and are looking for a way to shelter as much money as possible from taxes. Based on their savings rate and growth in their investments, they anticipate that their tax bracket will remain high in retirement.
The couple files their taxes jointly and neither spouse qualifies for a Roth IRA based on income.
Fred’s 401(k) plan allows him to do the Mega/Super Roth strategy within his plan. Here is what his contributions could look like for 2023:
| A. Total Contributions Allowed in 2023 | $73,500 |
| B. Fred’s Pre-Tax Contributions: | $30,000* |
| C. The Company Match: | $9,000 |
| D. Line A minus B minus C = | $34,500 |
Fred likes the idea of putting an additional $34,500 into the Roth bucket of his 401(k) account, but he really likes investing in individual stocks. Fortunately for Fred, his 401(k) plan allows him to do a conversion/rollover into his Roth IRA — a brokerage account where he can trade individual stocks. Always check the plan rules to be sure that there is no penalty when doing the after-tax rollover/conversion.
Frankie also wants to put in as much as possible into the Mega/Super Roth, and her plan allows it. So, Frankie does the following:
| A. Total Contributions Allowed in 2023 | $73,500 |
| B. Frankie’s Pre-Tax Contributions: | $30,000 |
| C. The Company Match: | $0 |
| D. Line A minus B minus C = | $43,500 |
Because Frankie’s hospital doesn’t offer a match, she can contribute more after-tax dollars to her 401(k) and then convert to Roth than her husband can. She would prefer to take this contribution and roll it into a Roth IRA outside of the plan to get more investing options, but that is not available in her 403(b) account.
A few important details
There’s a lot more to know about Mega/Super Roths. Here are some basics:
Automatic in-plan conversions
Some retirement plans allow automatic in-plan conversions. That means that as soon as money goes into the after-tax bucket, it is immediately converted to Roth. The benefit is there is no growth of those after-tax funds prior to conversion.
If a retirement plan doesn’t allow after-tax contributions to be automatically converted to a Roth, the plan may allow one of two other things:
- The participant may have the option of paying taxes on the growth in the current calendar year and converting the funds to Roth, or
- The participant may be able to leave the growth from the after-tax funds in the pretax portion of the plan and convert the after-tax contributions to Roth, , avoiding any additional taxation for the current calendar year. Doing more frequent, or better yet, automatic conversions of the after-tax money will minimize this issue.
Keeping the Roth in a retirement plan vs. an IRA
Some people or advisors prefer the investing options of a Roth IRA brokerage account to the limited investments in their retirement plan. In that case, if the plan rules allow it, they can convert and roll over the after-tax money instead of leaving it in the plan. Keep in mind that any other legal or cost advantages of keeping money in the retirement plan — such as federal protection from lawsuits or lower fee mutual funds — may not be available outside of the retirement plan. (Some states protect IRAs from lawsuits in the same way that a retirement plan has legal protections.)
Separate designations may be available
Some companies have a separate designation for withholding from regular paychecks vs. bonus checks. This can be nice if you are trying to manage a client’s cash flow. For example, if the client doesn’t normally use their bonus money for essential living expenses, they can make a larger contribution of the bonus account into the retirement plan so their goals are met without hampering their regular cash flow.
Do your homework
Please refer to this list of important questions. Most clients wouldn’t feel comfortable asking the provider all these questions. You would give your client great service by calling the provider, with your client on the line, so that you can ask the questions and record the provider’s answers.
Since plans change their rules from year to year, it wouldn’t hurt to call periodically to see if there are any updates. Also see this flowchart for additional details.
Avoid plan penalties
Make sure that any conversions of after-tax funds to an outside Roth IRA will not trigger a penalty by the plan. Penalties usually preclude the client from being able to contribute to their plan for a specific period. So not only does the client miss out on their contribution, but they also miss out on matching contributions for that period.
Monica Dwyer, CFP, CDFA, is a Registered Investment Advisor with Harvest Financial Advisors, LLC in the Cincinnati/West Chester, Ohio area. She may be reached at monica@harvestadvisors.com. This article is for informational purposes only. Any commentary and third-party sources are believed to be reliable but Harvest Financial Advisors cannot guarantee their accuracy.
