Learning how Mega Roths can kick retirement savings into higher gear is a great way to help add value for your clients. After all, who wouldn’t want to sock away tens of thousands of extra dollars tax-free if they have this opportunity?
Navigating retirement plans can be difficult. Some plans do not allow after-tax contributions, conversion of after-tax funds into a Roth source, or a conversion/rollover of after-tax funds into a Roth IRA. Below are some questions you and your clients can use to see what options may be available in their retirement plan.
Questions to Ask a Retirement Plan Provider
Are there limitations on what percentage of my pay I may contribute to my plan?
If I am eligible for bonuses, does the same limit apply to my bonus earnings as well as my regular income?
Am I allowed to contribute after-tax funds into the plan?
Is a Roth source available within the plan?
If I make an after-tax contribution into my account, may I convert that to the Roth source within the plan?
If I make an after-tax contribution into my account, may I do a rollover conversion into a Roth IRA outside of my plan? Many providers allow plan participants to roll money from a pretax source into a Roth IRA directly at their firm with a phone call.
Will my contributions be suspended in any way if I roll the pretax funds into a Roth IRA as a conversion outside of the plan?
Am I allowed to do unlimited conversions from the after-tax source into the Roth source or Roth IRA conversion /rollover? If so, how many conversions/rollovers may I do per year/quarter?
If I am doing an in-plan conversion or a rollover Roth IRA conversion, will the plan allow me to convert automatically or do I have to call in to do this each time?
Does the company offer a “true up” match if I max out my contribution too early?
If your client’s plan doesn’t allow the Mega/Super Roth, suggest they speak with their employer’s human resources department to request it. Oftentimes, if there is enough interest, companies will revise their plans to allow their employees to take advantage of the changes to tax law.
Here are some points to bear in mind:
If Automatic Conversions in the Retirement Plan Are Not Allowed
Some plans allow for automatic conversions from pretax contributions into the Roth source in the plan, whereas others do not. If your client’s plan does not allow automatic conversions, they must call in periodically if they wish to make those conversions. This takes time and energy, and it means that there will be a lag between the time that they contribute to the after-tax source and the time they can convert to a Roth source.
If your clients’ investments have appreciated between the time of contribution and time of conversion, they will owe additional ordinary income on the amount of growth, and the more frequently they convert, the less they will pay in taxes. Your client will owe less on tax the more frequently they convert simply because there will (presumably) be less growth on the after-tax source the more quickly they convert it into Roth funds. Once converted, any growth on those funds is tax-free if distributions are taken five years from the first conversion or at/after age 59 ½, whichever comes later.
The Five-Year Aging Period
Money converted to a Roth IRA or Roth 401(k) is subject to the five-year aging period. The clock starts ticking upon the first conversion in the plan or the first conversion/rollover into the Roth IRA. Regardless of your age, you may tap into converted Roth funds after that five-year period without penalty. Remember that retirement plan rules still apply, and the plan may not allow for distributions from the Roth source.
Taxation of Early Withdrawals
Contributions directly to a Roth IRA or Roth source in a retirement plan are withdrawable without penalty (if the plan allows). However, the growth would be taxed and penalized if made prior to age 59 ½.
The Age 55 Rule
Plan participants who separate from service between the age of 55 and 59 ½ are eligible to take distributions penalty free from their plan from any source. Converted funds that have not reached the five-year aging period can potentially be taxed, and many plans give you the option to choose from other sources when taking distributions. After all, clients would want to keep those Roth sources invested as long as possible to get the best tax benefit. This is a special rule for retirement plans and does not apply to IRA accounts. Clients who need to take distributions prior to age 59 ½ from the IRA may want to look into the 72T Rules for an option of doing that to avoid penalties
Summary
Not everyone will benefit from the Mega/Super Roth. As an advisor, you must take the needs, goals, age, circumstances and wishes of each client into consideration. Each person’s situation is different. Make sure that any strategy you employ is well thought through and accomplishes the goals intended by the client.
Monica Dwyer, CFP, CDFA, is a licensed investment adviser representative 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.
