AfterTax and Roth Opportunities in 401k or 403b

After-Tax and Roth Opportunities in 401(k) or 403(b) Plans Robert M. Kaplan, CFP, CPC, QPA, APA Director of Technical Education American Retirement Association 1

Agenda • • Rothification Why Roth? After-Tax Overview Conversion Opportunities 2

Rothification • $2, 400 proposal – Deferrals over $2, 400 would have to be Roth – 2018 limit is $18, 500 • First $2, 400 could be either Roth or pre-tax • $2, 401 and above would be Roth – Some have suggested 100 percent of deferrals as Roth – Camp proposal suggested anything above 50 percent of § 402 limit as Roth 3

Rothification • Did you notice that many of the state Auto IRA proposals have Roth either as the only option or the default option? • There is a reason for this – current tax revenue 4

Why Roth? • Taxable in year contributed • Qualified distributions tax free (including earnings) in year distributed – Age 59 ½ – Five years (or death, disability) • Limit in plans is much higher than IRA world (and income restrictions) • IRS website: www. irs. gov/retirement-plansfaqs-on-designated-roth-accounts 5

Roth IRAs • • 2017 and 2018 IRA limit - $5, 500 2017 and 2018 IRA Catch-up limit - $1, 000 2017 Single filers phase out $118, 000 to $133, 000 2017 Joint filers phase out $186, 000 to $196, 000 6

Who Should Consider Roth? • Low tax bracket currently – so deduction is not as valuable – This may include younger participants or those reentering workforce – Gig economy workers – Those phasing into retirement (leave full-time job but work part time) – some live off savings before pre-tax • Higher tax brackets in future than currently • Tax diversification 7

Who Should Consider Roth? • Estate planning (paying tax currently so beneficiaries can get tax-free distributions) • No RMD? ? Yes and No – No during owner’s lifetime – Death benefit RMD rules apply 8

Concerns • Will Congress ever change rules on tax-free distributions? • Will I contribute less now because I have to pay more in current taxes? • Auto enroll – mostly pre-tax • Not all plans have a Roth-deferral provision – Vanguard 2016 Plan Data Survey shows 65 percent of plans offer Roth feature 9

Conversions in Plan Rollovers • Plan provisions must allow – Plan only can do this if it has a Roth deferral provision • Can be all or any sources – see plan document • Current taxation of conversion amount 10

After-Tax Contributions • Allowable but not common – Current taxation but earnings grow tax-deferred – Immediate distribution – Must be included in 401(m) match ACP testing – Conversion opportunity (to be discussed) • Vanguard 2016 Defined Contribution survey shows 18 percent of plans offer after-tax contributions • See next slide for example 11

After-Tax Contributions • Example - 2017 – Plan allows for deferrals – Match is dollar-for-dollar to six percent – Defer $18, 000 and receive $18, 000 as match – $36, 000 total and plan has NO nonelective source – Annual additions limit is $54, 000 – Room for $18, 000 as after-tax – See next slide 12

After-Tax Contributions • Example – But the $18, 000 is used in ACP test – Don’t only HCEs have the ability to afford this extra contribution – This could doom testing even with match • SH plans still have to test for after-tax – Not so fast 13

After-Tax Contributions • Example – How about companies with a lot of NHCEs who make a very good salary? • Think Silicon Valley – Consider using top paid group election • Only top 20 percent are HCEs even if over the prior year HCE $ limit – $120, 000 for 2017 14

After-Tax Contributions • Another candidate – Owner-only business – Second job/business • Professors who have consulting jobs • Doctors who have side practices • People who sell real estate on weekends • People who dabble in writing/acting/music/art • Anyone with a second income 15

After-Tax Contributions • • • If earnings are less than $144, 000 may want to consider $144, 000 x 25 percent (deduction limit) = $36, 000 $18, 000 could go in as deferral = $54, 000 Adjust for catch-up See next slide for example 16

After-Tax Contributions • • • Earnings $100, 000 Deduction (25 percent) = $25, 000 $18, 000 deferral = $43, 000 Room for $11, 000 after-tax I have assumed they want to maximize plan contributions while retaining flexibility (so no DB plan) 17

After-Tax Conversion Opportunity in Plan Rollover • If maxed out on deferral limit and I can contribute after-tax – If plan allows for Roth deferrals AND – Has a Roth conversion provision • Why not convert and have earnings tax-free instead of taxdeferred? • A no-brainer – Example – next slide 18

After-Tax Conversion Opportunity • Example – $18, 000 deferral – $18, 000 match – $18, 000 after-tax Roth conversion – Could have $36, 000 Roth in this case • Too good to be true for some? • Works unless Congress closes this “loophole” 19

After-Tax Conversion Opportunity • Do I have this opportunity for an IRA? • Yes – No conversion limit – Taxes paid – No ten-percent penalty if within 60 -day window • Re-characterization (IRA only not plans) – By October 15 th of following year 20

Questions?

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