The following article, Super Roth, was originally published on LinkedIn…
The following is meant to be educational and not specific advice. I assume my readers are big boys/girls and understand that, but in today’s climate I have to tell everyone again anyways – people might do something dumb and go hurt themselves! (like stick a fork in an electric socket or something – don’t do that!). Consult a qualified advisor before attempting tax strategies.
What if you could add $10-$20,000/yr to your Roth IRA – would you be interested? Are you tired of hearing that you don’t qualify for certain tax breaks because you “make too much money?”
Would you like more of your money completely shielded from The Tax Man – and protected in your Roth IRA?
If this sounds good to you, I have great news. In June of 2014, the IRS gave you a big green light.
How Super Roth Works: The Key Lies Inside Your 401k
Inside your 401k plan, there is a potential benefit that you may have missed. Something that could help you supersize your Roth IRA without those nasty taxable conversions: It’s the ability to roll over non-deductible contributionsseparately to your Roth IRA.
In the summer of 2014, the IRS issued Notice 2014-54 – in short they said that “after-tax contributions” to a qualified retirement plan can be rolled into a Roth IRA directly – and split from your “pre-tax” money.
What does this mean?
It means that if you have a plan at work that allows you to put more than the maximum deductible amount into the plan (these would be “after tax” contributions meaning no tax deduction), you can (at a later time) roll over those “after-tax” contributions into a Roth IRA!!! And separately, you can roll the tax deferred earnings into a regular IRA.
Lets look at an Example of the Super Roth in Action
Hypothetically, lets say you maximize your 401k contributions – which means in 2015 you’re putting $18,000 in this year ($24,500 max if you’re age 50+). We’ll also guess that it’s likely your company matches if you work for a big firm like HP or Target.
After you maximize your contributions, you contribute further – these contributions are not deductible (you hit your max) but the earnings on those funds are still tax deferred.
Lets say you contribute an extra $10,000 for the next 10 years.
At the end of year 10, you’ve contributed $18,000 + $10,000 per year ($280,000 over ten years, which includes $100,000 of after tax contributions). And let’s assume your total 401(k) balance with some growth is $350,000. When you leave that job in the future, you could consider (among other options):
- Keeping the money where it is (keeping it at your old company’s plan).
- Rolling it to your new employer’s 401(k).
- Separating the source of funds by rolling the after tax balance ($100,000) into a Roth IRA and the remaining pre tax money ($250,000) into a traditional IRA or your new company’s plan.
Option 3 is awesome. Look what you’ve done – by choosing option 3, you’ve created a Super Roth. And you have added a huge chunk of tax free money that will growth further for you in retirement, with all the benefits of having a Roth including:
- No RMD (Required Minimum Distributions) at age 70.5
- No tax on the kids if you pass away and leave the Roth IRA to them
- No bump up in taxable income when you cash some out in retirement – the income bump up tends to knock you out of deductions on health expenses and increases taxes on social security benefits (overall it’s a lousy deal!)
I highly recommend exploring this strategy if you fit this profile:
- Higher income (you have the ability to overfund a 401k)
- Have financial goals that you would like to actually accomplish
- Prefer keeping more of your money instead of donating to the US government pay interest on debt fund
- Want more flexibility in how you spend your money
YOU Are a Government Tax “Target”
Of course certain politicians don’t like this “Super Roth” idea because this, along with other planning strategies like NUA (which I wrote about a few weeks ago) and529 plans, these strategies really only help higher earning workers – for example, a single worker earning over $200,000 or a two income couple earning $250,000+ (Moderate income folks don’t typically have the disposable income to fund 529s and to fully fund 401(k)s).
The Real Situation of the Typical Higher Earner
Who is a higher earner? The higher earner brings home what the average American would consider to be a great income. However, between helping out parents, and paying for college (because they don’t come close to qualifying for financial aid), they often don’t have the fancy lifestyle that some might think they have.
They don’t feel rich, even though the tax code says they are. If this is you, I understand. I work with people like you and I know you’re not out there buying 3 Maseratis. You’re building security for your entire family – often including your parents, your in laws, and your (future) children. But to the government, you’re a target – you’re rich.
Want to Take Action?
If you think you could benefit from utilizing more awesome planning strategies – like the Super Roth – in your comprehensive financial plan, that would coordinate and work together to deliver some oomph to your net worth, contact me. Either:
By the way, don’t forget to sign up for my email newsletter to stay in touch. Thanks for your time!
For more reading on this go to:
IRS Notice on After tax balances rolling to a Roth IRA: IRS Notice 2014-54
White House targeted tax breaks (including the “Super Roth”): White House Budget Proposal Summary by McDermott, Will, & Emery