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

Agenda Rothification Why Roth? After-Tax Overview Conversion Opportunities

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

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

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-plans/retirement-plans-faqs-on-designated-roth-accounts

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

Who Should Consider Roth? Low tax bracket currently – so deduction is not as valuable This may include younger participants or those re-entering 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

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

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

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

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

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

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

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

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

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

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)

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 tax-deferred? A no-brainer Example – next slide

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”

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 15th of following year

Questions?

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