Creating the Super Roth

Investing, Roth IRA
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By Larry Weiss, CFP®, CPA

Learn more about Larry on NerdWallet’s Ask an Advisor

Many financial advisors’ clients are looking for good planning ideas that will benefit their retirement.

Roth IRAs can be an ideal investment. Their benefits can include tax-free growth, tax-free access to the money and no minimum required distributions, which traditional IRAs face after the account holder reaches age 70½. While the Roth IRA is a wonderful investment, its annual limits are low, and many successful peoples’ incomes are too high to use the tool because of income limitation established by the IRS.

There is a new opportunity for these high-income earners: what I call the “Super Roth.”

Here’s how it works:

  1. If you have a 401(k) plan at work in 2015, as an employee you can contribute $18,000 over the course of the year ($6,000 more if you are over age 50).
  2. The employer often provides a match. Let’s assume for our discussion it is $5,000. Thus the total employee and employer contribution is $23,000 if you are under age 50.
  3. In 2015 the total amount allowed for retirement contribution per IRS Section 415 limitations is $53,000. Most people are substantially below the maximum contributions levels.
  4. Some 401(k) plans allow employees to make after-tax contributions to their plan. So if you were an employee who had contributed $23,000, this would provide an opportunity to contribute $30,000 more, up to the $53,000 IRS limit. Unlike your contribution of $18,000, this contribution would not lower your taxable income by using pretax dollars.
  5. Like all funds inside your 401(k) plan, growth would be tax-deferred. You would only have to pay income taxes when you began taking distributions in the future. Your original after-tax contribution ($30,000 in the above example) can be distributed without taxes.
  6. To make this strategy ideal, you take the additional $30,000 after-tax dollars you contributed to your 401(k) plan and convert it to a Roth pool of money inside your 401(k). Thus the $30,000 and all future growth of these funds would be income tax-free and not subject to minimum required distribution at age 70½. These funds could be a wonderful planning tool that could be ideal for retirement, creating a legacy or maybe a great way to fund a grandchild’s college fund. You have created a “Super Roth IRA.”

This strategy can provide wonderful long-term benefits. But to create the Super Roth, your 401(k) plan needs to have the right provisions: allowing after-tax contributions and providing for “in-plan” Roth conversions. Every retirement plan has specific rules about when and how funds can be removed from the plan or rolled over into a traditional or Roth IRA. Careful attention to detail is essential to yield the greatest benefits.

For clients who are looking to save more for retirement and have already maxed out their pre-tax 401(k) contributions, adding after-tax dollars to the 401(k) (if the plan allows it) and then doing an “in-plan” Roth conversion can provide an ideal investment vehicle for the future.