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The Evolution of the “Super Saver” Strategy
How to help participants contribute up to $57,000 per year in their retirement plan and receive attractive tax benefits
By: Peter Nadeau, ARPC, Partner and Senior Consultant
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In an ever-improving retirement plan industry, guided by both regulatory and recordkeeper evolution, plan participants are now able to contribute up to $57,000 in a 401(k) or 403(b) plan within a calendar year. For those who would benefit from saving more than the commonly referred to $19,500 “maximum,” this solution, also known as the Mega Backdoor Roth, could be tremendously beneficial.
You may have seen articles in the past explaining a method whereby a participant, who was looking to save beyond the then $18,000 limit, could take advantage of a process where they would contribute after-tax dollars to their 401(k) or 403(b) account, then remove those dollars from the plan and convert them from after-tax to Roth within an Individual Retirement Account (IRA).
In recent years the process has become significantly more efficient because many recordkeepers are now able to convert the after-tax dollars to Roth within the plan. Furthermore, some recordkeepers now can convert those dollars the day after the contribution is made, reducing the exposure to taxable investment earnings while in after-tax status. The improvements to recordkeeping capabilities have removed many of the prior complications that discouraged Plan Sponsors and participants from taking advantage of this potential benefit. In today’s environment, depending on the recordkeeper being utilized, many Plan Sponsors may benefit from revisiting this process to determine if it would benefit their participants.
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• A participant contributes $19,500 as a Roth (or pre-tax if that is what they would prefer) 401(k)/403(b) contribution.
• Assuming there is no employer match or profit sharing, the participant contributes an additional $37,500 of after-tax dollars. Employer match would reduce the amount of after-tax dollars that could be contributed.
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o Example: If the employer match or profit sharing is $5,000, the participant could only contribute $32,500 of after-tax dollars. The total contribution cannot exceed $57,000 in 2020.
o Caveat: Participants over the age of 50 can contribute an additional $6,500 above the $57,000 total.
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• The participant completes required forms for the recordkeeper and converts the after-tax dollars to Roth dollars.
• The participant now has $57,000 (or more depending on age) of Roth dollars, all deferred within a calendar year.
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This may seem appealing to participants and Plan Sponsors. However, prior to amending the plan document(s), there are some issues for the Plan Sponsor to consider.
Considerations:
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• Recordkeeping – Not all recordkeepers can deliver this type of in-plan conversion from a software perspective. For those who can, the process may vary.
• Testing – A spike in contributions by higher income earners could trigger failures in testing. Projections can be run by most recordkeepers to determine the likelihood of a failure.
• Taxes – With both Roth and after-tax, the participant pays taxes today on the dollars contributed from their paycheck. If the participant was accustomed to pre-tax contributions and had not planned on paying taxes on the Roth dollars, they could be surprised by a sizable tax bill.
• Earnings – Any earnings on the after-tax contributions, prior to the conversion to Roth, are taxable. Therefore, most participants who want to take advantage of this conversion will want to convert the after-tax dollars to Roth as quickly as possible, so the tax implications are minimal.
• Previously offered after-tax money – If after-tax contributions were previously offered within the plan and are being reinstated as part of this process, previous contributions may be converted by the recordkeeper (as opposed to the more recent after-tax contributions), triggering a larger than expected tax bill due to the earnings on the “older” monies.
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To reiterate, the reason this strategy may be so impactful is because the “super saver” plan participants would be able to contribute $57,000 ($63,500 for those over 50) in Roth dollars in a single calendar year. Those dollars would grow tax-free and are withdrawn tax-free. For a participant able to save $57,000 per year, the potential impact of compounding over a long-term time horizon would be considerable.
For questions regarding the implementation of this strategy and its place in your portfolio, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
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| Peter Nadeau is Partner and Senior Consultant of Fiduciary Investment Advisors, LLC which is a wholly owned subsidiary of DiMeo Schneider & Associates, L.L.C.
This report is intended for the exclusive use of clients or prospective clients of DiMeo Schneider & Associates, L.L.C. Content is privileged and confidential. Any dissemination or distribution is strictly prohibited. Information has been obtained from a variety of sources which are believed though not guaranteed to be accurate. Information has been obtained from a variety of sources believed to be reliable though not independently verified. Past performance does not indicate future performance. This paper does not represent a specific investment recommendation. Please consult with your advisor, attorney and accountant, as appropriate, regarding specific advice.
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