By |February 12th, 2016|Categories: Athletes & High Net Worth Individuals|

A new strategy for upping your retirement contribution game

retirementometer-sqMany people are aware of the ability to contribute to their employer’s 401(k) plan, currently set at $18,000, either through a tax-deferred 401(k) account or a tax-free Roth 401(k) account. However, many employer 401(k) plans include the ability to also make after-tax contributions. But until recently, these contributions, which are limited to annual contributions of $53,000 (including both employee and employer contributions to plans) per 2016 requirements, did not offer much of an advantage.

That’s because if you retired with a qualified retirement plan that held both pre- and post-tax dollars, you ran into a conundrum when rolling these funds into a traditional IRA or a Roth IRA. All of the funds were considered pooled together, which meant you were unable to specify which dollars were pre-tax and which were post-tax.

But in light of a new IRS notice that went into effect in late 2014, you now have the great opportunity to boost after-tax funding—and eventually roll these dollars into a Roth IRA. Generally speaking, the IRS now allows you to segregate pre- and post-tax dollars in an employer plan. You can do this by directing trustee-to-trustee transfers of the pre-tax dollars to a traditional IRA and post-tax dollars to a Roth IRA.

For example, say you contributed the maximum $18,000 (following 2016 contribution limits) to your employer’s Roth 401(k) plan and $10,000 to your after-tax account for 10 years. This assumes your employer’s plan allows for after-tax contributions, of course. Your account balance totals might look like this:

Roth 401(k) Account After-Tax Account
Contributions $180,000 $100,000
Earnings $40,000 $20,000
Account Balance $220,000 $120,000

Let’s say you decided to leave the company at this point, and you direct your trustee to make two transfers out of your employer’s 401(k) account. Your trustee directs the after-tax portion of your Roth 401(k) balance—which totals $320,000 and consists of the $220,000 Roth 401(k) balance plus the $100,000 in after-tax contributions—to a Roth IRA. Then, because the untaxed earnings on the after-tax portion must stay separate to avoid taxation under current regulations, your trustee transfers the remaining $20,000 to a traditional IRA.

Given this scenario, you would have essentially contributed $28,000 per year to a Roth account, which surpasses current contribution limits—and is an undisputable advantage to your retirement savings.

It’s possible you could benefit from this strategy, so be sure to talk to your CPA about making after-tax contributions a part of your retirement-planning game.

About the Author: Wade Christensen

Wade Christensen, CPA is a tax partner at Froehling Anderson specializing in working with businesses, professional athletes, and high net worth individuals.