SUPER Roth Contribution Beneficial for Millennials
Super Roth Contributions are a concept where 401k participants can increase their retirement account balances with after-tax deferrals if the plan permits. Millennials are in a great position to take advantage of Super Roth Contributions since they have a longer time-span to retirement and a large portion of an account balance will be from investment earnings. The strategy is available if your plan offers the after-tax Roth investment option. Recently Michael Stuber, Director of Operations at Primark Benefits and Board Member of the National Institute of Pension Administrators (NIPA) speaks with Fred Barstein, Founder and CEO of 401kTV to discuss how the Roth option functions and how the Super Roth Contribution can benefit all plan participants who have that option.
Full Transcript Here
This is Fred Barstein with 401kTV for the NIPA 401kTV Monthly. I’m here with Michael Stuber. Welcome, Michael.
Thank you, Fred.
Okay if we ask you a few questions?
Thank you. So Michael is the Director of Marketing and Operations for Primark Benefits in the San Francisco Bay area with over 600 clients. A mix of 401(k), 403(b), and defined benefit, which I’m sure is what your clients in Silicon Valley like, a little bit of a mix.
Oh, yes. They like a mix.
So today, I wanted to talk a little bit about what you’re calling a “Super Roth.” So what is a “Roth” and who really should be using a Roth 401(k)?
Okay, so traditional 401(k), you make a deferral, you get an immediate tax deferral.
So you’re not paying taxes on that. However, with a Roth, you still pay taxes on your contribution; eventually, when you do pull it out in retirement, not only does the contribution come out, but all of those gains will come out tax-free.
Right, and so for millennials, why is that like very attractive, the Roth?
Well, millennials are younger, and the value of Roth is especially important for people who have a long time to earn those gains. Potentially, over half, maybe even three-quarters of that balance is going to be gain that you would never have to pay taxes on if it’s a Roth.
And millennials are probably at their lowest tax income, and they’re … you know, it’s only gonna rise and we suspect taxes could actually rise if we actually have to pay for the deficit at some point.
So, it’s a really great deal for the millennials. But you … today, we wanna talk about a concept called the “Super Roth.” What is that?
Yes, well under a regular 401(k) plan, the cap, the dollar amount that you can put into a Roth is $18,500. However, you may be able to afford to put more in, and the way you would do that, certain plans will allow you to put in an after-tax contribution which would be over the $8,500.
$18,500. Now you would never get the tax benefit of that. It’s basically after-tax; you’ve already paid taxes, so what happens is it goes into the plan, and then it immediately converts into a Roth without creating a tax, a new taxable event because you’ve already paid taxes on it.
You’ve already done it. But there are testing issues, what are they?
Well, one of the things that do happen is, you always have to test in a plan the participation rate of the highly-compensated or the highly-paid employees versus everybody else.
Even in that after-tax?
Right. This tax is not covered by what’s known as the “Safe Harbor.” It has to be tested on its own, so the highly-paid people, the highly-compensated, they will be limited by the participation rate of the non-highly-compensated employees. So you have to have some interest from those non-highly-compensated employees.
But there is a way to get around it a little bit at least in the beginning for an employee. How is that?
Well, in your first year of employment, unless you own more than five percent of the business, even if you’re paid really well, you are always a non-highly-compensated employee. To be a highly-compensated employee, you actually have to earn more than $120,000 in the prior year. So a lot of these well-paid people might not be highly-compensated employees in the first year, maybe not even in the second year. So this is something to do in your first year of participation.
Why not in the second year?
Well, you actually have to pass the 120 mark.
Okay, so if they haven’t passed the 120 in the second year …
Right, you might have been employed mid-year, or close to the late of the end of the year.
Got it. So Roth 401(k), a great thing to put in, especially for younger people and even above the $18,500 limit, there’s a way to do that.
Which I’m sure is very popular in Silicon Valley.
Well, there are companies out there where more than half the people do earn all that $120,000. You can also further define highly-compensated people by only the top 20.
So you could have a group of super highly-paid people who are the highly-compensated. You may even have some what I call “extremely well-paid non-highly-compensated people” because they fall under that top 20.
Right, I got it. But as much as they’re highly-compensated, they have to make it up with the high cost of real estate and homes there, so it all balances out.
That’s one of the issues, yes.
Thanks for your time today, and thank you for your support of 401kTV.
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