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Expert Insights for Smart Financial Planning

How to Super-Fund a Roth IRA

You can use after-tax 401(k) contributions to save significantly more for your retirement and reap the tax advantages of a Roth.


There is good news for people who work and contribute to a 401(k) retirement plan. Because of a recent Internal Revenue Service ruling, anyone making after-tax contributions to these plans can often turn this money into tens, and possibly hundreds, of thousands of income tax-free dollars when they quit their job or retire.

See Also: Why You Need a Roth IRA

Most workers are familiar with 401(k) retirement plans. As of 2016, people can contribute up to $18,000 annually to these plans—or $24,000 annually for those over age 50—to defer taxes until this money is withdrawn in retirement.

But some companies also allow workers to make after-tax contributions to their 401(k) retirement plans in what is called an "after-tax account." For the senior-level manager or executive looking to retire in a few years, or leave for another job, the money in these after-tax accounts can generate a significant amount of tax-free income for them in retirement. That's because the IRS ruled in late 2014 that a person's after-tax contributions can now be rolled directly into a Roth IRA and avoid tricky tax issues. In other words, you can effectively "super-fund" a Roth IRA once you leave your employer.

Here's an example of how this strategy can work. Let's assume you make the following contributions:

  • Annual Pre-Tax contribution to 401(k): $18,000
  • Annual Pre-Tax "catch up" contribution (50 and older): $6,000
  • Employer Match (varies by employer): $9,000
  • Annual After-tax employee contribution $26,000

Once you leave your employer, your $26,000 in after-tax contributions can be rolled into a tax-free Roth IRA. By taking this step, you have effectively quadrupled the amount of money in future tax-free Roth retirement assets compared with the standard method of funding a Roth IRA. In 2016, annual contributions to Roth IRAs are limited to $5,500 for anyone under age 50 and $6,500 for those 50 and older.

Of course, the benefits really add up the longer a person contributes to their after-tax account in their 401(k) plan. For example, a person putting aside $26,000 in after-tax contributions annually for five years will have saved $130,000—not counting any appreciation. If the same person (who is over the age of 50) made maximum annual contributions directly to a Roth IRA, they would only have $32,500. That's a difference of nearly $100,000.

The after-tax contribution strategy also has other significant advantages. First, there are no earned income limitations on contributions to an after-tax 401(k) account; anybody, even those earning $1 million or more annually, is eligible. On the other hand, to contribute the maximum to a Roth IRA, you must earn less than $117,000 annually, if single, and $184,000 if married filing jointly. (Certain phase-out limits apply for incomes above these levels). This after-tax 401(k) strategy presents an opportunity for high-income individuals to significantly build income-tax free assets in a Roth IRA.

Next, a person contributing to an after-tax 401(k) account can still make the maximum contribution to their company's pre-tax 401(k) account, enabling those 50 and older to defer up to $24,000 annually, while still making after-tax contributions to their plan. There is a limit, of course, on how much money can be poured into these two accounts each year: $53,000 for people under age 50 and $59,000 for those age 50 and older. These totals include money contributed by the employee and the company.


Finally, even if your company has discontinued its after-tax contribution provision in recent years, those who have funded after-tax dollars in previous years can take advantage of the Roth IRA strategy once they leave their employer.

I've advised several of my clients to take advantage of this super-funded Roth strategy. Here's a good example: One of my clients recently retired at age 65 and had accumulated more than $350,000 in lifetime after-tax contributions. We took all of this money and rolled it into a new Roth IRA. It would have taken him more than 50 years—longer than his entire working career—to deposit that much in a Roth IRA at today's limits.

If your company offers this benefit, high-income taxpayers should make it a point to start funding, or keep funding, after-tax contributions into their 401(k) plan. It will enable you to accumulate more assets in a tax-efficient manner for retirement.

See Also: Are You Saving Enough for Retirement?

Lisa Brown is a partner and wealth adviser at Brightworth, an Atlanta wealth management firm. She specializes in investment management, executive compensation, retirement transition and estate planning.

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