How ‘Mega Roths’ Help 401k Plans

401k, 401k taxes, roth ira, dc plan

Circumvent the standard limits.

Do you have plan sponsor-clients who want to allow participants to contribute more Roth monies to a defined contribution (DC) plan than the standard limits? There is an option: An in-plan Roth conversion of after-tax contributions in the same year they are made to the DC plan.

These contributions work like this:

  1. Participants defer up to the limit set by Section 402g of the Internal Revenue Code ($18,500 in 2018) and receive any employer matching and/or non-elective contributions.
  2. Participants then contribute additional money up to the Section 415 limit ($55,000 in 2018) as an after-tax contribution.
  3. That money is then converted into a Roth in the same year the taxes were paid. (These are known colloquially as “mega Roth” contributions but we prefer “enhanced Roth contributions” to avoid images of Japanese monster movies!).
  4. A conversion can also be made outside of the plan if the participant is eligible for withdrawals or distributions, which involves moving money from the 401k plan into a Roth IRA.

The principal and earnings of any Roth amounts are not taxed for “qualified distributions” (i.e., the participant is older than 59½ and the amounts have been in the plan for at least five years). The earnings on any after-tax contributions not converted to a Roth are taxed when distributed from the plan.

This offers a number of opportunities for plan sponsors and participants:

Remind plan sponsors and participants to keep the following in mind:

This plan feature requires participant action. Educating and communicating this option to employees may be challenging.

Advisors should recommend that plan sponsors:

Jana Steele is a senior vice president and defined contribution consultant in Callan‘s Fund Sponsor Consulting group. Jana has been in the consulting industry since 1999, working with qualified and nonqualified retirement plans, including plan design, vendor management, vendor searches, fee benchmarking, data security analysis, and compliance support.

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