Who wants more tax-free money?

Your first reaction was probably “Don’t we all?”. If you do, you should talk to your CPA about what some in the financial industry refer to as the “Mega-Super Roth” to see if it makes sense for you.

Many of our clients talk with us about wanting to save more for retirement but aren’t sure what is the best way to do it. There is an option out there that we have found many people don’t know about: After-Tax 401k.

Let me first point out that you wouldn’t want to utilize this strategy until you have already maximized your pre-tax and/or Roth contributions. If you aren’t already maxing those out, stop now and bookmark this page for when you are.

Now, you might be saying “Okay, what is a “Mega Super Roth”?”.

“Mega Super Roth” is a phrase that some advisors and CPAs use to describe how individuals are utilizing After-Tax 401k options within their current employer’s 401k retirement plan to contribute more money for their retirement.

Many people understand how a 401k works and the reasoning to put money into it to save for retirement. Many plans today offer employees the choice between pre-tax (tax savings today), and Roth (tax savings in the future) 401k contributions. I’m going to skip over all of these and talk about a small (but growing) number of 401k plans that allows for after-tax contributions into the plan.

What are after-tax 401k accounts, and why should you care?

After-tax 401k accounts are somewhat of a combination of Pre-tax and Roth. Just as the name suggests, the contributions (principle) are made on an after-tax basis like a Roth. However, the gains on the investments are tax-deferred like a pre-tax account.

“So wait; I’m missing out on the advantages of each!?!? Not only do I NOT get tax savings today, but I don’t get tax-free growth either? Why in the world would I do this?” This is why I said you wouldn’t want to look at this unless you are already maximizing your 401k contributions already.

So, why would you do an after-tax 401k? In late 2014 the IRS ruled that upon separation of service, a person’s after-tax contributions can be rolled into a Roth IRA, and the gains can be rolled into a Rollover IRA. Here’s an example:

For 5 years, you max out your current 401k contribution at $19,000 (2019 limit) and receive a company match of $6,000. You have more money you want to put aside for retirement, and you choose to contribute $20,000 each year into your after-tax 401k account. That gives you $95,000 pre-tax contributions ($19k x 5 years), $30,000 company match ($6k x 5 years), and $100,000 after-tax contributions ($20k x 5 years). Your investments have done well over the 5 years. Your pre-tax and company contributions have gained $43,750 and your $100,000 after-tax contributions have gained $35,000.

This is where the “Mega Super Roth” magic happens. You leave your employer. The after-tax account in your 401k, you split into two – the principle contributions and the gains. You roll the $100,000 principle into a Roth IRA, and the $35k gains into Rollover IRA to continue the deferral.

This $100,000 Roth contribution is where the “Super Roth” name comes in. You just put $100,000 into a Roth IRA. It would take you almost 17 years via regular Roth IRA contributions to reach that amount. And don’t forget a Roth IRA contribution has income limitations whereas this Super Roth strategy does not.

Now you get to re-invest that $100k for tax-free returns. If you are already planning on positioning money for retirement, wouldn’t you rather have tax-free returns?

If you are currently maximizing your 401k contributions and want to save more, check with your plan provider and company HR to see if an after-tax 401k is available to you.

Any opinions are those of Kevin Wilson and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves Risk and you may incur a profit or a loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Please note, changes in tax laws may occur at any time and could have substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issue presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

The accounts mentioned here are long-term investment vehicles meant for retirement savings, In general, non-qualified withdrawal made prior to age 59-1/2 may be subject to taxes and possible penalties.