What to Know About After-Tax Retirement Plan Contributionsby
A retirement plan, whether it’s a Roth 401(k) or Roth IRA, will allow your clients to make after-tax contributions to their assets. Keep in mind, some still do not have a Roth option, and you will want your clients to check with their plan administrator to see if it is available. As I discussed recently in Benefits of Opening a Pre-Tax Retirement Plan, it is important to invest for retirement using both pre- and post-tax monies.
Using the Roth option will allow your clients to put away funds that will accumulate, grow and be distributed from the account tax free in retirement. The money they invest today will not provide them with any tax benefits now, but it creates a pool of funds that will not incur any tax in the future--as long as the rules are followed.
As an example, in 2019, employees under the age of 50 can defer a maximum of $19,000 into their company’s 401(k). Assuming their company offers both the Roth and Traditional 401(k) options, they can allocate that $19,000 maximum however they want.
How your client breaks up the contributions between these two options would depend on how much of a tax deduction they require now and/or how much they can forgo. This presents a fantastic opportunity for you to have a meaningful conversation with them. Ideally, your client will want your advice on how to balance the pre- and post-tax contributions. Just keep in mind they cannot go above the $19,000 maximum combined between the two types of contributions.
When planning for retirement, there are many variables accounting professionals try to include, but they may change over time. As an example, we have no idea where tax rates will be in the future, and it is virtually impossible to discern if your clients are better off taking the tax deduction today or simply planning for tax-free growth going forward.
In response to these uncertainties, it is important to have your client plan ahead and have several income streams in retirement—namely, those that will be taxable and tax free. This will give them more flexibility once they retire. If they have more income in certain years, they could utilize funds from the post-tax accounts established and remove those monies tax free. On the other side, in those years where their income may be lower, they could rely on the pre-tax monies and pay the taxes on the monies as they are removed. Keep in mind this strategy will also work if tax rates see a dramatic increase in the future.
There is one additional benefit to having monies set aside post-tax: There are no required minimum distributions (RMDs). Retirement accounts, such as 401(k)s and IRAs, have rules where your clients need to begin removing funds from those pre-tax accounts based upon their life expectancy. This will force them to remove a portion of their retirement money and pay taxes on it. The penalty for not doing so is steep: They’ll have to pay 50 percent of what they were required to take as an RMD. Post-tax retirement accounts, such as Roth 401(k)s and Roth IRAs, do not carry this RMD requirement.
There are many ways to save for retirement, and your clients should have a plan that incorporates the most flexibility possible for them. Conversations like these will elevate your relationship with your clients and ensure they are better prepared to face their future, too.
This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.
Lawrence Sprung CFP® is the President and Founder of Mitlin Financial, Inc. He entered the financial industry in 1996 and continues to be inspired and energized by the challenge of helping his clients achieve and even surpass their financial goals.
Mitlin Financial, Inc. is an SEC Registered Investment Advisor (RIA) that prides itself on...