The Mega Backdoor Roth IRA and Other Ways to Maximize a 401(k)
Did you know: Numerous 401(k) retirement plans allow after-tax contributions. This creates financial planning opportunities that are frequently overlooked. Read this blog post for more information on maximizing your 401(k) plan.
The most popular workplace-sponsored retirement plan is far and away the 401(k) — a plan that can be both simple and complex at the same time. For some of your clients, it functions as a tax-deductible way to save for retirement. Others might see its intricacies as a way to maximize lifetime wealth, boost investments and minimize taxes. One such niche area of 401(k) planning is after-tax contributions, an often misunderstood and underutilized area of planning.
Before we jump into after-tax contributions, we need to cover the limits and the multiple ways your clients can invest money into 401(k) plans.
Employee Salary Deferrals and Roth
The most traditional way you can contribute money to a 401(k) is by tax-deductible salary deferrals. In 2019, employees can defer up to $19,000 a year. If they’re age 50 or older, they can contribute an additional $6,000 into the plan. In 2020, these numbers for “catch-up contributions” rise to $19,500 and $6,500 respectively.
Someone age 50 or over can put up to $25,000 into a 401(k) in 2019 and $26,000 in 2020 through tax-deductible salary deferrals. Additionally, the salary deferral limits could instead be used as a Roth contribution, but with the same limits. The biggest difference is that Roth contributions are after-tax. And as long as certain requirements are met, the distributions, including investment gains, come out income tax-free, whereas tax-deferred money is taxable upon distribution.
Employer Contributions
Employers often make contributions to a 401(k), with many matching contributions. For instance, if an employee contributes 6% of their salary (up to an annual indexed limit on salary of $280,000 in 2019 and $285,000 in 2020), the company might match 50%, 75%, or 100% of the amount. For example, if an employee earns $100,000 a year and puts in $6,000 and their employer matches 100%, they will also put in $6,000, and the employee will end up with $12,000 in their 401(k). Employers can also make non-elective and profit-sharing contributions.
Annual 401(k) Contribution Cap
Regardless of how money goes into the plan, any individual account has an annual cap that includes combined employee and employer contributions. For 2019, this limit is $56,000 (or $62,000 if the $6,000 catch-up contribution is used for those age 50 and over). For 2020, this limit rises to $57,000 ($63,500 if the $6,500 catch-up contribution is used for those age 50 and over).
Inability to Max Out Accounts
If you look at the limits and how people can contribute, you might quickly realize how hard it is to max out a 401(k). If a client takes the maximum salary deferral of $19,000 and an employer matches 100% (which is rare), your client would only contribute $38,000 into the 401(k) out of the maximum of $56,000. Their employer would need to contribute more money in order to max out.
Where After-Tax Contributions Fit In
Not all plans allow employees to make after-tax contributions. If the 401(k) did allow this type of contribution, someone could add more money to the plan in the previous example that otherwise maxed out at $38,000.
After-tax contributions don’t count against the salary deferral limit of $19,000, but they do count toward the annual cap of $56,000. After-tax contributions are what they sound like — it’s money that’s included into the taxable income after taxes are paid, so the money receives all the other benefits of the 401(k) like tax-deferred investment gains and creditor protections.
With after-tax contributions, clients can put their $19,000 salary deferral into the 401(k), get the $19,000 employer match, and then fill in the $18,000 gap to max out the account at $56,000.
Mega-Roth Opportunity
If the plan allows for in-service distributions of after-tax contributions and tracks after-tax contributions and investment gains in separate accounts from salary deferral and Roth money, there’s an opportunity to do annual planning for Roth IRAs.
Clients can convert after-tax contributions from a 401(k) plan into a Roth IRA, without having to pay additional taxes. If a plan allows in-service distributions of after-tax contributions, the money can be rolled over to a Roth IRA each year. However, it’s important to note that any investment gains on the after-tax amount would still be distributed pro rata and considered taxable. Earnings on after-tax money only receive tax-deferred treatment in a 401(k); they aren’t tax free.
Clients can roll over tens of thousands of dollars a year from a 401(k) to a Roth IRA if the plan is properly set up. They can even set up a plan in such a way so the entire $56,000 limit is after-tax money that’s distributed to a Roth IRA each year with minimal tax implications. This strategy is referred to as the Mega Backdoor Roth strategy.
Complexities Upon Distribution of After-Tax Contributions
What happens to after-tax contributions in a 401(k) upon distribution? This is a complex area where you can help clients understand the role of two factors:
- After-tax contributions are distributed pro-rata (proportional) between tax-deferred gain and the after-tax amounts.
- Pre-tax money is usually considered for rollover into a new 401(k) or IRA first, leaving the after-tax attributed second. The IRS provided guidance on allocation of after-tax amounts to rollovers in Notice 2014-54.
Best Practices for Rollovers
Help your clients navigate the world of rollovers with after-tax contributions by following best practices. If a client does a full distribution from a 401(k) at retirement or separation of service, they can roll the entire pre-tax amount to a new 401(k) or IRA and separate out the after-tax contributions to roll over into a Roth IRA. The IRS Notice 2014-54 previously mentioned also provides guidance for this scenario.
You can help your clients understand after-tax contributions by envisioning after-tax money in a 401(k) as the best of three worlds. These contributions enter after taxes and give your client tax-deferred money on investment growth, allow them to save more money in their 401(k) while also giving them the opportunity to roll it over into a Roth IRA at a later date.
After-tax contributions build numerous planning options and tax diversification into retirement plans. Before your clients allocate money toward after-tax contributions, it’s important they understand what their plan allows and how it fits into their overall retirement and financial planning picture.
SOURCE: Hopkins, J. (17 December 2019) "The Mega Backdoor Roth IRA and Other Ways to Maximize a 401(k)" (Web Blog Post). Retrieved from https://www.thinkadvisor.com/2019/12/17/the-mega-backdoor-roth-ira-and-other-ways-to-maximize-a-401k/
Employers ban vaping as its reputation goes up in smoke
Vaping and e-cigarettes are being used to cut out, cut back or completely quit traditional tobacco. With vaping becoming more common in the workplace, employers are realizing that the same policies in effect for traditional cigarettes are not in effect for e-cigarettes. Read this blog post to learn why employers are implementing vaping policies.
Reports on the health concerns associated with vaping and e-cigarettes are mixed. While some say the products are less harmful than traditional cigarettes, others link them to serious health consequences such as lung disease, noted Julie Stich, vice president of content at the International Foundation of Employee Benefit Plans (IFEBP).
Given the popularity and risk associated with vaping, it's made an impact on employers. "Vaping and the use of e-cigarettes pose many of the same risks of cigarette smoking to employees and the workplace," Haynes and Boone Partner Jason Habinsky said in an email to HR Dive. What's more, workers who choose to use e-cigarette products can put those who share their space at risk as well.
A lack of vaping policies
Vaping has been around for a little while now, said attorney Marissa Mastroianni, an associate at Cole Schotz, but a lot of employers still haven't created policies.
Stich concurred, noting that only 46% of U.S. employers in a recent IFEBP wellness survey reported having a vaping policy, with a "large chunk" of respondents say they weren't sure if they did.
But this may soon change. A recent increase in vaping-related illnesses, combined with a warning from the Centers for Disease Control and Prevention has driven some employers to take a second look at their policies, said Kerry Sylvester, director of product management, wellbeing solutions at HealthAdvocate. In the absence of specific vaping-related laws, company culture and priorities are driving policy. "Many larger employers including Target and Wal-Mart are leading the way by including vaping in their workplace tobacco policies, and many smaller employers are following their example," she said.
Mastroianni concurred: "There is a trend that employers have been adding vaping to their no-smoking policies," she said. This is a good thing, according to Habinsky. "[I]t is important that employers review all policies which regulate smoking or other health and safety considerations and modify the scope of such policies to include vaping and e-cigarettes," he said.
For employers that lack policies putting boundaries on vaping, the first step is to consider any applicable local laws, Mastroianni said. New York and New Jersey, for example, have adopted vaping laws relating to smoke-free workplaces and smoking in public areas. "If a law like that exists in your jurisdiction, you need to comply," said Mastroianni.
Stich noted that laws in some areas may treat vaping differently than smoking, and employers need to be aware of this (she cited a list of current vaping laws here). Additionally, employers will need to note that vaping and e-cigarette use "may also be prohibited in certain industries and work environments where health and safety may be at risk," said Habinsky.
Competing priorities
When no specific law applies, however, employers have more flexibility. This is the point at which priorities begin to compete.
"Vaping has been viewed as a substitute for traditional tobacco use both for recreational users as well as by individuals who are trying to cut back or quit smoking," said Sylvester, speaking to HR Dive via email. "Employers want to support employees who are trying to make positive changes in their health by quitting smoking, but must consider the needs of their entire workforce."
Employees who want to sit at their desks and vape may say they're not bothering co-workers, but this is not necessarily true, said Stich. "There can be a residual odor and co-workers can find this annoying."
Annoyance is not the only thing e-cigarette users may inflict on coworkers. "Vaping can pose challenges for individuals with scent sensitivities, not to mention the concerns related to secondhand exposure to vaping aerosol," said Sylvester. And, unlike traditional cigarettes, "[a]n e-cigarette can also malfunction or even explode, causing harm to individuals in the workplace," said Habinsky.
Productivity concerns also factor in. "[E]mployers must also consider the positive or negative impacts on productivity by allowing employees to take vaping breaks away from their workspace versus vaping at their desks," said Sylvester.
Once employers have updated or created vaping policies, it's up to them to make sure employees know about the changes. "Employers should also update any related employee training to include a discussion of such prohibitions," said Habinsky. "Employers should also examine any wellness policies and employee education to ensure the inclusion of such use."
A call employers need to make
"While supporting employees who want to quit tobacco is a priority, employers must decide if allowing the use of nicotine products that are not [Food and Drug Administration-]approved is beneficial in the short and long term," said Sylvester. It's worth noting that "the jury is still out" as to whether vaping and e-cigarettes actually do help people stop smoking regular cigarettes, Stich said.
"It's kind of tough at the moment," said Mastroianni, and it's an area with a lot of nuance. "On the one hand, you want clear air for employees to work and to protect against inhaling secondhand smoke. On the other hand, a lot of people do use vaping and e-cigarettes as a way to stop smoking actual cigarettes."
Ultimately, said Mastroianni, "employers need to make a judgment call and decide, 'what's better for us?'"
SOURCE: Carsen, J. (13 December 2019) "Employers ban vaping as its reputation goes up in smoke" (Web Blog Post). Retrieved from https://www.hrdive.com/news/employers-ban-vaping-as-its-reputation-goes-up-in-smoke/568941/
Inviting Remote Workers to the Holiday Party
Are your employees working remotely? Owl Labs found that at least 62 percent of employees work remotely once a month, and 49 percent of those work remotely full-time. Further research from Buffer discovered that remote employees cite loneliness as their second-largest struggle. Read this blog post to learn more.
Text messaging-based personal shopping concierge service Jet black has 370 employees, two-thirds of whom work outside of its New York headquarters. When it comes time for its annual holiday party no one is left out, though. Instead, remote workers get their own take on the festivities so everyone feels like part of the team.
Jet black's holiday celebrations include a company-wide gift exchange, deliveries of restaurant gift cards to those who work the holidays, and a remote holiday meet-up. "We make a conscious effort not only to include but also engage our remote employees," explained Odette Lindheim, the company's director of people operations. "We get a room that's central to our remote workers, set up games and snacks, send them company swag, and put on holiday music. People are invited to come for an hour or all day. It gives our people working from home offices a way to get that office party feeling even if they don't normally go into an office."
'Tis the Season
Holiday parties have a firm foothold in corporate America. At the same time, remote work is way up. The 2019 "State of Remote Work Report" by Owl Labs found that 62 percent of employees worked remotely at least once a month; 49 percent of those respondents say they work remotely full-time. According to Buffer's "State of Remote Work 2019" report, remote workers also cite loneliness as the second-largest struggle they face.
Keeping these facts in mind, HR managers and those who are planning the company holiday party may want to make a more concerted effort to bring remote workers into planning parties and celebrating, says S. Chris Edmonds, president and CEO of The Purposeful Culture Group, a work culture consulting firm based in Conifer, Colo. They shouldn't feel isolated or alone during what is touted as the happiest time of the year.
"Keeping people connected and sharing information with each other is something companies must think about throughout the year. Sharing common experiences and giving employees the opportunity to have some fun around the holidays helps improve relationships and is immensely powerful," he said.
The most obvious way to accomplish this is to fly everyone in for whatever event you plan at the main office. This may not be the easiest option for those companies that have a significant number of remote employees, though, simply due to cost and logistics. For some companies—although flights, hotels, and meals add up—the extra cost and trouble can be worth it, says Cheryl Johnson, chief human resources officer at Chicago-based software company Paylocity. Johnson, for example, piggybacks her own 150-person department's—half of whom are remote—holiday celebration with a staff-wide meeting and professional development program.
"As a company, when we look at employee experience, we believe that everything should be equitable," Johnson said. "We budget a certain amount per head and plan events that cater to every group."
There's a similar plan in place at the Ken Blanchard Companies, although inclusion takes a more virtual bent. About half of the company's 300 employees work remotely, with office locations scattered across the U.S., France, the United Kingdom, and Asia. In order to show appreciation and create team bonding, the company holds an annual Shop and Share program, sending out $50 to every employee and asking them to do a show-and-tell with what they buy. Originally, the company flew everyone in to the main Escondito, Calif., headquarters, but today that's changed.
"Now we start the Shop and Share program with an all-company meeting that everyone participates in, either in the headquarters or through a live broadcast. After the meeting and at an appointed hour, everyone goes out shopping for something for themselves," said Shirley Bullard, the company's chief administrative officer and vice president of HR. "Then we all come back and share our purchases with each other. As we have become more decentralized and people move into the field, [the program] becomes more and more important because it helps us stay connected."
Bullard says it's just one of many strategies that the company employs to help people feel engaged. Organizations that can't fly everyone in can try holding a similar virtual holiday celebration, using Facebook, Google Hangouts or Zoom so employees can interact and get that crucial face-to-face contact that helps bring people together.
It's also important that all employees get the same holiday perks whether they make it to a holiday party or not. At Paylocity, for instance, remote employees who don't live close enough to one of the three office-hosted parties can choose from three end-of-year gifts. This year, those employees will also get in on their annual party raffles, too. "We created a virtual raffle. In order to get that virtual ticket we want them to answer a survey question: What are you grateful for? It's new this year, and it's about giving people one more way to feel connected," said Johnson, who says it's just another piece of the company's overall remote employee inclusion program.
This kind of commitment is important, say experts. While it's nice that remote employees feel included during December, such efforts should be part of a larger, year-long program. "It's not just about the holidays," Bullard said. "It's about sharing life events throughout the year so [the employee] feels like a part of the organization no matter what. That's why anything we offer [at the main headquarters], we are always asking, 'How do we bring it to our remote staff?'"
SOURCE: Bannan, K. (12 December 2019) "Inviting Remote Workers to the Holiday Party–Remote workers should get to celebrate with co-workers—in person or virtually" (Web Blog Post). Retrieved from https://www.shrm.org/ResourcesAndTools/hr-topics/employee-relations/Pages/Inviting-Everyone-to-the-Holiday-Party.aspx