I’ve Maxed Out My 401(k), Now What? The Mega-Roth Strategy

Co-authored by Tom Krieg, CPA, Partner at Wipfli LLP
The following article was prepared in collaboration with our affiliate, Wipfli LLP. With more than 2,000 associates across the United States and in India, Wipfli ranks among the top accounting and business consulting firms in the nation.

One of the first pieces of advice we hear at the beginning of a career is to contribute to a 401(k) plan. But what happens once pre-tax or Roth 401(k) contributions are maximized, and annual limits are met? 1 First off, congratulations on hitting this level of savings! Next, it’s time to assess other available savings opportunities. If you qualify, Health Savings Accounts (HSAs) can be an effective retirement savings tool. Utilizing a backdoor Roth IRA conversion strategy is also a great option.

But if these options have been exhausted, it may be time to turn back to the 401(k) plan. While the backdoor Roth IRA strategy noted above has become more widely understood in recent years, many investors are not well-aware that there is a second, larger Roth conversion strategy that may be available — the Mega-Roth conversion.

What Is a Mega-Roth Conversion, and How Does It Work?

The Mega-Roth involves making an after-tax contribution to a 401(k) and subsequently converting those funds to a Roth account. Per the IRS Section 415 Limit, the total of annual employee pre-tax or Roth contributions, employer-matching or profit-sharing contributions, and employee after-tax contributions to a 401(k) cannot exceed $56,000.2 The Mega Roth strategy gets its name from the opportunity to contribute and then convert some or all of the $37,000 difference between the employee contribution limit of $19,000 and the Section 415 limit of $56,000.

Let’s say, for example, an employee earns $150,000 annually and has maximized their pre-tax 401(k) contributions at $19,000. Additionally, their employer matches 4% of salary, or $6,000, resulting in total contributions of $25,000. Provided the plan document allows after-tax contributions, there is an additional $31,000 available before the Section 415 Limit is reached.

Is This Available in My 401(k)?

Two key provisions within a 401(k) plan are necessary to allow the Mega-Roth conversion strategy.

1.  After-Tax Contributions: 401(k) plans commonly allow for employee pre-tax or Roth deferrals, as well as employer-matching or profit-sharing contributions. The plan must also allow after-tax (non-Roth) contributions.

2. In-Plan Roth Rollover (IRR) or In-Service Withdrawals: Either of these features are viable methods for moving after-tax contributions to a Roth vehicle.

In-plan Roth rollovers convert after-tax dollars to a Roth subaccount within the 401(k) plan. This provision first became available as a result of legislation within the Small Business Jobs Act of 2010 (SBJA) and it was later amended and expanded by the American Taxpayer Relief Act of 2012. Plan sponsors must adopt these provisions within their workplace retirement plan to make it available to employees. Some plans have only updated their documents for the SBJA legislation, which restricts the balances that can be converted, so those plans may want to amend their documents to remove those restrictions.

If your plan doesn’t offer an IRR, you may still be able to execute this strategy through an in-service withdrawal. In-service withdrawals allow an employee to distribute their after-tax contributions to a Roth IRA outside of the 401(k) while still working. If the after-tax contributions have appreciated prior to conversion, any earnings will be considered taxable. Going forward, however, the full amount converted to Roth will grow tax-free.

Still unsure if these provisions are included in your plan? Contact Wipfli Financial Advisors to review your 401(k)’s Summary Plan Description (SPD) and determine if the Mega-Roth conversion strategy is available. If your plan currently doesn’t have the above two provisions, ask your employer to consider adding them.

Both Provisions Are Available in My Plan, Now What?

In addition to the provisions noted above, there are other 401(k) plan rules that participants must understand prior to executing the Mega-Roth conversion strategy. ERISA retirement plans are not allowed to discriminate in favor of highly compensated employees (HCEs).3 With regards to the Mega-Roth strategy, to ensure that HCEs are not benefitted at the expense of other employees, plans must pass the Actual Contribution Percentage (ACP) test. The ACP calculation is in-depth and complex; suffice to say, if you meet the definition of HCE, your ability to contribute after-tax dollars will be restricted based on the participation of all other participants who are non-highly compensated employees (NHCEs). Also, note there is no “safe harbor” from testing for this feature, regardless of plan design.

If you are an HCE and are considering after-tax contributions to execute a Mega-Roth strategy, first check with your employer and third-party administrator. You’ll want to ensure that your participation in an after-tax account within the retirement plan will not lead to an ACP test failure.

What Is the Benefit?

If you are able to navigate these complexities, the beauty of this strategy is the ability to convert amounts in the plan that otherwise would be tax-deferred to amounts that are tax-free, for little or no additional tax from the conversion (assuming the conversion is done soon after the after-tax contribution is made). If you are able to reach the Section 415 limit of $56,000, you could be saving up to $37,000 per year into a Roth 401(k) subaccount with little or no immediate tax impact and potentially decades of tax-free growth!

The tax-free treatment is subject to two caveats, both of which must be met. First, the converted dollars must remain in the plan for at least five years for each conversion done. Partial conversions are allowable. Your third-party administrator will need to track the five-year clock on each conversion. This five-year clock is separate from the five-year clock on the first Roth dollar contributed. Second, you must be age 59.5, incur a disability or suffer death at the time of the distribution for you or your beneficiaries to receive penalty- and income-tax-free distributions on the converted dollars. It is also important to note that the conversion is irrevocable and the income tax assessed at the time of the conversion transaction should be paid with dollars outside the retirement plan.

Where Is This Strategy Most Effective?

There are three common situations where we’ve seen this strategy executed successfully:

1.  Non-Highly Compensated Employees: As noted above, NHCEs have the most flexibility because they need not be concerned about nondiscrimination testing, and therefore they are free to utilize the Mega-Roth strategy provided that plan provisions and personal cash flow allow.

For HCEs, see the two additional scenarios below:

2. Large Organization; Many Participants: For participants that work at a large employer (i.e., several hundreds, if not thousands of employees), additional after-tax contributions made by a single HCE often will not meaningfully change the ACP testing at year-end.

3. Solo-401(k)s: Sole proprietors looking to set up a retirement plan for themselves have a great opportunity to take advantage of this strategy. As plan sponsor, you have control of the provisions that are available under the plan and can include the after-tax contribution and in-plan Roth rollover feature. In addition, as the sole participant in the plan, you don’t have to worry about non-discrimination testing even though you are considered a highly compensated employee. Note: In most cases, sole proprietors will want to first maximize the $56,000 Section 415 Limit with pre-tax employee salary deferrals and pre-tax employer profit sharing contributions.

Everything in Moderation

With few exceptions, distributions cannot be taken from a retirement plan prior to age 59.5 without penalty. Thus, investors should maintain sufficient liquid assets to cover unexpected cash needs or emergencies before considering the Mega-Roth strategy. There are also other great tax-efficient savings opportunities you may want to consider first, such as HSA or backdoor Roth IRA contributions noted above.

Interested in which savings opportunity may be most appropriate for you? Contact Wipfli Financial Advisors for a discussion on cash-flow planning and saving for retirement.

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Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC); however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services, fees and conflicts of interest is set forth in Wipfli Financial’s current Form ADV Part 2A brochure and Form CRS, copies of which are available from Wipfli Financial upon request at no cost or at www.adviserinfo.sec.gov. Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Benjamin Hayes

CFP®, MBA | Senior Financial Advisor

Benjamin Hayes, CFP®, MBA, is a Principal and Senior Financial Advisor for Wipfli Financial Advisors in Green Bay and Appleton, WI. Benjamin specializes in comprehensive financial planning for major life transitions, focusing on retirement, tax and risk-management considerations.

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I’ve Maxed Out My 401(k), Now What? The Mega-Roth Strategy

time to read: 5 min