By Laura Saunders
June 28, 2024
If you really want to get more dollars into your Roth IRA or Roth 401(k), you may need to take lesser-known paths to get around roadblocks.
These paths are newly useful for savers trying to move dollars into Roth accounts before the end of 2025. That’s when the 2017 tax cuts expire and income-tax rates will reset higher if Congress doesn’t act.
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It’s easy to see why Roth accounts are coveted. Among other things, both growth and withdrawals can be tax-free, and that can reduce other levies like income-based Medicare premiums or the 3.8% surtax on net investment income.
“Everybody with Roth accounts loves them. They’re like sacred money. But getting there can be tough,” says Martin James, a CPA and adviser with Modern Wealth Management in Indianapolis.
The main barrier to funding Roth IRAs and 401(k)s is paying taxes on dollars going into them. Contributions to traditional IRAs and 401(k)s, by contrast, are often tax-deductible. Nobody likes accelerating tax bills, especially when future tax rates are unclear.
Yet even savers who are willing to pony up taxes face roadblocks to Roth accounts. For example, single filers must have less than $146,000 of modified adjusted gross income this year and married joint filers less than $230,000 to make full contributions directly to a Roth IRA. While some savers can use backdoor contributions to boost Roth savings, it’s not always a wise move.
In particular, employees with the bulk of their savings in traditional 401(k) plans can feel stymied. These workers may not have many—or even any—funds in traditional IRAs to convert to Roth IRAs.
And while more companies are offering Roth 401(k) options and a “mega backdoor” feature that can boost Roth contributions, often these are recent. So older workers putting in the max may still have only a fraction of what they want in Roth accounts.
The good news is that savers who can pay the tax often have other Roth options. If you’re gung-ho for Roth, check these out and speak with your plan administrator.
In-plan 401(k) conversions
In this strategy, the saver moves dollars from an employer’s traditional 401(k) plan to its Roth 401(k) option—paying tax, of course. Because these moves are of existing dollars, not new ones, there’s typically no limit on them.
“They’re a great way to get more savings into the tax-free bucket,” says JoAnn May, a CPA and adviser with Forest Asset Management near Chicago.
But employees who want to do these conversions must work at companies with Roth 401(k)s, and the rules must permit these swaps. Not all do: About 40% of nearly 24,000 plans held at Fidelity Investments allow in-plan conversions, according to a spokeswoman.
May says it’s important to check the tax effects even if in-plan conversions are allowed. Would the taxes push the saver into a higher federal bracket that could be avoided by waiting until retirement? Would a conversion raise the Medicare premium surcharges known as Irmaa, or trigger the 3.8% surtax on net investment income?
And don’t forget state-tax effects, which can be surprising. May notes that Illinois—which is often a high-tax state—has no tax on retirement income, even on Roth conversions. But savers planning to retire to a lower-tax area should evaluate waiting to convert.
In-service distributions
This strategy allows an employee to roll funds out of a company’s traditional 401(k) or similar plan into his or her own traditional IRA or a Roth IRA while still working. Rollovers to a traditional IRA can be tax-free, while rollovers to a Roth IRA are taxable.
If the worker does a tax-free rollover into a traditional IRA, he or she can still do taxable conversions to a Roth IRA later on.
In-service withdrawals like these can help if a company doesn’t have a Roth 401(k) option. They can also be a way to gain access to different investments, or even alternative assets, not allowed by a company plan.
The main hitch is that while many 401(k)s permit in-service payouts, they typically aren’t allowed until the worker is 59 ½. According to a Vanguard Group spokeswoman, 88% of more than 1,500 plans it manages allow in-plan withdrawals at this age.
One exception: If a company’s 401(k) is among the relatively few that allow after-tax contributions, participants younger than 59 ½ may be able to get their after-tax dollars out of the plan and into Roth IRAs, tax-free. For more information, check your plan.
Roth solo 401(k) plans
Solo 401(k)s have become a popular option for business owners, whether the account is for their principal occupation or a side business like consulting. This year, an owner can put in up to $76,500, and more if a spouse works in the business, in some cases.
Since January Charles Schwab has been offering a Roth solo 401(k) plan as well as its traditional solo 401(k) plan. However, Schwab’s plans don’t currently allow owners to convert traditional assets in them to Roth assets. Fidelity doesn’t have a Roth solo 401(k) option now, but a spokeswoman says the firm is working on one for 2026, when the law will require it.
Savers who want to convert solo 401(k) funds to Roth funds can do so if they have a custom plan that allows it, says Martin. The ones he’s aware of cost about $2,000 to set up. He says, “Whenever I help a client with a solo 401(k), I always build in a Roth option.”
Write to Laura Saunders at Laura.Saunders@wsj.com
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