As we close in on the end of 2011, we’ve had many inquiries about what 401(k) profit sharing provisions may be retroactively effective to January 1, 2011, even if a plan amendment is not signed until December.
In addition to making retroactive 2011 profit sharing allocation and discrimination testing changes in December, it’s also possible to retroactively implement a Roth-it-SharingSM plan amendment and participant election to convert 2011 profit sharing contributions to Roth status.
Roth-it-SharingSM – Expanding the Boundaries of the 401(k) Plan
For decades, business owners and high income individuals have taken advantage of qualified retirement plans to shelter income from current taxation and to accumulate substantial savings for retirement. Beginning in 2006, the law allowed a 401(k) plan sponsor to offer its participants the option to make their 401(k) contributions on a post-tax Roth basis. While the Roth 401(k) feature was initially met with low adoption by plan sponsors, and even lower utilization by plan participants, recent events have caused renewed interest.
Why the renewed interest?
It appears that two factors are driving the groundswell of interest in Roth:
1. A growing consensus that the top federal income tax rates will rise, and perhaps rise significantly. By paying income taxes now, and allowing the earnings to grow tax free, participants may effectively lock in the income tax rate at what many consider to be a historic low.
2. A realization that many business owners might never need all of their qualified plan accumulation in retirement. While pre-tax monies will be taxed to either the participant or to their beneficiary at some point in the future, Roth accounts may be passed on to the next generation without taxation.
So what’s the problem?
For the last five years, the law has allowed participants to make their 401(k) contributions on a post-tax Roth basis. The law does not allow the plan sponsor to contribute the employer matching or profit sharing contributions on a post-tax basis. For many business owners, the 401(k) deferral portion represents only about one-third of the annual amount being contributed on their behalf.
So what’s the solution?
By using MandMarblestone’s customized Roth-it-SharingSM approach to maximizing Roth contributions in a qualified plan, participants may elect to have not only their 401(k) contribution treated as a post-tax Roth contribution, but also their profit sharing and matching contributions treated as post-tax Roth contributions as they are funded. The Roth-it-SharingSM approach is unique and available by utilizing our customized OCPP® plan document and annual consulting services.
A quick example of the Roth-it-SharingSM approach
A 40 year old physician who is a new partner in a medical practice contributes $49,000 a year [a $16,500 401(k) contribution and a $32,500 profit sharing contribution] to the practice’s 401(k) profit sharing plan. Assuming the physician will contribute at this rate until age 65, and earns a 5% rate of return, the account will have accumulated $2,455,560, either to spend, or to pass on to beneficiaries. A distribution from a traditional 401(k) account would be 100% taxable. Assuming a 35% income tax bracket, a lump sum distribution would result in income tax of $859,446. This also assumes that Federal Income Tax Rates do not increase.
The same distribution from a MandMarblestone Roth-it-SharingSM Plan is 100% tax free, providing an additional $199,831, for an enhanced retirement at the time of distribution! Here’s what the comparison looks like.
MandMarblestone Roth-It 401(k) Plan Traditional 401(k) Plan
Account Balance After 25 Years $2,455,560 $2,455,560
Taxes Due Upon Redemption @ 35% $0 $859,446
Taxes Paid During Accumulation @ 35% $659,615 $0
Roth-It Sharing Tax Savings $199,831
Who is a Roth-it-Sharing candidate? Roth-it-Sharing may be right for any 401(k) plan, since all participants, regardless of age, compensation level or annual contribution amount they receive, may conclude that Roth is right for them. Certainly, those participants who currently are funding Roth 401(k) contributions or have recently completed a Roth IRA conversion are likely fits for Roth-it-Sharing. Participants should consult with their individual tax advisors to determine if Roth contributions are right for them.
If you’d like to discuss how MandMarblestone might help you or any of your clients to implement Roth-it-Sharing, call Bob Mand, Ken Marblestone, Lori Gordon, Ian Haring or Mike O’Connell at: 215-222-5000, or e-mail us at: rmand@mand.com, marblestone@mand.com, lgordon@mand.com, iharing@mand.com, moconnell@mand.com.
We also remediate problematic plans to full IRS compliance.
You also may reach us through our website: www.mand.com.
