Retirement Accounts, Part 3 – Workplace Retirement Plans   Leave a comment

Yesterday I covered IRAs and workplace retirement plans in general. Today, I’ll be discussing the specifics of the 401k, 403b, 457b, and 401a.

401k

This is the most common workplace retirement plan. They are generally offered in both the Traditional and Roth flavors (though your employer is not required to provide both to you). The contribution limit in 2015 is $18,000 (or $24,000 for those who are 50 or older).

Just like IRAs, you can withdraw from a 401k for any reason penalty free starting on the calendar year you turn 59.5. However, there one exception to this rule – if you terminate employment from your employer on or after the calendar year you turn 55, you can withdraw money from that 401k penalty free for any reason. However, it is only from that particular 401k – if you have other 401ks from previous employers, you cannot withdraw money from those 401k’s penalty free. The workaround to this is to roll in your old 401k money into your current 401k before you terminate employment from your current employer (assuming your current 401k allows for such rollovers).

Also, if you roll over the 401k into an IRA, the “rule of 55” does not apply to the IRA.

403b

A 403b is more or less the same thing as a 401k, except that public education organizations and some non profits use 403b’s instead of 401k’s. If you happen to have a 401k and a 403b in the same year (if your employer offers both, or if you work for two employers, one offering a 401k and one offering a 403b), your combined contribution limit to all 401k’s and 403b’s is $18,000 (for 2015). You do not get an increase in your contribution limit from a 403b.

457b

These plans are somewhat similar to the plans listed above, but they have a couple of key differences. Some of these differences are dependent on whether the 457b is provided by a governmental employer

  • There is no penalty for early withdrawal once you terminate employment (but this rule doesn’t apply if you roll over the 457b to an IRA)
  • You can simultaneously max out a 401k or a 403b and max out a 457b
  • A nongovernmental 457b is not held in trust on the behalf of the employee, meaning that if the non governmental employer goes bankrupt, the 457b funds can be used to service the debt
  • Non governmental 457b funds cannot be rolled into any other type of retirement plans, only other non governmental 457b’s
  • Governmental 457b funds can be rolled into other workplace retirement plans

I would not recommend you use a non governmental 457b because of bullet 3 above.

If you are lucky enough to have both a 401k or a 403b and a governmental 457b available at your workplace, do your best to max out both of them! Having double the tax advantaged contribution limit of most others is an amazing asset.

401a

These plans vary from employre to employer. They’re typically designed to retain key employees for long periods of time. The contribution amounts are set by the employer, not the IRS. And they may not give you any investment choices

For example, my school offers regular faculty or staff a choice of one of two 401a plans: one where the employee contributes 6% of their salary, and the employer matches 13.15%. But, it takes 10 years to vest (if you leave within the first 10 years, you lose everything in the 401a). Or, the employee can choose the other 401a with a 6% employee contribution and a 9.25% match, with immediate vesting.

As you can see from this example, the first 401a can motivate regular faculty or staff to stay for at least ten years.

The Mega Backdoor Roth

There are actually three types of contributions that the IRS allows employers to offer to their employees: Traditional, Roth, and after-tax. The difference between Roth and after-tax contributions is that while in both scenarios, taxes are paid before the contribution, for the after-tax contribution, taxes are paid upon withdrawal.

So why do I bring this up? It’s basically just the same thing as a non-deductible IRA. Well, similar to how a non-deductible IRA can help taxpayers with a high AGI to contribute money to a Roth IRA indirectly, an after tax contribution can allow you to contribute more money to a Roth.

The IRS allows employers to offer their employees the ability to make an in service rollover of some or all of their 401k/403b funds   If you make an after tax contribution to a 401k [I believe this will also work with a 403b, but not a 457b because they follow a different set of rules], and your 401k allows you to do an in service rollover, then you can roll over the after tax funds to a Roth IRA. You will owe any taxes on the investment gains on the after tax contributions Рbut if you do this immediately after the after tax contribution, then there will be no gains to pay taxes on.

The total contribution limit to a 401k/403b for 2015 is $53,000 (this is employer + employee contributions). Assuming you’re under 50, that means you could make a $18,000 Traditional contribution and contribute $35,000 after-tax, to roll into a Roth IRA, and pay no taxes on the rollover (assuming no employer match). You would effectively be allowed to contribute an extra $35,000 to a Roth IRA. Hence the term the mega backdoor Roth.

You should take advantage of this if you can – but after you’ve maxed out your Traditional or Roth contributions to the 401k/403b, and maxed out your IRA contribution. Having an extra $35,000 of Roth contribution limit is an incredible asset! But remember, to be able to do this, you will need a 401k/403b with the following two key characteristics

  • In service non hardship rollovers of funds
  • Allows for after-tax (not Roth, but after-tax) contributions
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Posted January 17, 2015 by Fiby in Uncategorized

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