Maximizing the Value of Your 401(k)

You may know that over-50 workers can generally contribute up to $24,000 per year to their 401(k) plan on a pre-tax basis. But, did you know that a worker’s total 401(k) contribution (pre-tax contributions, matching company funds and after-tax contributions) rises to a $59,000 limit?

But wait, it gets better. Starting in 2013, new legislation permits people to convert any portion of their 401(k) into a Roth 401(k). It’s done via an in-plan Roth conversion (also known as an in-plan Roth rollover). One implication of this is that you can immediately transfer the after-tax portion of your 401(k) contribution to a Roth IRA and, unlike 401(k) distributions, never pay any tax on the growth of that account!

Since Roth IRAs do not require withdrawals until after the death of the owner, this is a great way to build your estate. So, even if you’re 50 years old, your beneficiaries may realize 35 or so years of tax-free growth. Let’s look at an example of this. Suppose your contributions plus any employer-provided matching funds hit the $59,000 maximum. Further, suppose $35,000 of this represents your pre-tax contribution plus the employer’s matching funds. This means you contributed $24,000 in after-tax funds. Further, assume you’re now 50 years old and that you work until you’re 65. If you contribute $24,000 per year for 15 years, and if it grows at 3.5% annually, you’ll have about $480,000 at retirement. Now, if you live 20 years past retirement, your heirs will end up with about $950,000. Not bad!

There are a number of things to watch out for with this approach. First, tax legislation is constantly changing. Second, the rules of your employer’s 401(k) plan must permit this. Third, only vested amounts can be converted. Fourth, tax offsets (like significant medical expenses) can reduce the tax burden of the conversion. Finally, if you have a 403(b), thrift savings plan or a 457(b) plan, this same strategy applies.

So, it pays to have some professional advice if this sounds interesting. Guidepost Financial Planning is able to help you with this and all other aspects of your financial planning. Please visit our website or give us a call at 970.419.8212 so that we can discuss your financial goals in a no-charge, no-obligation initial meeting.

This article is for informational purposes only. This website does not provide tax or investment advice, nor is it an offer or solicitation of any kind to buy or sell any investment products.  Please consult your tax or investment advisor for specific advice.