There is a lot of discussion around the favorable benefits of Roth IRAs, but for many higher-earning Americans, contributions to Roth IRAs are out of reach. The IRS begins limiting contributions to individual Roth IRAs at higher income levels (the current maximum income for eligibility is $144,000 per year for a single filer). However, there are a few ways higher-earning Americans can still access a Roth IRA.
One of the easier ways to manage around these strict IRS limits is to invest into a Roth 401(k) or 403(b). This can be a challenge if you are an employee, and your employer does not offer a plan like a 401(k), or they have a plan that doesn’t include a Roth 401(k) provision. The good news is that adoption of a Roth provision is on the rise. The Plan Sponsor Council reported that 86% of 401(k) plans included a Roth provision in 2020. However, according to the Bureau of Labor Statistics, in 2020, only 67% of workers were covered under a qualified retirement plan, leaving many Americans on the outside looking in.
If you are a business owner or a self-employed individual, you have more control over your ability to contribute to a retirement plan and include a Roth. You can simply add the Roth provision to your existing Plan Document (the document that governs the terms and conditions of the 401(k) Plan).
Adding the Roth provision may require a ‘Plan Amendment’ and the firm that is currently administering your Plan can typically handle this amendment for a few hundred dollars (hopefully not more). Or, you can add a Roth provision when you are completing your required Plan Restatement which is a mandatory exercise required of each Plan every six years. There is a standard cost to this Plan Restatement, but during this process you can typically edit your Plan Document at no additional charge so many companies choose to add a Roth during Restatement.
Unfortunately, we have seen instances where the lowest cost, most standard, ‘off-the-shelf’ prototype Plan Documents do not allow for a Roth provision. In this situation, the business owner has to make a decision: to continue without a Roth Provision, or switch to a more robust Plan Document that includes a Roth provision. If the decision is to switch to a new Plan Document, an advisor may be able to shop for a different Plan Document at a competitive price point.
The strict income limits that the IRS otherwise imposes on Roth contributions are not included inside a 401(k) so even a higher earning business owner or key executive can benefit. This is ideal for a younger person who has the chance to defer a portion of their salary, albeit on an after-tax basis, into the Roth 401(k) and keep the money invested while it hopefully grows tax free until it is withdrawn – of course subject to IRS guidelines.
To be sure, the tax reduction that accompanies a pre-tax contribution to a traditional 401(k) is valuable and may be missed by a high earning business owner who now is deferring into a Roth 401(k). If benefitting from a current tax deduction is still an objective, there may be an option to split contributions between the Roth 401(k) and the traditional 401(k). Also note, that some employer discretionary profit-sharing contributions can only be made to the traditional 401(k) side.
Overall, a small business owner has more control over the type of qualified retirement plan their company uses, and they can more readily add attractive features like a Roth provision. If you work for a small business that does not offer this benefit, don’t hesitate to ask them to explore adding it. They may be simply unaware of the benefits of the Roth and of how easy it can be to add. If they ultimately adopt a Roth provision, they may even wind up thanking you!