New Tax Law Changes the Math for Roth Contributions

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Who this applies to: Those making supplemental employee contributions to 403(b) and 457 retirement plans

Benefits to you: Designating contributions as Roth instead of pretax can potentially lower taxes in three ways

  • Paying taxes now at a lower rate than might be imposed during retirement
  • Roth assets can provide a tool for lowering marginal tax rates on pretax income sources during retirement
  • Roth assets can mitigate the substantial risk of uncertain future tax structures

Summary: The tax bill passed in 2017 modifies individual income tax brackets for tax years 2018 through 2025. Marginal tax rates (the rate at which the next dollar of taxable income is taxed) are now reduced for many due to the broadening of the brackets and an overall reduction in tax rates.  In light of these reductions, one might assume there is a reasonable probability that marginal rates will increase in the future. For these reasons, making supplemental retirement plan contributions as Roth instead of pretax could be a smart choice.

Annual contribution limits to 403(b) and 457 plans are significantly higher than for Roth IRAs. Maximum annual limits for Roth contributions to these plans are the same as for pretax – $18,500 and $24,500 (for those 50 or older), as opposed to $5,500 and $6,500 for Roth IRAs. Contributions to 403(b) and 457 plans are also not subject to income phase outs as Roth IRAs are.

Prior to the 2018 tax year, a married couple filing jointly with taxable income of $165,000 would have had a federal marginal tax rate of 28%. Pretax contributions to a supplemental retirement plan would allow the couple to avoid the 28% in federal income taxes due at the time of contribution. Instead, taxes will be paid at prevailing tax rates when withdrawals are made.

For tax years 2018-2025 the marginal rate for this couple falls to 22%. If Roth contributions are made and taxes paid now at 22%, future withdrawals of both contributions and earnings will not be taxed if the first deposit to the account occurred at least five years prior to any withdrawal. Future retirement income needs can be met by judiciously drawing a combination of Roth and pretax assets to potentially reduce income taxes on withdrawals from pretax accounts, as well as taxable income sources such as pensions and social security benefits. Additionally, by having both Roth and pretax assets, the couple would now have a measure of flexibility to react to changes in future tax structures.

How the change to Roth contributions can be implemented: Either with a paper salary reduction agreement or through your employee portal, as your university instructs, select “Roth” as your contribution type along with the provider you have chosen and the contribution amount for each payroll period. The custodian of your account will maintain records of pretax and Roth assets in your account. Contact your advisor with questions or for assistance.

*Tax information provided by CCM should not be solely relied upon. Instead, one should conduct their own independent research or consult a tax professional.

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