Ideally, with each paycheck or bonus paid we would have all the cash flow we need to support regular cash-flow needs, achieve our larger financial objectives and optimize deferrals to tax-advantaged accounts and other tax savings opportunities. However, money is a resource, and like most resources it’s limited. We are forced to prioritize where we spend, the objectives we further, and the extent to which we utilize tax-saving opportunities.
Because many employees prioritize maxing pre-tax contributions to their 401(k)s and HSAs (as I think they should in most cases), we are often asked what to prioritize once those contributions are maxed out. Specifically, employees who are eligible to defer to Intel’s deferred compensation account (“SERPLUS”) ask:
Should I make after-tax contributions to my 401(k) (a.k.a., mega Roth contributions) OR should I contribute to SERPLUS?
The final decision depends on the individual employee’s situation so let’s look at the benefits and risks of each to inform the decision and then review what an individual should consider in assessing the decision for themselves.
Benefits and Risks of SERPLUS
We recently detailed 4-Steps to consider when you evaluate the decision to defer to SERPLUS in any capacity, but for the purpose of this post let’s look at the benefits and risks at a high level.
Employees who are eligible to contribute to Intel’s deferred compensation account, SERPLUS, are given the opportunity to forgo income today in order to reap both current and future tax-benefits.
- The immediate tax benefit is that you reduce income in the year you defer thus paying less in tax for that year.
- The future benefit is two-fold: 1) funds in the SERPLUS account can be invested and are allowed to grow tax-deferred until distributed, and 2) when those funds are distributed there is a high probability the employee will be in a lower tax bracket then they are in currently.
Of course, these benefits come with some risks, the largest of which is that when you defer to SERPLUS you become an unsecured creditor of Intel. In other words, Intel has to survive and be able to pay its debts in order for you to eventually receive the income you deferred.
In other words, with SERPLUS, you get a potentially significant dual tax-benefit that comes with a risk tied to the future of Intel.
Benefits and Risks of Mega Roth Contributions
For a detailed look at the benefits of after-tax contributions and how to take advantage and optimize them, I encourage you to read this post on Understanding Intel’s New Mega Roth 401(k).
Last year (2019), was the first year an Intel employee could make what is called a Mega Roth Contribution. This is an after-tax contribution to a 401(k) which is then immediately converted to Roth. We were thrilled that this new opportunity for additional tax-preferenced savings was made available to our Intel-employed clients because it allows them to take two advantageous actions:
- Maximize the amount of 401(k) savings beyond pre-tax limitations with after-tax contributions up to the IRS limits; and
- Convert those after-tax contributions to Roth where they can be invested and grow tax-free
The benefit of a mega-Roth contribution is the tax-free growth of the investments in the account. Since many employees who are eligible for SERPLUS are otherwise unable to contribute to Roth IRAs because their income exceeds IRS thresholds or because “Backdoor Roth” contributions are unavailable to them, this offers an opportunity for tax-free investment growth that wouldn’t otherwise be available.
The main risk is legislative. And while that could be said for any 401(k) or other retirement account contribution, I see it as a greater risk here because there have already been two congressional proposals in recent years (neither enacted) to limit or remove the ability to convert after-tax 401(k) contributions to Roth. While a real risk, keep in mind that if congress enacted a change, contributions would still be in a 401(k) and allowed to grow tax-deferred. Tax-deferred growth is not as nice as tax-free growth, but the benefit is still material and I see this risk as minimal compared to that of SERPLUS.
SERPLUS or Mega ROTH: Factors to consider
As I said in the beginning, whether a contribution to SERPLUS or Mega Roth is best for you will depend on your individual situation. In many cases, the dual tax benefits of SERPLUS (even with the risks) outweigh the benefit of the tax-free growth that comes with Mega Roth contributions, but that is not always the case. Here is what we consider when we look at this decision with our clients.
- Current tax bracket – How much of a benefit is reducing income in the coming year with a deferral to SERPLUS. Keep in mind, this benefit could be much greater in years where income is higher. For example, you or your spouse expect a large bonus, increased capital gains, or one of you is retiring in the coming year and there will be other benefits paid out—any of these would make a SERPLUS deferral more attractive.
- Expected future tax Bracket – How much tax does the client expect to pay when the SERPLUS funds are distributed. If the client expects to be truly retired and have no or very little income, the benefit of paying income tax in those years as opposed to paying at current income tax rates could be huge. We often see clients go from the 35% federal marginal tax bracket while employed to the 10% marginal bracket when retired. If you deferred $50,000 dollars to SERPLUS, that could be a difference of $12,500 in federal taxes owed on that income!
- Expected time for Growth –SERPLUS will be limited to the elected period of deferral, but a Mega Roth contribution could have an extremely long time horizon for growth. For example, if an estate objective is a client’s priority, the ability to get funds into a Roth account where the funds could be invested and grow tax-free and untouched for the client’s life could greatly increase the likelihood of achieving the estate objective.
- Magnitude of the Risk – As stated above, the more acute risk is with SERPLUS – the magnitude of which is all about how much the client already depends on the future of Intel. With our clients we ask:
- Would they have opportunities at other companies if Intel didn’t survive?
- If married, do both spouses work for Intel?
- How much do they already have deferred into SERPLUS?
- How much company stock do they hold?
If you are making this decision for yourself, I hope my outlining the benefits, the risks and the factors to consider helps inform your decision. If you would like help analyzing your situation specifically so that you can make the decision that is best for you, please feel free to reach out. I’m happy to take some time to discuss how this or any other deferral decision could impact your situation.