Spirit Airlines Pilots’ 401k Plan Now Allows Mega Backdoor In-Plan Roth Conversions
Spirit Airlines and the Air Line Pilots Association (ALPA) recognize that saving for retirement is one of the most important things its employees will ever do. That’s why the airline recently enhanced its 401k plan by adding the ability to make after-tax contributions as well as automatic in-plan Roth conversions.
The benefit of contributing after-tax assets to your retirement plan is that it allows you to build a tax-exempt source of retirement income, which can help you manage your tax liability in retirement. An in-plan Roth conversion refers to the process of converting pre-tax assets to Roth assets within the retirement account.
Roth vs. traditional (pre-tax) contributions
The first step in determining whether Roth 401k contributions make sense for you is understanding the difference between Roth and traditional contributions.
| Traditional 401k | Roth 401k | |
|---|---|---|
| Tax-advantaged growth | Tax-deferred growth — no federal taxes are due until distributions are taken at retirement. | Tax-exempt growth — no federal taxes are due at retirement as long as the account has been open for five years and the account holder has reached age 59 ½. |
| Distributions | Distributions in retirement are taxed as ordinary income. | Retirement distributions are tax-exempt once you reach age 59 ½ and have held the account for at least five years. |
| Early withdrawal penalties | Distributions before age 59 ½ may be subject to a 10% early withdrawal penalty and are taxed as ordinary income. | Distributions of money contributed are tax-exempt. Investment earnings may be taxable if they have been in the account for less than five years. |
| Required minimum distributions (RMDs) | RMDs must begin once the investor reaches age 72. | No RMDs are required. |
| Contribution type | Contributions are made on a pre-tax basis, which reduces the taxpayer’s taxable income in the year contributions are made. | Contributions are made on an after-tax basis, which provides no immediate tax benefit. |
| Income phase-outs | None. Anyone with any level of earned income can contribute. | None. Unlike Roth IRA contributions, higher income earners are not phased out from contributing to a Roth 401k. |
| Contribution limits | 2024: $23,000 for those under age 50 with an extra $7,500 catch-up contribution permitted for those age 50 and older. | |
Considerations
Following are several important considerations to keep in mind as you’re deciding whether Roth contributions are right for you.
- Taxes – Taxes play an important role in the type of 401k contributions you make. Because they’re made with pre-tax dollars, traditional 401k contributions offer the benefit of lowering your taxable income during the year in which they’re made. However, all pre-tax contributions and associated earnings are subject to ordinary income tax when they’re withdrawn (typically in retirement).
In contrast, Roth 401k contributions are made with money that has already been taxed. That means the funds are tax-exempt when withdrawn as long as you’ve reached age 59 ½ and held the account for at least five years. - Future income – As a general rule of thumb, if you expect your retirement income to put you in a lower tax bracket, it may make sense to make pre-tax contributions to your 401k in order to lower your current (higher) income.
On the other hand, if you expect to fall into a higher tax bracket in retirement, it may make sense to make Roth contributions that can provide a tax-exempt source of retirement income. - Other sources of retirement income – Similar to the benefits of diversifying your investments, tax diversification across account types can help reduce your long-term risk and provide tax advantages when it comes time to establish a monthly stream of retirement income. If you already have multiple sources of pre-tax retirement savings, it may make sense to diversify by making Roth contributions to your 401k.
One-time Roth conversions
In addition to allowing Roth contributions, the Spirit Airlines Pilots’ 401k Plan now allows participants to convert all or a portion of their account balance to Roth assets. A Roth conversion refers to the process of moving assets from a pre-tax status to an after-tax (Roth) status within your retirement account.
Any amount you convert is subject to ordinary income taxes during the year in which the conversion is made, which can be a major tax drag if not properly planned for. However, those assets become tax-exempt when withdrawn in retirement.
Before making a move, be sure to consult with your wealth manager, who can help you avoid unintended tax consequences.
Automatic conversion of future contributions
One way to reduce your potential tax liability while converting assets within your account is by using another new plan feature: automatic in-plan Roth conversions. This feature allows you to make contributions that are automatically converted to Roth status. Although you’ll need to pay taxes as conversions take place, these automatic conversions can save you on taxes in the long run because contributions are converted before they have time to generate earnings.
Again, it’s wise to consult with your wealth manager before taking action. He or she can help you evaluate whether automatic Roth conversions make sense for your particular situation.
Are you interested in learning more about the features of Spirit Airlines Pilots’ 401k Plan? Creative Planning can help. Our aviation specialty practice includes teams of experienced professionals who focus on helping pilots navigate the unique financial challenges of their professional and personal lives. If you could use some help with your retirement saving strategy, schedule a call with a member of our team.
