Jump to content

Enabling After-Tax Contributions to 401K


pone55

Recommended Posts

I have read online that 401K plans can adopt provisions to enable after-tax contributions *beyond* the $18K/$24K limits of contribution into a Roth 401K.   Such a provision would enable an employee to contribute the amount to bring the total 401K annual contribution up to $53K/year.    Can anyone refer me to pages that describe these plan provisions in more detail?

Link to comment
Share on other sites

Are you seeking information about the applicable rules that make such arrangements unusual (because of limited value or viability) in plans, or are you expecting a blueprint for implementation?  I suggest you get an understanding of the former before wasting your time on the latter.  Sorry, but  "I have read online" is an invitation to skepticism.  

Link to comment
Share on other sites

6 hours ago, QDROphile said:

Are you seeking information about the applicable rules that make such arrangements unusual (because of limited value or viability) in plans, or are you expecting a blueprint for implementation?  I suggest you get an understanding of the former before wasting your time on the latter.  Sorry, but  "I have read online" is an invitation to skepticism.  

 

I am looking for information on the applicable rules.   If there are in fact specific constraints or rules that make such arrangements unusual, or not valuable, then of course that is part of getting an understanding of those provisions.

I am not looking for blueprints.

Link to comment
Share on other sites

Plans can allow the contributions posited but as QDROPhile accurately points out, very few do. The reason is that taking advantage of the provisions subjects a plan to extra non-discrimination testing (known as the  ACP test) and since most people who wish to take advantage of such a provision end up being part of the class of employees subject to limitations due to the non-discrimination testing a plan will frequently find itself needing to un-do the contributions anyway.  Hence, unless: 1) the plan is not subject to ACP testing (because 100% of the employees of the plan sponsor are highly compensated; or, 2) a plan finds itself in the position of welcoming non-highly compensated employees to the ranks of those who take advantage of the provision, the plan will fail the ACP test and have to disgorge the contributions made.  A waste of effort, essentially.

Link to comment
Share on other sites

1 hour ago, Mike Preston said:

Plans can allow the contributions posited but as QDROPhile accurately points out, very few do. The reason is that taking advantage of the provisions subjects a plan to extra non-discrimination testing (known as the  ACP test) and since most people who wish to take advantage of such a provision end up being part of the class of employees subject to limitations due to the non-discrimination testing a plan will frequently find itself needing to un-do the contributions anyway.  Hence, unless: 1) the plan is not subject to ACP testing (because 100% of the employees of the plan sponsor are highly compensated; or, 2) a plan finds itself in the position of welcoming non-highly compensated employees to the ranks of those who take advantage of the provision, the plan will fail the ACP test and have to disgorge the contributions made.  A waste of effort, essentially.

 
 
 
 
 
 

I guess the reason so many plans adopt a Safe Harbor provision is so they do not have to worry about ADP and ACP testing.  Or are you saying that if you have an after-tax provision that you are no longer eligible for Safe Harbor, and the plan would be forced to go through ADP/ACP testing?

In the ADP/ACP testing, are they looking at total contributions - including after-tax contributions - of the HCEs into the plan? The percentages used in the ADP/ACP testing aren't the pre-tax and Roth 401K contributions that add up to $18K/$24K, but include any additional amounts that go into the after-tax contribution pool?

That said, why would any company not want to advertise such an after-tax feature to all employees of every rank?  Contribution by the employee of after-tax money, in excess of the Roth 401K contribution of $18K/$24K, is not going to be taking any company matching money.  So what possible economic incentive would any plan have to discriminate against any employee who wants to use that option?

I'm imagining that such a provision might be extremely desirable for some low-income employees.  For example, someone who is married and makes $60K / year may have a spouse whose income alone provides living expenses.  The person making $60K/year might want to stick every available dollar into an after-tax retirement pool.   It's hard to see why any company would discourage that.

P.S., Would a single-employee 401K plan be eligible to adopt the after-tax provisions?

Link to comment
Share on other sites

It's not that the employer is trying to intentionally discriminate, but more the fact that many NHCEs don't participate at the highest levels possible, while more HCEs do (or at least contribute higher %s because they have more spendable overall income).  And that poses an ACP nondiscrimination issue along with refunds, etc.

You can advertise all you want to every rank of ees, but you will find the lower ranks just won't participate as much.  There really just aren't that many workers at lower levels trying to "stick every available dollar into an after-tax retirement pool" especially now that there are so many private options to do the same thing. Why tie that money up in an employer 401k that has (possible) distribution limits ?

This was VERY common in the 1980s/1990s and yes, you have to ACP test (match + aftertax).  At the time, I would say only about 1/2 our clients offered the option.  And many replaced their aftertax option with Roth when Roth 401k became available because truly it was a better option (if held long enough the earnings aren't taxable where in aftertax moneys they are always taxable)

Plus you are adding a whole 'nother source of funds for the employer/recordkeepter to deal with -- possibly with its own set of fees, communication issues, loan/distribution rules, plus tracking and testing.  

I have to agree that most would find it unviable for the amount of possible participation. I suggest you research backwards to when this was more common prior to the mid to late 1990s.  I worked directly on plans back then and did a lot of ADP/ACP testing -- it was required of every plan prior to the Safe Harbor rules.  Honestly what you are considering loses the advantage of that -- you are trying to move backwards, which may or may not be a good thing. 

Link to comment
Share on other sites

I'm imagining that such a provision might be extremely desirable for some low-income employees.  For example, someone who is married and makes $60K / year may have a spouse whose income alone provides living expenses.  The person making $60K/year might want to stick every available dollar into an after-tax retirement pool.   It's hard to see why any company would discourage that.

Back when I did 4k plans I saw this now and then but it is in fact a pretty rare set of facts.  But yes now and then you would find someone (typically a wife) whose spouse made great money and the kids were all grown up and the lady got a job because she was bored.  So she was putting the 402(g) limit into the plan.  It made the ADP test that much easier to pass.  Such a person could benefit with this kind of provision.  But for this rare fact set very few companies are going to add this complex feature. 

Link to comment
Share on other sites

I believe if you search on the words "solo" and/or "after-tax" you will find threads about a solo 4k plan and this idea on this board.  I know it has been discussed before.  I at times get real luck on the searches and find exactly what I want and other times I know it is out there and seem to not find it. 

Link to comment
Share on other sites

7 hours ago, pone55 said:

I'm imagining that such a provision might be extremely desirable for some low-income employees.  For example, someone who is married and makes $60K / year may have a spouse whose income alone provides living expenses.  The person making $60K/year might want to stick every available dollar into an after-tax retirement pool.   It's hard to see why any company would discourage that.

This is only going to be relevant for a small population of plans.

Think about who would take advantage of this, especially now that there are Roth 401(k) contributions:  pretty much only those participants who are already maxing out.  And usually who is that?  The HCEs.  Granted, there are some NHCEs who max out.  But, for most plans, it will only be a very small portion of the staff (unless you have a professional group with a top paid group...but, again, that will be a small portion of plans).  Then what happens when the NCHE(s) leave the company?  Are you going to tell teh HCEs they can't make voluntary after tax contributions any more?  Passing the ACP test would probably be a difficult endeavor.

Does this mean you shouldn't do it?  Nope.  But just be aware of the demographics of the employer and see if it could fit. 

It seems like a great idea until you run the numbers through that ACP test...

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

Link to comment
Share on other sites

I'm not sure you should describe $60K/year as "low-income".

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

Link to comment
Share on other sites

5 hours ago, hr for me said:

This was VERY common in the 1980s/1990s and yes, you have to ACP test (match + aftertax).  At the time, I would say only about 1/2 our clients offered the option.  And many replaced their aftertax option with Roth when Roth 401k became available because truly it was a better option (if held long enough the earnings aren't taxable where in aftertax moneys they are always taxable)

4

First thanks for your entire reply and those facts.

The section I quoted above makes me think there is something I don't understand about the feature I am asking about.   A Roth 401K is taxed prior to going into the 401K, but it is not taxed going out.   Your reply raises the possibility that after-tax contributions to the 401K are taxed both going in and coming out.  Did you mean it that way?

If yes, then that is of course why I see articles describing techniques to tax after-tax money out of the 401K and convert it into a Roth IRA, where of course the money would not be taxed coming out.

Link to comment
Share on other sites

yes, earnings on pure after-tax contributions are fully taxable at the time of distribution regardless of how long they have been in the plan. The earnings never lose that taxability. If the contributions were made prior to 1987, they could be withdrawn separately from their earnings and the earnings would stay in the plan BUT be taxed when they were later distributed.  Any contributions made after 1986 and later distributed had to be distributed pro-rata with earnings associated...The IRS got tired of employees taking out a fully nontaxable distribution.  I still remember the "pre-87" and "post-86" basis buckets on our old mainframe program.  It was one of those things we had to check regularly for anyone that had aftertax contributions or taking aftertax distributions and often we had to manually calculate the taxable part of a distribution! (I am majorly dating myself here.....I started in the 401k field in 1991 so some people still had both types of money and we were responsible to track the tax basis -- and you would still have to do so now if you implemented aftertax contributions so you would know how much of the source is taxable and how much has already been taxed.)

As opposed to earnings on Roth 401k contributions where if you leave the money in the plan long enough the earnings become nontaxable along with the already taxed Roth contributions.

Honestly it sounds like you are missing some of the very basic historical 401k concepts. It might be worth it for you to look into the CEBS certification-- especially the ones on Retirement plans that will give some basic, history, definition and knowledge that you seem to be lacking.

Link to comment
Share on other sites

IRS Notice 2014-54 and allowing in-service rollovers of after-tax contributions have made them a more valuable 401k feature. This notice allows the direct rollover of the after-tax contributions to a Roth IRA and the pre-tax earnings to a traditional IRA (or convert to the Roth IRA)

Surprisingly a fair number of plans manage to pass ACP testing and those that wouldn't, a fair number of them manage to pass with a modest (8-10%) contribution limitation on HCEs. This is especially true if the plan match is extended to after-tax contributions. Also, it is best if after-tax contributions are fully available without requiring the reaching of the 402g limit first.

That said, it is still a minority of plans offering after-tax contributions.

Link to comment
Share on other sites

On 2/13/2017 at 2:57 PM, hr for me said:

yes, earnings on pure after-tax contributions are fully taxable at the time of distribution regardless of how long they have been in the plan. The earnings never lose that taxability.

 

So let's use some specific examples.

1) If the after-tax contribution is made for $10K, and five years later that is still $10K and you convert that into a Rollover Roth IRA, you owe no tax, and earnings moving forward from that point compound tax-free.

2) If the after-tax contribution is made for $10K, and five years later the after-tax contribution is worth $20K, you can convert that $20K into a Rollover Roth IRA.   But you owe ordinary income tax on $10K of earnings for the period the after-tax contribution stayed in the 401K.

So putting these together, what would be most desirable would be an additional provision that allows non-hardship withdrawals or transfers while you remain employed by the company.   That way you could rollover after-tax contributions into a Roth IRA in the same year you make the contribution (or the year after), before the contribution has taxable earnings.  Even if this were allowed, however, many plans require any distributions to be pro-rata from all of the different 401K components:  pre-tax, Roth 401K, and after-tax.

Is there any reason the after-tax contributions could not be done in a single-employee 401K?   The brokers that support plans for single-employee 401K generally segregate each type of 401K money into a separate account type, and they allow transfers to IRAs from each of the components individually.

Link to comment
Share on other sites

On 2/15/2017 at 7:56 PM, John Feldt ERPA CPC QPA said:

After-tax contributions must be tested for nondiscrimination (the ACP test), even if the plan is a safe harbor 401(k) plan. That means: if zero NHCEs contribute true “after-tax employee contributions”, then the HCEs can only put in $0.00 of after-tax contributions – thus the HCEs all get a full refund back of their after-tax contributions, and if refunded too late, it is subject to a penalty.

...

By adding an after-tax contribution option, this business owner now has the ability to put more money away for retirement in the 401(k) plan by utilizing the entire 415 limit including catch-up deferrals. You'll have to scroll, probably, to see the figures below to the right, but its $24,000 deferral, $15,000 profit sharing, and $21,000 after-tax.

 

Elective Deferral (includes $6,000 catch-up):

$24,000

Employer Profit Sharing (limited to 25% of pay):

$15,000

After-tax Contrib. (can convert to Roth):

$21,000

Total Contributions:

$60,000

 

I hope this helps.

What is the basis in law for requiring an ACP test for after-tax contributions, when the plan is a Safe Harbor plan?  There is a lot of confusion on this issue in the discussion online.   Many administrators are saying that the 2014 / 2015 IRS rulings that made it possible to rollover after-tax contributions to a Roth IRA talked specifically about plans with the ACP tests.  But supposedly those rulings did nothing to specifically prohibit plans with Safe Harbor doing the same thing.   The online discussion makes it sound like a Safe Harbor plan might be able to do these after-tax contributions without ACP testing, but could run a risk that the IRS rules in some unpredictable way about that.    If the law is clear and explicit that Safe Harbor cannot be used in combination with an after-tax plan provision, where is that in print and how unambiguous is the language there about Safe Harbor?

Changing subject, in your example there is $60K in total contributions.   I thought - even with the catchup employee contribution of $24K - that the total contribution limit was $53K?   How is the limit being expanded by $7K in your example?

Link to comment
Share on other sites

1 hour ago, pone55 said:

What is the basis in law for requiring an ACP test for after-tax contributions, when the plan is a Safe Harbor plan?  There is a lot of confusion on this issue in the discussion online.   Many administrators are saying that the 2014 / 2015 IRS rulings that made it possible to rollover after-tax contributions to a Roth IRA talked specifically about plans with the ACP tests.  But supposedly those rulings did nothing to specifically prohibit plans with Safe Harbor doing the same thing.   The online discussion makes it sound like a Safe Harbor plan might be able to do these after-tax contributions without ACP testing, but could run a risk that the IRS rules in some unpredictable way about that.    If the law is clear and explicit that Safe Harbor cannot be used in combination with an after-tax plan provision, where is that in print and how unambiguous is the language there about Safe Harbor?

Changing subject, in your example there is $60K in total contributions.   I thought - even with the catchup employee contribution of $24K - that the total contribution limit was $53K?   How is the limit being expanded by $7K in your example?

 

The catch-up limit for 2017 is still $6,000, but the 415 limit is now at $54,000. Thus a total of $60,000 is possible in 2017. A catch-up deferral can go above the 415 limit. Note that the owner's wages could be as low as $54,000 and still allow a total of $60,000 if at least $6,000 is done as an elective deferral, but that’s another side topic.

So, where is the basis in the law? Let’s look at the law, as passed by Congress, Internal Revenue Code Section 401(m)(1), which states:

  • In general. A defined contribution plan shall be treated as meeting the requirements of subsection (a)(4) with respect to the amount of any matching contribution or employee contribution for any plan year only if the contribution percentage requirement of paragraph (2) of this subsection is met for such plan year.

    Be sure to look at the term employee contribution – this is a voluntary after-tax contribution. This is not the same as a salary deferral election which is defined as an elective deferral. Thus, employee contributions (same thing as voluntary after-tax contributions) are lumped into the same nondiscrimination bucket as matching contributions. Seems clear. The rest of that section of the law goes on to explain a little about ACP testing with the limitations and it provides for the Treasury Secretary to write regulations (yes, the regulations apply too).

    So that is the basis under the law. As to all the details, I personally find the regulations to be clear about including after-tax contributions in this test, no ambiguity about that question. Look at Treasury Regulation 1.401(m)-2. Please note that the law has a clause to allow the regulation to interpret the law, and unless the regulation contradicts the law, the regulations are generally treated as having the weight of the law.

After-tax contributions have been around for decades, so I have not heard that there was any confusion about this. Who, or where is this confusion stemming from?

Link to comment
Share on other sites

19 hours ago, John Feldt ERPA CPC QPA said:

After-tax contributions have been around for decades, so I have not heard that there was any confusion about this. Who, or where is this confusion stemming from?

John, the confusion is coming from about 95% of people writing that they've discovered a miracle. Search "backdoor roth 401(k)" for a sampling.

William C. Presson, ERPA, QPA, QKA
bill.presson@gmail.com
C 205.994.4070

 

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
×
×
  • Create New...