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Good Morning to All!

I have been asked to post the following question to the group:

"The concept of a back door Roth has been talked about lately through the use of Voluntary After-tax Employee Contributions into a 401(k) Plan that permits in-plan Roth conversions. It seems obvious that this strategy would be enticing to many HCEs wanting to effectively increase their salary deferral limit for a given year. But considering most NHCEs would not likely make deferrals of this sort, how do you pass the ACP test? It appears to be a real problem but perhaps there is some solution."
 
Thank you in advance for any comments/experiences/advice you wish to share.

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@shERPA, I believe that's what the head of our firm suspected would be the case, but he promised someone to run it up the flagpole and be sure before we discount the idea as being impractical.  Thanks for the response.  Let's see if anyone else wants to chime in.

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Actually, it'll work in more situations than just owner only.  A small firm, with a wide disparity in wage may benefit as well, but at a cost.  A small law firm, for example, with 10 lawyers and 4 staff may implement it, at the cost of a QNEC to cure the ACP failure - which might be insignificant enough to justify doing so.  In addition, a (very) large firm with many HCEs who can make use of the top paid election to "eliminate" a number of highly paid individuals from being "defined" as HCEs can do so - but only with respect to the NHCEs.  We have as a client a large law firm (1000+ employees) who do this - which effectively allows the associates - who would be HCEs but for the top paid election to make these kinds of contributions/conversions.  Of course, staff can also do so if they choose.

It's a numbers game.....

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I just had this conversation with a doctor who was upset that she couldn't do this in the practice she just joined.  The numbers don't work at all for them.

"well my brother works for Facebook and they can do it, do we just have to get a plan from the same place they do and then I can do it?"

🙃

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1 minute ago, Madison71 said:

I heard the Facebook PEP coming next year is outstanding 😀

Can you even imagine ... Facebook already knows everything you look at on the internet, now they know your retirement account too. You look up a medical procedure on the internet, next thing you know you're getting ads that say click here to take a hardship withdrawal from your 401(k). 

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50 minutes ago, C. B. Zeller said:

Can you even imagine ... Facebook already knows everything you look at on the internet, now they know your retirement account too. You look up a medical procedure on the internet, next thing you know you're getting ads that say click here to take a hardship withdrawal from your 401(k). 

And then you can easily (or inadvertently) "share" all that information with your Facebook "friends"!

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The other scenario two (presumably Facebooks) is a plan where there is a huge passing margin on the ACP test AND there are "hundrends" of HCEs so that if just one of them does a lot of after-tax it will have a muted affect on the testing.  The reality is of course that for most HCE's it is likely a stretch even to do the $19,000/$26,000, so even if available only a handful would put the pedal to the metal so to speak...

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At the FIS seminar in Orlando last week, there was a little discussion of this 'technique.'  In summary, the discussion was that

1. Testing, etc. work for a single life 401(k) plan;

2. Testing, etc. work in the context austin3515 describes above;

3. However, the Mega Back Door Roth may run afoul of the IRS's long standing enforcement position that you cannot do in two steps what you cannot do in one step.

No one commented on the results of IRS audits of these plans.

For some practitioners, it doesn't pass the smell test.

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This provision is non uncommon for large 401(k) plans.   John Hancock's plan, for example, allows this to be done twice per year.    It is great for NHCEs, and within limits HCEs or those not within the top 20%.

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This design is very common for large Silicon Valley employers. ACP testing isn't an issue because people are paid so well that many well-paid employees aren't HCEs, due to the top paid group/20% rule. It's typical for people earning $200K+ to be NHCEs. Aggregate match rates tend to be lower for HCEs than for NHCEs because of how the formulas work. A common match design in the Silicon Valley is a simple 50% match. So assume two employees each defer the (2019) $19,000 maximum, both get a $9,500 match, but the employee making $100,000 has a match rate of 9.5%, while the employee making $200,000 has a match rate of 4.75%. For this reason, we regularly see ACP tests where the ACP for NHCEs is HIGHER than the ACP for NHCEs.

In this environment where a mix of both higher paid NHCEs and plain old HCEs both want to make after-tax contributions and convert their after-tax contributions to Roth, with an ACP test with lots of room, the only effective constraint on the after-tax contribution is the Section 415 limit ($56,000 in 2019). It's simple math to back out 401(k) and match to get to the after-tax contribution amount (in this example, $56,000 - $19,000 - $9,500 = $27,500). Hundreds of employees will contribute to this limit.

With regards to the IRS potentially challenging the two step "back door" conversion, I've seen that concern raised, but some of the largest companies in the Valley offer this benefit. Most companies have decided that IRS won't challenge these mega companies--the worst may be to announce that the technique will be prospectively disallowed. So more companies are offering this. The major recordkeepers now support immediate standing conversions of after-tax to Roth, so it's not even a two step process. The effect is an end-around on the 402(g) limit for Roth contributions. But it happens all the time.

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For large employers, the passing margin on the ACP test is typically much wider than it is for the ACP and just a small percentage of HCEs will request in-plan Roth conversions.  The plan design is quite viable for them.

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