Maximizing annual additions via after-tax contributions

[Santo Gold]

In trying to figure out a way for some owners to maximize their annual additions, I came up with the idea of using employee contributions to get there. I would appreciate any comments if what I have is way off base.

Company has 9 employees, with 2 owners (brothers), plus 5 more lineal family members, for a total of 7 HCEs, with 2 non-related NHCEs. Plan is a Roth 401(k) 3% safe harbor. No other contributions so far. New Comp. won't work in this plan if we try to favor the 2 owners. Everyone has elected to make Roth contributions rather than pre-tax 401(k).

What if the plan allowed for both Roth and after-tax employee contributions? The 2 owners (with comp of $225,000) make $15,500 in Roth contributions, get $6750 in s/harbor contribution, and a contribution of $22,750 in after-tax employee contributions, getting them to $45,000 in 2007. If none of the other 5 HCEs make after-tax employee contributions, the 401(m) HCE ACR would only be 2.89%. If the 2 NHCEs were to put in on average 1.45% after-tax (but not Roth) or if the company put in a 1.45% QNEC for NHCEs only, then 401(m) passes (1.45 *2= 2.90%).

Granted this is a pretty narrow set of circumstances, but does this work as well as it seems to work? The owners, who already favor after-tax plan money (compared to pre-tax) can hit $45,000 by either making a small QNEC or possibly no additional ER contribution if the NHCEs put in a small EE contribution.

Is there any difference tax-wise between after-tax employee contributions and Roth contributions? Am I correct in that both contributions go in after-tax, earnings grow tax-free, and both are not subject to income tax upon distribution? I know there are some differences regarding when and how withdrawals are made.

[Jim Chad]

What you are saying looks right to me, but here are three other ideas to consider.

1. I'm surprised that a new comparability plan can't be made to work if you have 5 HCE's that don't want to max. You may be testing on allocations rather than benefits, but I would think you would be able to do something good.

2. The goal seems to be to put money away for retirement in something that grows tax deferred even if you don't get a tax deduction today. If this is true you may want to talk to an insurance agent about a single premium deferred annuity, outside any employer plan. Unless there have been changes that I have missed, there is no testing, no limit on how much you can put in and the same tax benefits as after tax contributions.

3. There might be a way for a triple stacked match, to get you to $45,000 and have all of it be pretax.