401(k) after tax contributions

[Guest BruceC]

I've always understood the 402(g) limit to be, for 2010, 16,500, whether pre or after tax. But I have read on a company's web site that their employees may exceed this limitation if the excess contribution is designated after tax contributions. I then found this on another employer's web site...and this is not part of a plan with Roth provisions.

1. May 401(k) plans allow this? Where in the code is this allowed?

If so....

2. must the employee's after tax contributions be subject to the ACP test?

3. may after tax contributions only be made if the full pretax 402(g) salary deferral has been made, or may the employee designate any part of their salary deferral as after tax??

4. Are the after tax contributions subject to the 415© limitation?

Any other information on this would be appreciated.

BruceM

[rcline46]

research Voluntary Contributions

[Laura Harrington]

1. May 401(k) plans allow this? Where in the code is this allowed? Yes. Recharacterizing excess contributions as after-tax contribution is an allowable correction for the ADP test. I've never seen it in a document personally, but it is allowable. See Treas. Reg. §1.401(k)-2(b)(3).

2. must the employee's after tax contributions be subject to the ACP test? Yes.

3. may after tax contributions only be made if the full pretax 402(g) salary deferral has been made, or may the employee designate any part of their salary deferral as after tax?? The designation comes after the ADP test has failed, not before. So the ADP test fails, the excess contributions are calculated using the leveling method. The plan can then allow the HCE to choose if the excess is to be distributed or reclassified as after-tax.

4. Are the after tax contributions subject to the 415© limitation? Yes.

There are taxation issues of course since the money is being recharacterized as after-tax.

[hr for me]

This was much more common back in the late 90s when many of our clients allowed employees to put in both pre-tax deferrals and after-tax contributions. There was usually no requirement that the employee do pre-tax before after-tax, but many clients only matched pre-tax amounts. If they allowed after-tax deferrals, it was much easier to recharacterize pre-tax deferrals for the nondiscrimination testing because the money buckets already existed. Yes, the after-tax deferrals were tested under the ACP part of the test. And that was way before the safe harbor regulations. So we did everything we could to pass nondiscrimination tests. Aftertax contributions are not needed so much anymore because of Roth and Safe Harbor.

Wow...I sound old.....that was "back in the day" when we were still processing quarterlies and annual plans!

[BG5150]

3. may after tax contributions only be made if the full pretax 402(g) salary deferral has been made, or may the employee designate any part of their salary deferral as after tax?? The designation comes after the ADP test has failed, not before. So the ADP test fails, the excess contributions are calculated using the leveling method. The plan can then allow the HCE to choose if the excess is to be distributed or reclassified as after-tax.

If the plan allows for after-tax contributions in the first place (not necessarily the re-characterization of them) then can't people can do any percentages they want for either deferrals and/or after-tax (within plan/IRS limits of course)? For example, couldn't I do 10% 401(k) and 5% after tax even though I'm not gonna hit $16,500 with the 401(k)?

And, for re-characterization, doesn't the plan have to allow participants to make them also before it's allowed?

[Laura Harrington]

3. may after tax contributions only be made if the full pretax 402(g) salary deferral has been made, or may the employee designate any part of their salary deferral as after tax?? The designation comes after the ADP test has failed, not before. So the ADP test fails, the excess contributions are calculated using the leveling method. The plan can then allow the HCE to choose if the excess is to be distributed or reclassified as after-tax.

If the plan allows for after-tax contributions in the first place (not necessarily the re-characterization of them) then can't people can do any percentages they want for either deferrals and/or after-tax (within plan/IRS limits of course)? For example, couldn't I do 10% 401(k) and 5% after tax even though I'm not gonna hit $16,500 with the 401(k)?

And, for re-characterization, doesn't the plan have to allow participants to make them also before it's allowed?

Yes, after-tax has to be allowed in the plan in order for recharacterization of excess deferrals to happen.

And yes, unless there is some weird provision in the document an individual should be able to put in after-tax even if they haven't met the 402g limit on their pre-tax contributions.

[Guest BruceC]

Laura and others

Thanks for the responses.

But if the plan allows for recharacterizing excess of ADP to after tax contributions, and this amount must then be subject to ACP....wouldn't this pretty much eliminate after tax contributing for most employers?

Here's an example: 401(k) plan, consisting only of EE salary deferrals, tests and finds the ADP for HCE participants is 10% of salary and for NHCE is 4%. Thus, the HCE are 4% over budget (10 - (4+2)). One of the options is to recharacterize this excess to after tax...which for simplicity lets say all HCE do.

But now for the ACP, which for the HCE's is 4%, but for the NHCE is zero. This would mean that the plan could not allow after tax contributions by HCE....

....correct? Or am I missing something?

OTOH, there would be no limit (except 415©) for after tax contributions for NHCE. But I would guess (and its only a guess) that this is usually not a 'problem', as its not normally the NHCE's who are trying to stuff as much $$ as possible into the plan.....or am I just being presumptuous :-)

Thanks for the discussion, as this has been one of those QRP issues I've never understood very well.

Look forward to your comments

BruceM

[Laura Harrington]

Bruce, you are absolutely correct. Unless there are NHCEs also putting in after-tax (or there is a really generous match that gives the NHCEs a decent ACP average!) recharacterizing the excess contributions as after-tax is a moot point since the ACP test will then fail and the money will be returned anyway!

As one of the previous posters said, this was more popular back in the time when after-tax contribution features were actually being utilized by employees.

[Tom Poje]

in addition, if the plan had a last day rule or hours requirement for match. normally those individuals are excluded from the ACP test. but once you allow after-tax, you have to keep those people on the test as well.

and if your recharacterize, though there is no actual distribution, you still have to 1099 and create a 'basis' going forward.

as a side bar, now that Roth contributions (whioch of course are ADP tested) are available which would someone want

an after tax contributions in which you pay taxes on the gains at distribution time or an after tax roth with no taxes on the gains. hmmmmmmmmmmmmmmmmmm.

[Guest BruceC]

Bruce, you are absolutely correct. Unless there are NHCEs also putting in after-tax (or there is a really generous match that gives the NHCEs a decent ACP average!) recharacterizing the excess contributions as after-tax is a moot point since the ACP test will then fail and the money will be returned anyway!

As one of the previous posters said, this was more popular back in the time when after-tax contribution features were actually being utilized by employees.

Mucho thanks.

BruceM