After-Tax Contributions

[Guest SSSP]

I have a question on gains with after-tax contributions to make sure that I understand this correctly. To keep things simple (especially for me!), let's use a situation where a person puts in a first time after tax contribution of $10,000 into their 401k, and makes $10,000 in earnings.

Let's also assume that this person starts the after tax contribution at age 55. Is it correct to say:

1) After making the contribution, if the person immediately executed a Roth conversion of the funds within the plan (provided the plan documents permit), are they NOW Roth funds with gains no longer to be taxed? (This would be assuming that the funds remain in the plan for 5 years and the individual is over the age of 59 1/2 before they take contributions)

2) Using this same example, assuming they kep the funds in the plan for 5 years and are over 59 1/2, can the individual rollover both the basis and gains to a Roth IRA? Is it then correct to say the individual could then take out distributions on basis and gains tax free?

I am getting confused with this, but I was believing that if the funds are converted to Roth and meet the Roth requirements (e.g, 5 years, 59 1/2), then contributions and gains will come out tax free. And, if it makes it easier for me to understand : ) I would be starting by: 1) making an after tax contribution, 2) converting to Roth immediately within the plan, and 3) wanting to take out distributions tax free (with the assumption that i have met the 5 year and 59 1/2 rules) And, for options, I could always rollover the funds to a Roth IRA and take distributions from the IRA, if I chose.

Thank you so much.

[QDROphile]

What is causing you to go through this exercise rather than elect Roth contributions instead of after-tax contributions?

[Tom Poje]

QDROphile -

I think this is the 'scheme' being pushed by whomever as follows:

you can only defer 18,000.

but if you have after tax, then you can put in even more and then convert it to a roth, so of like a cheating end around the rules. e.g. put in $25,000 as after tax and convert to Roth.

it might work if there are no nhces, but if you have nhces then you would most likely fail the ACP test.

[Guest SSSP]

QDRO...only because as I understand the rules, while I can make my elective deferrals in a Roth or Pre-Tax manner, anything above that would be an employer contibution that would be pre-tax and tied back to profit share calculations. Tell me if I am wrong, but by doing after tax, I can max out the contributions in an after tax manner, do a conversion to Roth (I am already paying the tax anyway), and make as much contributions to the plan in an after tax manner.

Does this help explain? Thanks.

Oh and since Tom's comment just came through, it is an individual plan so there should be no issues related to highly compensated employees, etc., correct?

[John Feldt ERPA CPC QPA]

If it's an individual plan with a Roth option, you can contribute deferrals as Roth and the employer dollars go in as pre-tax - then convert all of that thar account to Roth if you are so inclined.

But if your compensation is so low that the employer pre-tax contribution is limited by the deduction limit, then that's where the after-tax contribution can help you.

Assuming a future Congress won't tax Roth accounts, something like their promise to not tax social security.

[Tom Poje]

correct, without other employees it can work (at least it appears to on paper)

when I used the term 'scheme' I meant that there are those who sell the concept and might not even be aware of the ramifications / consequences if there are other participants, in this case the ACP test.

similar to the plans sold as deferral only - "you never have to put in employer $" and then the plan turns out to be top heavy, with a great big surprise to the owner.

[K2retire]

And based on the number of recent inquiries on the subject, someone is definitely peddling this concept.

[Guest SSSP]

Guys, thanks for all of the comments. I think we are on the same page. John wrapped it up nicely and correctly in that deferrals can be all Roth and employer profit share contributions (while needing to be made as pre-tax) could be converted to Roth within the plan, provided the plan documents permit. Further, the after tax could be very valuable when one doesn't max out deferrals/employer contributioins and has the ability to put in after tax money. I think there is not really a downside with it...provided it is done correctly.

Just to confirm tho with my question above....if after tax contribution is made,funds are there for 5 years (minmum) and age of 59 1/2 has been satisfied, the person could take out distributions (or rollover to Roth IRA) on both the basis and gains without tax...correct? Thanks again so much. This concept is definitely out there, but I FULLY agree the "bang for the buck" is with the individual plan, not so much the multi-participant plan. Thanks, again!

[Jim Chad]

That is my understanding.

[ERISA1]

I was glad to see Voluntary Contributions go by the wayside 20 years ago. Now, I have to re-learn the rules because of IRS Notice 2014- 54 and the incredible amount of press that is making clients feel like they are loosing out on the greatest opportunity since living trusts.

I've been trying to do research in the ERISA Outline Book but cannot make any progress. This forum is f far more helpful. Can anyone tell me how/whether Voluntary Contributions fit into the 401(k) Safe Harbor rules?

Thanks

[Tom Poje]

they don't. you still have to run the ACP test.

so if you have a basic match and get lucky enough to have everyone defer 5% then the NHCE will be at 4%

so the HCE could have after tax of 2% and still pass ACP, assuming all thing being equal.

since the plan accepted contributions other than safe harbor I believe the "get out of top heavy free' card is not applicable.

Though it would be a moot point if everyone received the 4% match.

ha ha ha. all NHCEs defer 5%. what odds will you give me on that?

dang it, where is my map to who-ville?

[Guest hk73]

Guys, thanks for all of the comments. I think we are on the same page. John wrapped it up nicely and correctly in that deferrals can be all Roth and employer profit share contributions (while needing to be made as pre-tax) could be converted to Roth within the plan, provided the plan documents permit. Further, the after tax could be very valuable when one doesn't max out deferrals/employer contributioins and has the ability to put in after tax money. I think there is not really a downside with it...provided it is done correctly.

Just to confirm tho with my question above....if after tax contribution is made,funds are there for 5 years (minmum) and age of 59 1/2 has been satisfied, the person could take out distributions (or rollover to Roth IRA) on both the basis and gains without tax...correct? Thanks again so much. This concept is definitely out there, but I FULLY agree the "bang for the buck" is with the individual plan, not so much the multi-participant plan. Thanks, again!

Another benefit might be that combined plan limits per 404(a)(7) don't seem to apply to after-tax contributions, whether converted to Roth or not. An individual plan participant could make contributions to the DC plan up to the section 415 limits, above and beyond the limits on elective deferrals, independently and separately from contributions to a DB plan in the same year. I asked the related question in an earlier thread, but didn't get a definite answer. Can someone confirm, or are there any rules or limits I didn't consider?

[John Feldt ERPA CPC QPA]

They do not count against the 404(a)(7) limit. So , yes, it can be good for an owner-only DB/DC combo where the owner is not wanting (or needing) all contributions to be tax deductble.