After-Tax Contributions (Again!)

I know this board is probably tired of After tax/mega backdoor roth questions....but here I go.

I'm an advisor who only does 401k/403b/Cash Balance plan advising.  We pride ourselves on our ERISA knowledge and everyone on my team has the QKA at least, but a client has come to us with questions that I wasnt sure of.  The TPA was on the call and they are researching but I thought Id ask this group as well.

The client is a young business owner (~10 employees)who loves after-tax/MBDR strategies. We have shown him numerous profit sharing plan designs, discussed the issues with after tax contributions for a company his size, etc.  His question as we reviewed profit sharing is what if instead of profit sharing he does $35k in after tax contributions to get to $70k.  Then can he simply do the $80k in profit sharing were showing due to employees as employer after-tax contributions?  Everything I read says after tax is subject to ACP, and the only remedy for after-tax is the owner removing their contributions, but could he instead of that just do very large after tax contributions to his employees like a QMAC remedy?

There are a ton questions I have that come out from this - who pays the tax, would this money have to be considered fully vested, etc. 

Yes it needs to pass ACP on after tax that's why it doesn't typically work in the situation you are describing. The QNEC to the employees would be fully vested and be pre-tax employer contributions to the NHCE employees unless the plan has a ROTH employer contribution feature and the employees elect to be taxed on it and receive as ROTH.

But if he's looking for ROTH contribution, why not just tell him about the option make the employer contribution as ROTH under Secure 2.0 and go with the original design and have him elect to take his employer portion as ROTH instead of pre-tax and the Plan sends him a 1099-R for the income?

What you are describing would likely need something on the order of an 8% of pay fully vested QNEC to the NHCEs to pass ACP assuming his after tax is $35K on $350+K salary where he's the only HCE and no NHCE makes after tax contributions.

Why couldn't he contribute as normal pre-tax, then immediately do an in-plan Roth rollover? Maybe easier than messing with the employer contribution as Roth?

15 hours ago, mjbais1489 said:

I know this board is probably tired of After tax/mega backdoor roth questions....but here I go.

I'm an advisor who only does 401k/403b/Cash Balance plan advising.  We pride ourselves on our ERISA knowledge and everyone on my team has the QKA at least, but a client has come to us with questions that I wasnt sure of.  The TPA was on the call and they are researching but I thought Id ask this group as well.

The client is a young business owner (~10 employees)who loves after-tax/MBDR strategies. We have shown him numerous profit sharing plan designs, discussed the issues with after tax contributions for a company his size, etc.  His question as we reviewed profit sharing is what if instead of profit sharing he does $35k in after tax contributions to get to $70k.  Then can he simply do the $80k in profit sharing were showing due to employees as employer after-tax contributions?  Everything I read says after tax is subject to ACP, and the only remedy for after-tax is the owner removing their contributions, but could he instead of that just do very large after tax contributions to his employees like a QMAC remedy?

There are a ton questions I have that come out from this - who pays the tax, would this money have to be considered fully vested, etc. 

Why bother with after-tax and MBDR when you could just do Roth Match or Roth Non-Electives?  When you do conversions, you have a separate 5 year clock for each conversion, only one 5 year clock with Roth Match or Roth Non-Electives, its just an easier solution.  We use this for clients already and its not rocket surgery.  PM me if you want to discuss @mjbais1489

Edit: vesting of employer Roth contributions (must be 100%) has not been an issue for our clients who have implemented this.  They either don't have significant forfeitures, or the benefits outweigh the "cost" of 100% vesting.  

15 hours ago, Lou S. said:

Yes it needs to pass ACP on after tax that's why it doesn't typically work in the situation you are describing. The QNEC to the employees would be fully vested and be pre-tax employer contributions to the NHCE employees unless the plan has a ROTH employer contribution feature and the employees elect to be taxed on it and receive as ROTH.

But if he's looking for ROTH contribution, why not just tell him about the option make the employer contribution as ROTH under Secure 2.0 and go with the original design and have him elect to take his employer portion as ROTH instead of pre-tax and the Plan sends him a 1099-R for the income?

What you are describing would likely need something on the order of an 8% of pay fully vested QNEC to the NHCEs to pass ACP assuming his after tax is $35K on $350+K salary where he's the only HCE and no NHCE makes after tax contributions.

 

Okay thanks!

We've discussed Roth employer contributions.  My question becomes he cannot have a vesting schedule on the Profit Sharing then correct?  Hes only been in the business for 2/3 years.  If he wants to do his "profit Sharing" as Roth he would need to make the vesting schedule something where he is immediately vested in those dollars which means all his employees would be as well?  Thats the downside but as @RatherBeGolfing describes maybe that's less of an impediment for some clients than I assume it is.

2 hours ago, mjbais1489 said:

If he wants to do his "profit Sharing" as Roth he would need to make the vesting schedule something where he is immediately vested in those dollars which means all his employees would be as well?

You need to be 100% vested to elect Roth employer contributions. Partially vested participants cant elect Roth employer contributions.  In some circumstances, this means you may have to amend the vesting schedule if your 'target" (like an owner) isnt 100% vested. Other times, your target may be 100% vested but newer employees are not.  Other times, you may want to make the source 100% to allow all participants to benefit from the Roth election.  It all depends on what you feel is best for the company, the plan, and the participants.  Its not going to be one size fits all.

Something wrong with a top hat plan? 

With respect to Roth company contributions, that is something that makes no sense to me. If a company decides to make Roth employer contributions available, I don't believe IRS guidance allows plan sponsors to mandate that action - employees must have the opportunity for no less than an annual election to Rothify employer contributions. 

However, could an employer incorporate the in-plan Roth conversion features, while offering an unmatched pre-tax 401k and Roth 401k contribution up to an inside limit less than that allowed under 402(g), say a $1 default to Roth, to get the Roth 5 year clock running, with unmatched catch-up pre-tax and Roth contributions to the 414(v) maximum, while allowing 401(a) after tax contributions up to the IRC 415(c) limit with a stretch match contribution on say the first 8% or 10% of pay?

The plan could clearly explain the advantages of in-plan Roth conversion provisions. 

I am not a small plan expert, so, I am probably missing something. What is that?  

I would also link a Deemed Traditional IRA to the plan, limiting investments to the Core investments offered in the qualified plan (and requiring the same investment allocation for all assets, regardless of the source bucket) where the only option for Roth would be to "direct transfer" from the Deemed Traditional IRA to the plan, and then convert to Roth. That's another $7,000, plus $1,000 in catch-up if age eligible.