Why it can be a good idea to add an after-tax contribution option to a 401(k) or a 403(b) plan

Tip of the day

By Stephanie Reagan

sreagan@sunlin.biz

Do the following statements pertain to your 401(k) or 403(b) plan?

  • Your plan does not have a problem passing the ACP discrimination test.

  • You have  plan participants who usually reach the maximum 402(g) limits ($18,000 for under age 50 and $24,000 for age 50 and older in 2015) on their Pre-tax or Roth-elective deferral contributions, and who would like to contribute more to the plan if they could.

If the answer to the above points is yes, then you may want to consider adding an After-Tax Contribution option to the plan.

Information on After-Tax Employee Contributions

Including After-Tax Contributions in your plan allows an employee participant to contribute more to the Plan during the calendar year.

Important points about After-Tax Employee Contributions:

  • The earnings in an After-Tax Contribution plan account are deferred until the earnings are distributed from the Plan.

  • After-Tax Contributions are subject to federal income taxes (and payroll taxes) in the year of deferral.

  • After-Tax Contributions are subject to ACP testing (note that the ACP test safe harbor does not apply to After-Tax Employee Contributions and does not qualify for the exemption from the Top-Heavy rules).

  • Employee Contributions are not subject to the 25% deduction limit or the penalty for nondeductible contributions.

  • A participant is able to receive a distribution from all or a portion of the After-Tax Contribution plan account at any time.

  • After-Tax Contribution plan accounts are protected from creditor claims.

  • The most important point is that the total After-Tax Contributions to a participant's account under a plan for any plan year are not limited by the 402(g) limits but are limited to the overall Code Section 415 annual dollar limit ($53,000 for 2015).

Examples to illustrate the maximum annual After-Tax Contributions that can be contributed to a plan:

Facts: An employee participant is age 51 and earns $150,000 in 2015. The employee contributes $24,000 in pre-tax (and/or Roth) deferral contributions in 2015. The plan has a 3% of pay match maximum and a 4% of pay profit-sharing contribution. The plan does not have a problem passing the ACP test.

Thus, the pre-tax (and/or Roth) deferral contributions (which include Catch-Up contributions) are $24,000, the Employer Match is $4,500 ($150,000 x 3%), the Employer profit-sharing contributions are $6,000 ($150,000 x 4%). The total contributions before After-Tax Contributions are $34,500. The total 2015 contributions allowed are $59,000 ($53,000 + $6,000). Therefore, the maximum additional After-Tax Employee Contributions available are $24,500 ($59,000-$34,500).

Same facts as above except the employee's age is 49 in 2015, and therefore the employee is only allowed to contribute $18,000 in pre-tax (and/or Roth) deferral contributions.

Thus, the pre-tax (and/or Roth) deferral contributions are $18,000, the Employer Match is $4,500 ($150,000 x 3%), and the Employer profit-sharing contributions are $6,000 ($150,000 x 4%). Therefore, the total contributions before After-Tax Contributions are $28,500. The total 2015 contributions allowed are $53,000. Therefore, the maximum additional After-Tax Employee Contributions available are $24,500 ($53,000-$28,500).

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You can see the benefit of adding the availability of After-Tax Contributions to a plan. In both examples, the participant who has maxed out either with his or her pre-tax or Roth elective deferrals could add additional After-Tax Contributions of $24,500 to the plan for 2015.

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