Please help me clarify some rules for 401k after-tax contributions

[doctorette]

Two questions for those who are experienced with after tax contributions. I can't seem to find reliable answers anywhere:


1. What is the maximum contribution allowed for after-tax contributions to 401k, assuming you're not going to meet the $57k limit for 2020? There is an IRS publication that is tailored for 403b plans which says 100% of includable compensation is the max allowed: Publication 571 (01/2021), Tax-Sheltered Annuity Plans (403(b) Plans) | Internal Revenue Service. I can't find an IRS publication that spells it out for 401k plans though.


2. When you do the MBR from 401k to Roth 401k, assuming you have pre-tax funds in the 401k, does the pro-rata rule apply or no? My accountant said no, but I am not convinced. I know for Trad IRA to Roth conversion, pro-rata rule applies but I am not sure about 401k funds if you have both pre and after tax dollars in the account. This IRS publication talks about Trad 401k to Roth IRA rollovers, or otherwise distributions when the funds leave the plan, being subject to pro-rata, but cannot find a publication on funds that stay within the plan for a rollover: Rollovers of After-Tax Contributions in Retirement Plans | Internal Revenue Service

Thanks

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[Financial Advisor Justin]

Two questions for those who are experienced with after tax contributions. I can't seem to find reliable answers anywhere:


1. What is the maximum contribution allowed for after-tax contributions to 401k, assuming you're not going to meet the $57k limit for 2020? There is an IRS publication that is tailored for 403b plans which says 100% of includable compensation is the max allowed: Publication 571 (01/2021), Tax-Sheltered Annuity Plans (403(b) Plans) | Internal Revenue Service. I can't find an IRS publication that spells it out for 401k plans though.


2. When you do the MBR from 401k to Roth 401k, assuming you have pre-tax funds in the 401k, does the pro-rata rule apply or no? My accountant said no, but I am not convinced. I know for Trad IRA to Roth conversion, pro-rata rule applies but I am not sure about 401k funds if you have both pre and after tax dollars in the account. This IRS publication talks about Trad 401k to Roth IRA rollovers, or otherwise distributions when the funds leave the plan, being subject to pro-rata, but cannot find a publication on funds that stay within the plan for a rollover: Rollovers of After-Tax Contributions in Retirement Plans | Internal Revenue Service

Thanks

Hi Doctorette,

just an FYI 401k/403b/457 very high level just indicates for-profit, not-for-profit, government.

1. Standard 401k/403b/457 plans all have a contribution limit of $19,500 for 2021 If you are over 50 years old you can add $6,500 to that number. If your company plan offers it you may put that full amount into after-tax (ROTH) contributions, however the employer match will likely be a pretax (traditional) contribution. Tax Sheltered Annuity Plan that was referenced has a limit equal to the lesser of 25% of eligible compensation or $57,000.

2. This question seems complicated to answer via messaging but I will do my best! Feel free to send me a private message to dive deeper. Generally in a 401k/403b/457 pretax (traditional) and after tax (roth) funds are kept separate so the pro-rata rule wouldn't apply if your situation is the same. You should not have to do a back door for a 401k/403b/457 as income limits don't apply to company sponsored plans only to IRA (Individual Retirement Accounts). To keep things as simple as possible when you retire and roll money from a 401k to an IRA most advisors will move the money to the same type of tax advantaged account pretax (traditional) or post tax (roth)

401k (also know as traditional 401k) moves to Traditional IRA this is NOT a taxable event

Roth 401k moves to Roth IRA this is NOT a taxable event

Let me know if you have more questions!!!

 

[FlowRate]

From looking into MBR recently myself, this is my read. I am absolutely not a tax professional.

Doctorette probably has an employer-sponsored 401(k) plan with three options: Pre-Tax, Roth, and After-Tax contributions. The $19,500 contribution limit (plus catch up if >50) is specifically for the individual contributions to the combined Pre-Tax and Roth amounts. The total individual + employer contributions to the whole of the 401(k) account are $57,000, as you mention. So if Doctorette does not have any employer match, she can also contribute $57,000-19500 = $37500 to the after-tax portion and then convert that to Roth.

Our Vanguard institutional accounts make this really easy although I'm still working on verifying that it all works as it looks before I set this up for myself.

 

[Phantom Spike]

So if Doctorette does not have any employer match, she can also contribute $57,000-19500 = $37500 to the after-tax portion and then convert that to Roth.

But what if she does have an employer match, can she still contribute the $37,500?
In other words, if you have maxed out your employee contributions to a 401(k) ($19,500) and your employer has also contributed a certain amount as a match, how does the $57,000 max figure fit in? Based on my prior understanding, only the employer can get you from $19,500 to $57.000 with their contributions (which of course will never happen), but the above makes me wonder if I can contribute myself with after-tax dollars after maxing out pre-tax contributions and deducting whatever the employer put in. Can someone clarify?

 

[FlowRate]

But what if she does have an employer match, can she still contribute the $37,500?
In other words, if you have maxed out your employee contributions to a 401(k) ($19,500) and your employer has also contributed a certain amount as a match, how does the $57,000 max figure fit in? Based on my prior understanding, only the employer can get you from $19,500 to $57.000 with their contributions (which of course will never happen), but the above makes me wonder if I can contribute myself with after-tax dollars after maxing out pre-tax contributions and deducting whatever the employer put in. Can someone clarify?

My understanding is that it's $57000 - individual Roth/Pre-Tax - employer contribution. So say your employer matches up to $10000 then you can contribute $27000 after-tax to do a MBR.

I can only realistically do a MBR for a couple of years with my employer b/c after making partner they don't match but do put dividend into 401k up to some amount around $25k.

 

[Phantom Spike]

Okay, just spoke to a representative from my employer's 401(k) provider and they do not allow after-tax contributions once you've hit the limit of $19,500 plus whatever the employer matches. He seemed to suggest that most plans do not offer this option nowadays, not sure how accurate that is. Regardless, the after-tax contributions to a 401(k) to get to $57,000 is not available to everyone.

But what this means is if you're self-employed you can open a solo 401(K) and contribute $57,000 to your retirement, but if you're employed you can only contribute $19,500 unless your plan offers an after-tax option ? Doesn't seem fair.

 

[RangerBob]

Okay, just spoke to a representative from my employer's 401(k) provider and they do not allow after-tax contributions once you've hit the limit of $19,500 plus whatever the employer matches. He seemed to suggest that most plans do not offer this option nowadays, not sure how accurate that is. Regardless, the after-tax contributions to a 401(k) to get to $57,000 is not available to everyone.

But what this means is if you're self-employed you can open a solo 401(K) and contribute $57,000 to your retirement, but if you're employed you can only contribute $19,500 unless your plan offers an after-tax option ? Doesn't seem fair.

I agree, but it’s also not fair that no one will ever match my contributions and I have to pay $15-20k/yr for my family’s health insurance. There’s pros and cons being employed vs self-employed.

If you do get any 1099 income (locums, etc) I believe that lets you open your own solo 401k and you could then contribute up to the max (including your employers plan)

 

[OraclePL]

Okay, just spoke to a representative from my employer's 401(k) provider and they do not allow after-tax contributions once you've hit the limit of $19,500 plus whatever the employer matches. He seemed to suggest that most plans do not offer this option nowadays, not sure how accurate that is. Regardless, the after-tax contributions to a 401(k) to get to $57,000 is not available to everyone.

But what this means is if you're self-employed you can open a solo 401(K) and contribute $57,000 to your retirement, but if you're employed you can only contribute $19,500 unless your plan offers an after-tax option ? Doesn't seem fair.

This is correct, fair or not

My understanding is that it's $57000 - individual Roth/Pre-Tax - employer contribution. So say your employer matches up to $10000 then you can contribute $27000 after-tax to do a MBR.

Also correct.

Couple points:

1) Roth and after tax contributions are not the same thing, as someone above seemed to indicate. Roth contributions are subject to the 19.5k employee contribution limit. After tax contributions allow you to contribute 25% of income until you reach 57k. Few companies 401ks allow this nowadays. Employer contributions fall into the same pool as after tax contributions.

2) The pro rata rule only applies to IRAs. Not to 401ks.

3) If you’re doing the mega backdoor, make sure your plan allows in service withdrawals. Otherwise you can do the mega but not the backdoor.

Again, I wouldn’t necessarily expect these features in your 401k. They’re less and less common nowadays. But everyone should check, because it’s a powerful way to increase tax savings.

 

[southerndoc]

@OraclePL If I read your message correctly, all Roth contributions are made in the employer share and not from the employee share?

 

[mvenus929]

@OraclePL If I read your message correctly, all Roth contributions are made in the employer share and not from the employee share?

No, Roth contributions are part of the employee share (the $19,500). After-tax contributions are not the same as Roth contributions and are part of the 'employer' share (up to $56,000 or whatever the limit it).

Roth 401(k) vs. After-Tax 401(k) - Nixon Peabody blog | Nixon Peabody LLP

While a Roth 401(k) and after-tax 401(k) involve making contributions using after-tax dollars, the two differ in a few key ways.

www.nixonpeabody.com

 

[southerndoc]

What's the purpose of an after-tax 401(k) or are you trying to do a megabackdoor Roth?

 

[FlowRate]

What's the purpose of an after-tax 401(k) or are you trying to do a megabackdoor Roth?

This is a great question... is there some asset protection benefit to doing after-tax 401(k) contributions vs putting money in a regular brokerage account?

Also @OraclePL mentioned 25%. Is it not possible to do more than that per paycheck into 401(k)?

 

[doctorette]

Thanks for the replies everyone. I can't reply to everyone individually but I did read all responses.

1. Yes, after-tax contributions are not the same as Roth. There seems to be some confusion on this.

2. My original question was what is the max allowed for after-tax contributions. We know that employee pre-tax or roth max is $19,500. We know that max for profit sharing (employer contribution) is 25% of salary.

The after-tax max is NOT 25% of salary, which is what some people are under the impression of. Also, the after-tax contribution is from the EMPLOYEE, not the employer.

From what I found, it appears the max for after-tax is whatever your salary is minus whatever you put in for pretax. From the IRS publication on 403b:

Publication 571 (01/2024), Tax-Sheltered Annuity Plans (403(b) Plans) | Internal Revenue Service

www.irs.gov

Generally, includible compensation for your most recent year of service is the amount of taxable wages and benefits you received from the employer that maintained a 403(b) account for your benefit during your most recent year of service.

Meaning, if you made $30,000 in salary, contributed $19,500 to pre-tax, then you can put in $10,500 into after-tax. (assuming the total contribution for the plan doesn't go above $58,000 for 2021).

I can't find an IRS publication that confirms this, other than the 403b one I posted above, but it seems like this is the case.

Yes most plans do not allow after-tax contribution, but if you are a sole proprietor or scorp, you can design the plan to allow it.


3. Regarding MBR pro-rata rule. I see that @OraclePL says the pro-rata rule doesn't apply for 401ks when the funds go from Traditional 401k to Roth 401k (so the funds do not leave the plan). That is also the impression I am getting from extensive browsing, but again I can't find an IRS publication that confirms it. If anyone can, let me know.


Thanks again everyone for your input. Please correct me if/where I am wrong.

 

[FlowRate]

From what I found, it appears the max for after-tax is whatever your salary is minus whatever you put in for pretax. From the IRS publication on 403b:

For most physicians the max total in your 401(k)/403(b) yearly is $57,000. If you look at your own link it's the lesser of your includable compensation or $57,000. I don't know any docs making less than that even part time. (Maybe a 0.3 FTE academic pediatrician?)

 

[southerndoc]

The max total cannot be crossed (even with after tax dollars) as @FlowRate has pointed out.

Keep in mind that after you max out the employer contribution as an sole proprietor/independent contractor, the max employer contribution is 25% of earnings after deduction of self employment tax.

 

[doctorette]

The max total cannot be crossed (even with after tax dollars) as @FlowRate has pointed out.

Keep in mind that after you max out the employer contribution as an sole proprietor/independent contractor, the max employer contribution is 25% of earnings after deduction of self employment tax.

Yes, as I pointed out the max plan amount is $58,000, for 2021. (Not $57,000 as some have referenced)