After tax contributions to 401k can help you maximize your retirement savings or 401k plan. However, you may want to pay close attention to the tax-friendly rules regarding after-tax money in your 401(k) plan or similar plan. You stand to benefit if you have made after-tax contributions, other than Roth contributions, to your retirement plan at work. If you’re looking for guidance on the IRS ruling, our Bay Area financial advisors as well as our Houston financial advisors are here to help.
A couple of years ago, a rule was introduced, titled IRS Notice 2014-54, which changed the game for rollovers from employer plans when the payout includes both pre-tax and after-tax dollars. The standard rule for contributing to a 401(k) plan is that contributions are made using pre-tax dollars and taxable as ordinary income when withdrawn. Some plans also allow non-deductible after-tax contributions to be made in excess of the pre-tax contributions made. For those who have maxed out on pre-tax contributions, but wish to increase their retirement savings, it has been appealing to make additional after-tax contributions; However, dealing with the IRS when you were ready to take distributions from these plans was akin to walking through a minefield of tax issues.
Generally, the answer was “no”. Whenever an employer plan is directly converted to a Roth IRA, after-tax contributions were applied on a pro rata basis to the distribution. Requesting that only the after-tax contributions be converted tax-free to a Roth IRA was not possible.
While you generally have no restriction on rolling over your prior employer plans to IRAs, the ability to do so with your current employer is based upon your age and the requirements of the plan.
Getting money into Roth accounts can be difficult. Income limits may prevent direct Roth IRA contributions; your employer may not provide a Roth plan (Roth 401(k) Roth 403(b)); and having a traditional IRA retirement account may prevent funding “backdoor” Roth conversions. Usually, the only solution left is to convert existing qualified plans or Traditional IRAs to Roth IRAs.
This new IRS ruling creates a new method for individuals to fund Roth accounts. Instead of making pre-tax contributions to their employer plan, an individual could intentionally elect to make only after-tax contributions, if allowed by their employer. These after-tax contributions will then be available upon separation from service or retirement allowing you to roll over to a Roth IRA retirement account without additional taxes or penalties.
In 2016, employee contributions to their 401(k), 403(b), or 457(b) were limited to $18,000 plus an additional $6,000 catch-up, if over age 50. Depending on the structure of the plan, employees may be able to make after-tax contributions in excess of these limits. Ultimately, the total of all employee contributions (pre-tax contribution, Roth contribution, and after-tax contribution) plus employer contributions (match, profit-sharing, etc.) cannot exceed $53,000 or $59,000 if over age 50.
While this IRS ruling is very welcomed news, you should still thoroughly review your specific tax issues with a qualified tax adviser and financial planner. This information is not intended to be a substitute for specific individualized tax advice.
Struggling with rolling over your 401(k)? Schedule a complementary consultation with one of our experienced financial planners to discuss your retirement financial future.