You may have read reports that the use of after-tax contributions can allow participants to contribute substantially more than the 402(g) limit of $18,000. And that such contributions can be immediately rolled over to a Roth IRA or possibly to a Roth 403(b). Is this true? The answer, as is often the case, is “maybe.” Here are the basics:
“After-tax contributions” are not Roth contributions. Unlike Roth contributions, earnings that accumulate in the after-tax account are taxable upon distribution. Such contributions are not new; before the growth of 401(k) plans, after-tax contributions were the most common type of employee contributions.
After-tax contributions are not subject to the 402(g) limit. Instead, they are subject to Section 415(c), which this year is $53,000. Therefore, a 45 year-old participant in a 403(b) plan to which there are no employer contributions could contribute $18,000 of pre-tax or Roth contributions and an additional $35,000 of after-tax contributions.
After-tax contributions are subject to the nondiscrimination test known as the ACP test. While this is an issue in an ERISA plan with non-highly compensated employees, governmental and church-sponsored 403(b)s are exempt from the ACP test.
The law allows distributions of after-tax accounts, without the occurrence of a distributable event, if the plan document permits.
IRS Notice 2014-54 clarified that a distribution consisting of both after-tax and pre-tax dollars can be allocated by the participant to different destinations. Thus, a distribution of an after-tax account could have the after-tax dollars rolled over to a Roth IRA and any taxable earnings rolled over to a traditional IRA. The issue of earnings is minimized or eliminated if the participant is in a position to make a direct rollover each time he or she makes an after-tax contribution. The ideal situation would provide the ability to contribute the full after-tax amount early in the calendar year and immediately roll over the account to a Roth IRA (or make an in-plan Roth conversion.) This probably isn’t practical for most employees.
If conditions are right, the 45 year-old participant mentioned above, whose adjusted gross income may prevent her from making a Roth IRA contribution, could instead contribute $35,000 into an after-tax 403(b) account and immediately roll it to a Roth IRA. Quite a difference from the $5,500 Roth IRA limit!
What are the hurdles and issues to consider?
First, your employer’s plan document will probably need to be amended to permit after-tax contributions. Most plans do not currently permit such contributions, and the benefit department may think that allowing Roth contributions is the same thing.
Second, an amendment permitting in-service distributions of after-tax accounts is needed. Allowing such distributions at any time, rather than restricting the number or timing of distributions, is ideal.
Lastly, remember to maximize pre-tax or Roth contributions first.
While making large after-tax contributions will not appeal to everyone, for those in the right situation the advantages can be substantial!David R. Blask, CPC, TGPC, AIF®, is Senior Pension Consultant at Lincoln Investment Planning
Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA, or its members.