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.
Recent Comments
Does the roth requirement for catch-up contributions for people who earned $145,000 apply to 457...
Hi Ed,
I really liked this article and I think you make a lot of sense. And I had no...
I believe there's a misstatement in that last quote - it should refer to governmental and...
Working with several medical providers as clients, I note that the high-end earners tend to push...
Congratulations to NTSAA for landing a good one. Nathan's breadth of experience and...