Tag Archive for: after-tax

Print Friendly Version Print Friendly Version

Is Congress Closing the Backdoor to Roth IRAs?

An advisor asked: “Is Congress Closing the Backdoor to Roth IRAs?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from California is representative of a common inquiry related to Roth conversions.

Highlights of the Discussion
Potentially, yes, as well as restricting other Roth conversion strategies. As part of the tentative measures to help fund the proposed $3.5 trillion budget reconciliation package (a.k.a., Build Back Better Act ), the House Ways and Means Committee has suggested, among other tactics, restricting “back-door Roth IRAs,” a popular tax-reduction strategy where individuals convert traditional IRA and/or retirement plan assets to Roth IRAs. If enacted as proposed, after-tax IRA and after-tax 401(k) plan conversions would be eliminated after 12/31/2021. For amounts other-than after-tax (i.e., pretax assets), traditional IRA and plan conversions for taxpayers who earn over the following taxable income thresholds would cease after 12/31/2031:

• Single taxpayers (or taxpayers married filing separately) with AGI over $400,000,
• Married taxpayers filing jointly with AGI over $450,000, and
• Heads of households with AGI over $425,000 (all indexed for inflation).

The buildup of Roth assets can be a source of tax-free income later if certain conditions are met. Ending Roth conversions using after-tax contributions in a defined contribution plan or IRA, and restricting Roth conversions of pre-tax plan or IRA assets would materially limit many taxpayers’ ability to accumulate Roth assets in a tax-free or tax-reduced manner.
You won’t find the phrase backdoor Roth IRA in the Internal Revenue Code or Treasury regulations. Nor is it a specific product, but the industry has known about the phenomena for years. A backdoor Roth IRA is merely a series of transactions or steps an individual can take to have a Roth IRA—regardless of income level. While initially poorly understood and lacking clear IRS guidance, so called “back-door Roth IRAs” have been legitimized over the years by the IRS.

The ability to make a 2021 Roth IRA contribution is phased out and eliminated for single tax filers with income between $125,000-$140,000; and for joint tax filers with income between $198,000-$208,000. Consequently, if a person earns too much, he or she cannot make a Roth IRA contribution directly (i.e., through the front door). But many can still take another route—by converting traditional IRA or qualified retirement plan assets, a transaction that has become known as the backdoor Roth IRA.

Congress repealed any income limitations for Roth IRA conversions in 2010. Consequently, regardless of income level, anyone could fund a Roth IRA through a conversion. For example, if a person exceeds the income limitation for contributions to a Roth IRA, he or she could contribute amounts (deductible or nondeductible) to a traditional IRA based on earned income and, shortly thereafter, convert the contribution from the traditional IRA to a Roth IRA. Similarly, a person with a 401(k)-plan account balance could convert eligible plan assets either in-plan to a designated Roth account (if one exists) or out-of-plan to a Roth IRA through a plan distribution. Assets that are taxable at the point of conversion would be included in the individual’s taxable income for the year. Going forward, earnings would accumulate tax-deferred and, potentially, would be tax-free upon distribution from the Roth IRA. Under the authority of IRS Notice 2014-54, a qualified plan participant can rollover pre-tax assets to a traditional IRA for a tax-free rollover and direct any after-tax assets to a Roth IRA for a tax-free Roth conversion.

Conclusion
Plan participants and IRA owners need to be aware that as part of the 2021 budget reconciliation process, the ability to convert assets to Roth assets may be sunsetting. If revenue-generating provisions of the Build Back Better Act are enacted as currently proposed, Roth conversions of after-tax IRA and after-tax 401(k) plan assets would be eliminated after 12/31/2021; and Roth conversions of pre-tax IRA and plan assets would cease after 12/31/2031.

Click here for an RLC webinar on the proposed changes.

© Copyright 2022 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

401(k) After-Tax Contributions May Be Testy–But Worth It

“What are the limitations, if any, on making after-tax contributions to a 401(k) plan?” Read more

© Copyright 2022 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

Retirement Savings Tax Credit

“What contributions are eligible for the retirement savings tax credit?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Oklahoma is representative of a common inquiry regarding available tax credits for retirement contributions.

Highlights of Discussion

IRA owners and retirement plan participants (including self-employed individuals) may qualify for a retirement savings contribution tax credit. Details of the credit appear in IRS Publication 590-A and here Saver’s Credit.

The credit

  • Equals an amount up to 50%, 20% or 10% of the taxpayer’s retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on adjusted gross income (as reported on Form 1040, 1040A or 1040NR);
  • Relates to contributions taxpayers make to their traditional and/or Roth IRAs, or elective deferrals to a 401(k) or similar workplace retirement plan; and
  • Is claimed by a taxpayer on Form 8880, Credit for Qualified Retirement Savings Contributions.

Contributors can claim the Saver’s Credit for personal contributions (including voluntary after-tax contributions) made to

  • A traditional or Roth IRA;
  • 401(k),
  • Savings Incentive Match Plan for Employees (SIMPLE) IRA,
  • Salary Reduction Simplified Employee Pension (SARSEP) IRA,
  • 403(b) or
  • Governmental 457(b) plan.

In general, the contribution tax credit is available to individuals who

1) Are age 18 or older;

2) Not a full-time student;

3) Not claimed as a dependent on another person’s return; and

4) Have income below a certain level.

2018 Saver’s Credit Income Levels

Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $38,000 AGI not more than $28,500 AGI not more than $19,000
20% of your contribution $38,001 – $41,000 $28,501 – $30,750 $19,001 – $20,500
10% of your contribution $41,001 – $63,000 $30,751 – $47,250 $20,501 – $31,500

*Single, married filing separately, or qualifying widow(er)

The IRS has a handy on-line “interview” that taxpayers may use to determine whether they are eligible for the credit.

Conclusion

Every deduction and tax credit counts these days. Many IRA owners and plan participants may be unaware of the retirement plan related tax credits for which they may qualify.

© Copyright 2022 Retirement Learning Center, all rights reserved
Print Friendly Version Print Friendly Version

After-Tax Contribution Limits in 401(k) Plans

“What are the considerations for a 401(k) plan participant who wants to “max out” his/her after-tax contributions in the plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Ohio is representative of a common inquiry related to after-tax contributions in 401(k) plans.

Highlights of Discussion

  • There are several considerations for making after-tax contributions to a 401(k) plan, including whether the plan allows for after-tax contributions and, if so, what limits apply.
  • In order for a participant to make after-tax contributions to his or her 401(k) plan, the plan document must specifically allow for this type of contribution. For example, using our “Plan Snapshot” library of employer plan documents, RLC was able to confirm that the 401(k) plan in question does permit after-tax contributions.
  • Additional considerations when making after-tax contributions include any plan specified contribution limits; the actual contribution percentage (ACP) test; and the IRC Sec. 415 annual additions test.
  • Despite having a plan imposed contribution limit of 50 percent of annual compensation according to the plan document, the advisor determined his client could maximize his pre-tax contributions and still make a large after-tax contribution as well.
  • After-tax contributions are subject to the ACP test—a special 401(k) test that compares the rate of matching and after-tax contributions made by those in upper management (i.e., highly compensated employees) to the rate made by rank-and-file employees (i.e., nonhighly compensated employees) to ensure the contributions are considered nondiscriminatory. Even safe harbor 401(k) plans are required to apply the ACP test to the after-tax contributions if any are made. If the plan fails the ACP test, a typical corrective method is a refund of after-tax contributions to upper management employees.
  • In addition, each plan participant has an annual total plan contribution limit of 100 percent of compensation up to $54,000 for 2017 and $55,000 for 2018, plus an additional $6,000 for catch-up contributions, under IRC Sec. 415 (a.k.a., the annual additions limit). All contributions for a participant to a 401(k) (e.g., salary deferrals, profit sharing, matching, designated Roth and after-tax) are included in a participant’s annual additions. If a participant exceeds his annual additions limit, a typical corrective method is a refund of contributions.
  • In general, a 401(k) plan participant can convert his after-tax account balance to a Roth IRA while working as long as 1) the plan allows for in-service distributions; 2) the after-tax contributions and their earnings have been segregated from the other contribution types in a separate account; and 3) the participant follows the standard conversion rules (IRS Notices 87-13, 2008-30 and 2014-54).

Conclusion

Roughly one-third of 401(k) plans today offer participants the ability to make after-tax contributions.[1]  While this may be viewed as a benefit from many perspectives, there are several important considerations of which plan participants must be aware.

[1] Plan Sponsor Council of America, 59th Annual Survey; and Retirement Learning Center Plan Document Database, 2018

© Copyright 2022 Retirement Learning Center, all rights reserved