After-tax 401k rollover question
Hello,
Client, 39, is sole owner and employee of his company (S. Corp.). He has a 401(k)/Profit Sharing Plan in place since the beginning of 2015 in which he gets $53k in total contributions [$18k elective salary deferrals + $35k employer profit sharing]. Since client is in a high marginal tax bracket and already has Roth IRAs in the 6-figures, he’s been deferring to the pre-tax/Traditional part of the 401(k) (w/ the employer profit sharing contributions also going to the pre-tax part). The Plan is maintained at a brokerage firm w/ a separate Acct.# for the Traditional piece and a separate Acct. # for the Roth piece (as he made a nominal contribution to the Roth last year).
Client also maintains an old Simple IRA of $100k plus that he was considering possibly converting, partially, over time into a Roth IRA. This may be considered more strongly to the extent marginal rates are reduced next year – at least for a few years (to hedge against the possibility of rates going up in the future).
Questions:
1. Is there any advantage to the client making after-tax contributions to the 401k Plan next year (of $35k let’s say – the employer match) and converting this to a Roth IRA (since the Plan permits in-service distributions) relative to partially converting $35k of the old Simple IRA into a Roth IRA? Does the “Mega Back-Door Roth” offer any advantage relative to converting a Simple (pre-tax) IRA into a Roth IRA?
2. If the client wanted to make $18k of after-tax contributions, is there any benefit to doing so versus designating the elective salary deferrals as Roth contributions?
3. If the client was going to make after-tax 401k contributions, since maintained at a brokerage firm would it be advantageous to set up a 3rd acct. for after-tax 401k contributions to make it easier to isolate the earnings for purposes of rolling over the contributions (to a Roth) and earnings (to a Traditional – unless the client wants to pick up the taxes now and convert the earnings to a Roth as well as presumably this may also be done)?
4. Do you have an update on the Retirement Improvement and Savings Enhancements (RISE) Act which, as per my understanding, among other things, it would prevent Roth IRA conversions from being made (to at least some degree as I’m not intimate w/ the specifics) and could go into effect as of Jan. 1, 2017?
Thanks!
Jason
Permalink Submitted by William Tuttle on Wed, 2016-11-16 17:58
I question the wisdom of substituting any post-tax retirement contributions/rollovers for pre-tax contributions at the client’s likely marginal tax rates. A $35K employer contribution requires at least $140K in salary and likely substantially more in distributions.
I think the best option would be to do a tax-free rollover of the SIMPLE IRA assets into the pre-tax 401k account. This is assuming it is two year qualified.This would enable doing a backdoor Roth IRA contribution each year. It makes far more sense to expand the client’s contribution space than make tax inefficient moves for the same space.
Permalink Submitted by Alan - IRA critic on Wed, 2016-11-16 18:55
Re Q 1 – I don’t think that the employer match can even go to the after tax sub account if the plan has one. These are so called “employee contributions” per Sec 72(d)(2) funded from the employee W-2 income for an S Corp employee. And notwithstanding the sub account funding source, I think that the employer match must go to the pre tax account of the employee so could not be made after tax in any case. Further, if both the pre tax match and the employee contributions were made in the same limited 35k space, the employee contributions would become excess annual additions to be corrected.
Permalink Submitted by Jason Hochstadt on Fri, 2016-11-18 20:56
Thanks for the above replies.In terms of the first response, why wouldn’t it be preferrable for the client to do a tax-free rollover of the Simple IRA into a Traditional IRA – and then do partial conversions if desired? Isn’t this more ideal than putting the monies in the 401(k) Plan (assume loans are not relevant)?Understood regarding the RISE Act – but I know lots of these damaging provisions have been in the Bluebook for the past 6 years that have never passed Congress and I was concerned the outgoing Administration would simply pass an Executive Order or somehow get a lot of this in place before 2017.With respect to the RESA Act, I see today it was added to the Senate’s legislative calendar – presumably this moves it a step closer to passing and would be effective immediately (e.g. 2017). From my quick review of a summary it appears that any accounts over $450k distributing to someone other than a (1) surviving spouse; (2) disabled or chronically ill individual; (3) individual who is not more than 10 years younger than the employee (or IRA owner) or (4) child of the employee who has not reached age of majority must take total distributions w/in 5 years from the employee or IRA owner’s death.With respect to the above, however, presumably #3 is meant to include a child so that any child who is over 18 or 21 would no longer be able to utilize the stretch. I assume this would be the case even if a Trust was named beneficiary for the benefit of the child since it would ‘look-thru’ and see the child is the beneficiary (provided the Trust meets the requirements of being a look-thru).Finally, in terms of Alan’s response, couldn’t the employee defer the $18k to the Roth + $35k to the after-tax account – with effectively no employer profit sharing match in the event the employee wanted to maximize the after-tax contributions to the Plan? If so, would there be any reaosn then for the employee to convert the after-tax contributions to a Roth IRA (with the earnings going to a Trad. IRA let’s say) as opposed to leaving it in the Plan? From a creditor’s perspective, the ERISA plan provides unlimited protection – would the conversion of the after-tax Plan monies to a Roth IRA be capped at rollovers (I believe somewhere over $1MM)? Thank you! Jason