…So a few days ago I came across a Forbes article detailing a fascinating new after-tax 401(k) rollover rule. You can read the Forbes article (by Ashlea Ebeling) here, and also IRS guidance on the new rule here… but in summary the new rule allows high-earning super savers to potentially contribute up to $53,000 per year in earnings to a Roth-IRA account by taking advantage of employer 401(k) plans that allow for employee after-tax 401(k) contributions (beyond the $18,000 pre-tax 401/roth 401k limit) and allow in-service distributions.
^The overwhelming majority of employer plans do not allow after-tax 401(k) contributions – as far as I can tell this is because allowing such contributions would make it harder for an employer to pass its non-discrimination test, which states that the average contributions of highly compensated employees – defined as those earning more than $120k in 2015 – cannot exceed the average contributions of employees making less than this amount by greater than 2%. Some employers have workforce demographics that make this less of a potential issue than others, however (such as those made up of only HCEs or that have safe harbor plans), making such a plan option viable.
…Ultimately, even a high earner that had access to such a plan option would be well served to max out their $18,000 pre-tax 401/Roth(k) contributions and $5,500 traditional/Roth IRA contributions before taking advantage of the new IRS rule; this is because the former options all enjoy intrinsic tax relief, while after-tax 401(k) contributions need to be rolled over into an IRA via an in-service distribution (or at retirement) before a contributor can enjoy the same benefits. With that said, I think this is a really cool perk that a Company with the right workforce makeup could make available to attract top talent since it protects earnings from the capital gains taxes they would be subject to if invested in a non-IRA account.
Thoughts? As always, please share in the comments section below.
P.S. Someone just told me that this is also known as a Mega Backdoor Roth IRA, and another great blog post on it can be found here.