On September 18, 2014, the IRS released Notice 2014-54 ("Guidance on Allocation of After-Tax Amounts to Rollovers"), which definitively authorizes clients to complete a direct rollover of their pre-tax plan funds to a traditional IRA while simultaneously allowing them to complete tax-free Roth IRA conversions of their after-tax plan funds.
Since the notice was released, advisors have been paying closer attention to after-tax plan funds, but many are still unclear about basic rules. Once those basic rules are understood, advisors can turn their attention to implementing more advanced planning strategies to take advantage of the new rules for eligible clients.
After-tax money in employer plans
A client's ability to make after-tax contributions to an employer-sponsored retirement plan is largely up to the plan. Although plans can allow for such contributions, nothing requires them to do so. Indeed, many plans don't offer this option.
One nice thing about after-tax contributions: The salary deferral limits that apply to other participant contributions do not necessarily apply to after-tax contributions.
In 2014, the combined salary deferral limit for pre-tax and Roth salary deferrals to 401(k) and similar plans was $17,500. If clients were 50 or older by the end of the year, then they could have contributed an additional $5,500, for a total of $23,000. If, however, they were eligible to make after-tax contributions to an employer plan, those contributions were not subject to these limits.
In addition to the $17,500/$23,000 limit on salary deferrals, there is a lesser known rule called the "overall limit." The overall limit for 401(k)s and similar plans for 2014 was $52,000 and considers the total annual additions to all of a client's accounts in plans maintained by one employer. Those annual contributions not only factor into clients' salary deferrals, but also matching contributions, allocations of forfeitures and other amounts.
If a client's plan allows them to make after-tax contributions, then (from a tax code perspective) they can make such contributions up to their overall limit for the year. Note, though, that after-tax contributions are subject to the ACP (actual contribution percentage) test which, in some cases, could further limit such contributions.
Example
Laura works for an employer sponsoring a 401(k) plan that allows her to make after-tax contributions. She plans on making a full $17,500 deferral to her Roth 401(k) and expects to receive, between matching and profit-sharing contributions, another $20,000 in employer contributions.
That would give Laura a total of $37,500 of additions to her plan for 2014. As such, assuming Laura has enough compensation to do so, she can contribute an additional $14,500 in after-tax funds to her plan ($52,000 overall limit – $37,500 of other additions) for 2014.
