In the following post, we explain how voluntary after-tax contributions made to a Solo 401k plan does not limit the ability to fully fund a defined benefit plan.
Question from Carolyn from Scottsdale, Arizona
My income is W-2 from my own PLLC, about $230k. My CPA calculated my solo 401k contributions up to (i) $18500 as an employee contribution and (ii) $13800 as a profit sharing contribution of 6% since I also have a defined benefit plan. My Defined Benefit Plan contribution for 2018 will be approximately $200k.
Does my solo401k plan allow for a Mega Back Door Roth contributions? Is there any way for me to put more money away for 2018?
Good question. Let’s first review the regulatory history and then address your specific question.
The Pension Protection Act (PPA) of 2006 amended the contribution limitations which made the practice of employers adopting both a Defined Contribution Plan and a Defined Benefit Plan (DBP) more favorable (see IRS Notice Certain Deduction Limits under the Pension Protection Act of 2006). This type of structure is sometimes referred to as a Combined Hybrid 401k and Defined Benefit Plan or DB(k) Plan.
Previously, few businesses used a dual plan strategy because Section 404(a)(7) of the Internal Revenue Code limited the total contribution made to both plans to 25% of eligible compensation.
This means that under old rules there was no reason for a business to offer both plans when the business could obtain the same tax deduction with just one plan.
The PPA relaxed the limitations that apply when an employer sponsors and makes contributions to both a defined benefit plan and defined contribution plan.
Under the revised rules, employers can fully fund a DBP, make salary deferrals to a 401(k) plan and make profit sharing contributions up to 6% of compensation.
Under the new rules, if profit sharing contributions exceed 6% of compensation, there will be a corresponding decrease in the ability to fund the defined benefit plan.
You are now asking whether voluntary after-tax employee contributions made to a 401k plan could limit the ability to fully fund the DBP.
This confirms that making voluntary after-tax contributions to the solo 401k will not reduce the ability to make deductible contributions to the defined benefit plan. This is because (i) voluntary after-tax employee contributions are not counted toward the IRC 404(a)(7) deduction limit and (ii) only contributions that are tax-deductible to the employer count toward the IRC 404(a)(7) limit.
Please note that you would need to also confirm that the 401k plan allows for voluntary after-tax contributions and ensure that such voluntary after-tax contributions are deposited into a separate sub-account. Please also see the following post regarding Mega Back Door Roth contributions: CLICK HERE