Voluntary After-Tax Money in Employer Solo 401k Plans
The ability for a plan participant to make voluntary after tax contributions is largely up to the solo 401k plan provider. Although a solo 401k plan can allow for voluntary after-tax contributions, the solo 401k plan provider is not required to provide a retirement plan document that allows for it. Indeed many plans don’t offer this option. A solo 401k plan from My Solo 401k Financial allows for all three solo 401k contribution types including voluntary after-tax contributions.
Mega Back Door Roth Solo 401k (a.k.a. After-Tax Solo 401k)
While not all solo 401k plans allow for after-tax contributions, My Solo 401k Financial offers a solo 401k plan document that allows for aft-tax contributions.
One benefit of after-tax contributions is that the salary deferral limits that apply to other participant contributions do not necessarily apply to after-tax contributions. For 2022, the combined salary deferral limit for pre-tax and Roth salary deferrals to Solo 401(k) plans is $20,500. For 2023, the combined limit increased by $2,000 to $22,500.
It Is All About The Overall 415 Limit
- However, there is a lesser known rule called the “overall 415 limit.” The overall 415 limit for 401(k) plans including solo 401k plans for 2022 is $61,000, or 100% of compensation, whichever is less.
- For 2023, the overall limit increased by five thousand dollars to $66,000.
- The overall limit looks at the total annual additions to all of a participant’s accounts in plans maintained by one employer, and includes not just their salary deferrals (employee contributions), but also employer profit sharing contributions.
Important Compliance Note: Catchup employee contributions cannot be applied as voluntary after-tax contributions. Instead, they can be applied as Roth solo 401k contributions for those aged 50 in older. This is an IRS rule not a solo 401k plan provider rule.
If a solo 401k provider’s plan document allows for after-tax contributions, then from a tax code perspective the self-employed individuals can make voluntary after-tax solo 401k contributions up to their overall limit for the year as described above.
Liz works for an employer that sponsors a full-time employer 401(k) plan that allows her to make after-tax contributions. For 2022, she plans on making the full $20,500 deferral to her Roth 401(k) and expects to receive between matching and profit-sharing contributions another $10,000 in employer contributions. That would give Liz a total of $30,500 of additions to her plan for 2022. As such, assuming Liz has enough compensation, she can contribute an additional $30,500 in after tax funds to her day-time job 401k plan ($61,000 overall limit – $30,500 of other deductions) for 2022.
Let’s assume the same as example 1 above except that Liz is also self-employed on the side and thus opens a solo 401k plan that allows for after-tax contributions. Therefore, Liz is participating in two separate plans (the full-time employer 401k and her own solo 401k plan sponsored by her self-employed business). Therefore, using the same numbers as example 1 above, Liz can make the $30,500 after-tax contribution to her Solo 401k plan provided, of course, she has enough earned income from her self-employed business to make the after-tax contribution. On the other hand, if Liz generates enough earned self-employment income through her self-employed business, she can contribute the full after-tax contribution amount of $61,000 to her solo 401k for 2022 instead of the $30,500 amount.
How can I get more money into my Solo 401k from my full-time employer 401k, 403b or 457b?
In addition to having different rules than pre-tax and Roth salary deferrals on their way in to a plan, after tax contributions also have different rules for how they may come out the plan. The plan distribution rules are complicated but, for the most part, if a 401k, 403b or 457b participant is still working for the company sponsoring their plan and they are under 59 ½, access to their pre-tax salary deferrals, Roth salary deferrals and their earnings is largely limited. However, once a participant leaves their job or turns 59 ½, that changes.
Great News, However
The same restrictions, however, do not apply to after tax contributions and their earnings, provided that they are maintained by a plan in a separate account. These funds may be fairly accessible, depending on a plan’s rules, even if a client is under 59 ½ and still working for the company offering their 401k, 403b or 457b. If their plan allows, they may be able to take a distribution of these funds at any time via “in-service distributions.” Being able to take-out the after-tax distributions from the plan opens the door to the following strategy.
The “Mega Back Door Roth Solo 401k”
The ability for a full-time employer plan participant to take a distribution of their after-tax contributions, including earnings, even before they reach age 59 1/2, opens the door to a strategy dubbed by some as the “mega back-door Roth Solo 401k.” In order for a client to take advantage of the mega-back-door Solo 401k Roth strategy, the following conditions must be present:
- The business owner’s solo 401k plan must allow them to make after-tax contributions.
- The business owner must have enough earned income from self-employment to make the after-tax contributions to their solo 401kplan.
- The Solo 401k plan must allow for in-plan Roth Solo 401k conversions.
Thanks to ATRA (the American Taxpayer Relief Act of 2012), which liberalized the conditions for executing in-plan Roth Solo 401k conversions, solo 401k participants can process in-plan conversions of all solo 401k funds. Before ATRA, in-plan Roth Solo 401k conversion were available to solo 401k participants only when a participant had satisfied a statutory or regulatory distribution trigger and as permitted by the solo 401k plan. For example, solo 401k plan deferrals generally are unavailable for distribution before a participant reaches age 59½. As a result, only at age 59½ or later could an in-plan Roth Solo 401k conversion of elective deferrals take place. ATRA changes this and permits an in-plan Roth Solo 401k conversion without the requirement that a participant have a statutory or regulatory distribution trigger if the plan language permits. So now, a solo 401k plan could permit participants under age 59½ to conduct an in-plan Roth Solo 401k conversion of deferrals.
As a result, a solo 401k participant can make after-tax contributions to their solo 401k plan on an ongoing basis. Subsequently, from a tax planning perspective, before there are large gains on those amounts, they can process an in-plan Roth solo 401k conversion of those funds and deposit the funds in the Solo 401k Roth designated account. Therefore, the converted funds will be all or mostly after-tax money, and the conversion will be virtually tax-free.
Mega Backdoor Roth Solo 401k Guides- Deep Dive
- Slides: Partnerships, LLC taxed as Partnership, Form 1065 Schedule K-1
- Video: https://youtu.be/of2J5e81pyM
- Slides: S-corporations, C-Corporations and LLC taxed as S-corporation
- Video: https://youtu.be/pRjTkZD5n8k
- Slides: Sole Proprietors, LLC taxed as Sole Proprietorship, Independent Contractors
- Video: https://youtu.be/qACxKuy8tGc
Difference Between Roth Solo 401k and Voluntary After-Tax Contributions QUESTION:
We actually have a good blog post that covers this topic which can be viewed by VISITING HERE.
Total Contribution Limit QUESTION:
In short, no because that would exceed the overall limit. The overall contribution limit to a solo 401k for 2022 is $61,000 per year or $67,500 for those 50 or older in 2022. Therefore, if you contribute $61,000 as voluntary after-tax contribution, you would only have the $6,500 catch-up limit left which can be contributed to the Roth solo 401k since the rules do not allow for treating the catch-up as a voluntary after-tax solo 401k contribution.
60-Day Rollover Distribution of After-Tax Funds QUESTION:
Reporting Gains on Voluntary After-Tax Funds Conversion QUESTION:
Income that can be Used QUESTION:
Good question. Just like pretax contributions can only be made based on net self-employment income, the same rules apply to after tax contributions–that is, after-tax contributions are also based on net self-employment income from the business that sponsors the solo 401k plan. In other words, the solo 401k rules do not allow for contributions based on your personal funds or wages from a full-time employer, for example.
Age 50 and Over Catch Up Contribution QUESTION:
The short answers is no. The IRS and 401k rules including the solo 401k rules, do not permit the treatment of catch up contributions to be applied as voluntary after-tax contributions. This is true for the current catchup rules for those age 50 or older as well as for the expanded catch up rules found in SECURE 2.0 Act which goes into effect starting in 2025 where those age 60, 61, 62 and 63 can make higher $10,000 (indexed for inflation) catch up contributions to their solo 40k.
The maximum amount of voluntary after-tax contributions that you can make to a solo 401k plan for 2023 is $66,000 even if you are 50 or older (assuming that you have the self-employment income to justify such contributions).
Assuming that (i) you are 50 or older, (ii) you have not already made employee contributions to another 401k plan (such as through a day job) and (iii) that you have sufficient self-employment income, you can make an additional $7,500 catch up contribution for 2022. This would be made as either a pre-tax or Roth employee contribution (not as a voluntary after-tax contribution) and would also not be counted in determining the amount of voluntary after-tax contributions that you can make.
Tax Topic 413 QUESTION:
Good question regarding ax topic 413 (https://www.irs.gov/taxtopics/tc413). That section deals with taxable distributions. In other words, when after-tax funds are converted to the Rot IRA, it is processed as a direct-rollover not as a distribution (i.e., the check is not made payable in the name of the individual, so the typical distribution code of 1 or 7 is not used on Form 1099-R; rather a code “G” is used in box 7.). The direct-rollover check is instead made payable in the name of the IRA custodian and the funds are directly deposited into the Roth IRA.
Impact of Voluntary After-Tax Solo 401k Contributions by Day Job Contributions QUESTION:
- The voluntary after-tax contribution limit is 100% of your self-employment compensation not to exceed the overall limit (IRC Section 415(c)) which is $61,000 for 2022 REDUCED BY any salary deferrals or profit sharing contributions made to the Solo 401k. For 2023, the overall solo 401k contribution limit increased to $66,000.
- The 415c limit is applied on a per employer basis (assuming that the employers are not related).
- This means that the fact that you made employee contributions (salary deferrals) to a 401k plan sponsored by an unrelated employer (via a day job) you can still make for 2022 voluntary after-tax contributions up $61,000 to the Solo 401k (assuming that you have the self-employment income to justify such contributions). This solo 401k contribution limit is $66,000 for 2023.
Convert After-Tax Funds to Roth Solo 401k Instead of Roth IRA QUESTION:
Yes you can also choose to convert the after-tax voluntary contributions to the ROTH Solo 401k (Roth Designate Account) instead of converting them to a Roth IRA. Per the following IRS website: https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts#irr you can convert the following types of funds to a Roth 401k:
- elective deferrals,
- matching contributions (including qualified matching contributions),
- nonelective contributions (including qualified nonelective contributions),
- rollover contributions,
- after-tax employee contributions and
- earnings on the above contributions.
1099-R Nontaxable QUESTION:
Correct as long as the basis is converted right away. If earning accumulate while in the after tax account, those will be subject to taxes.
The 10% Early Distribution Pentaly QUESTION:
The 10% early distribution applies to solo 401k distributions where the participant is under age 59 1/2 at time of the distribution. The conversion of voluntary after-tax contributions to a Roth IRA or a Roth Solo 401k is not subject to the 10% early distribution penalty because the movement of the funds from the solo 401k to the Roth IRA or the Roth Solo 401k is considered a conversion not a distribution.
Reporting to IRS QUESTION:
Please CLICK HERE to learn how after-tax solo 401k contributions are reported.
Still Time to Contribute QUESTION:
You can still make the full after-tax contribution because you have until the annual solo 401k contribution deadline of March 15, 2023 or September 15, 2023 if your file a timely business tax return extension to make all contributions types (i.e., employee, and profit sharing).
It is best to convert the after-tax funds to the Roth IRA or Roth Solo 401k as soon as a contribution is made; otherwise, the gains on the after-tax account could be subject to taxes when converted.
Transfer Current Employer 401k Voluntary After-Tax Funds QUESTION:
Yes we can assist in filling out the necessary transfer forms to transfer the voluntary after-tax contributions held in your current day job employer 401k if they will allow you to transfer those funds to another plan (your solo 401k plan). You will want to first check with your current employer before proceeding.
Which Sub Account QUESTION:
Pro-rata Rule QUESTION:
If the after-tax contributions are separately accounted for, the pro-rata rule only applies to the solo 401k after-tax sub-account (and if there are no gains on the after-tax contributions the pro-rata rule effectively does not apply).
- 72(d)(2) allows for separate accounting
- Per IRS Notice 2014-54 the pro-rata rule applies at the account level
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