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Mega Backdoor Roth Conversion - 401K Plans

Mega Backdoor Roth Conversion - 401K Plans

July 14, 2023

The mega backdoor Roth contribution incorporates your 401(k) and allows for potentially larger contributions than a nondeductible IRA to Roth conversion. How the strategy works: Once you make after-tax (not Roth) contributions to your
401(k) in addition to the maximum pre-tax contribution, the after-tax contribution is then withdrawn from the 401(k) and
moved into a Roth IRA. Note: Any growth on the after-tax contribution that occurred while in the 401(k) will be taxable
when transferred to the Roth. If the contribution and withdrawal are done within a short period of time, the tax should be
minimal. However, there are several impacts to your company’s retirement plan when adding after-tax contributions to a
401(k) plan. Some things to consider.

Average Contribution Testing

An average contribution (ACP) test compares the average rate of match and after-tax contributions of the highly
compensated employees (HCEs) versus non-highly compensated employees (NHCEs). When a plan includes after-tax
contributions, those contributions are then included in a plan’s ACP testing. This can be problematic for a few reasons:
▪ A safe harbor plan not previously subject to the ACP test would now need to test. There are often fees associated
with this type of testing.
▪ If primarily HCEs are contributing after-tax contributions, this test would fail, resulting in the after-tax contributions
being returned to the individual and not eligible for roll over. Also, if the dollars had already been rolled to a Roth
IRA, additional fees and penalties can be imposed on this distribution.

Top Heavy Contributions

The presence of after-tax contributions in a plan that is top heavy and only provides for a safe harbor contribution would
require the plan to be subject to the top-heavy minimum contribution. This may create unconsidered additional funding
for you as the employer. Here are a few examples:
▪ A plan that contributes a safe harbor match and then also adds after-tax contributions would now need to fund a
3% top heavy contribution to individuals who are eligible for the plan but are not deferring. Additional funding for
anyone receiving less than 3% of their full plan year compensation in match would also be required to ensure their
total employer contribution is 3% of their compensation for the plan year.
▪ A plan that contributes a 3% safe harbor nonelective contribution is permitted to base this on compensation from
the date your employee becomes eligible for the plan. Due to the after-tax contributions this contribution would now
need to be contributed for the entire plan year.
There are many complexities in determining which plans may be advantageous to utilize after-tax contributions. A solo
401(k) plan would be an appropriate option since these tests would not apply. For other plans, please consult with an
Avantax Retirement Plan Services expert for an analysis of your company plan demographics, discussion regarding your
desire to make additional contributions to the plan, and communication around employees understanding their dollars
may be returned to them after the annual testing.