Taking it Past the Limit
As a participant in a retirement plan, you have many ways to get money into your plan. Pre-tax deferrals, Roth contributions, match contributions, profit sharing contributions, rollover contributions (both pre and roth), and safe harbor contributions. All can be very beneficial towards reaching your retirement goals but as a participant, you only really control the deferrals you make.
Those seven "sources" of money into your plan are common. But what about the often written about and rarely used eighth money source? Yes after-tax contributions are yet another way to get money into your company plan. These are different from Roth contributions and have been around for a long time. Not all plans allow these contributions because they can trigger a number of testing issues for your plan. In the plethora of articles about after-tax contributions, this testing is given short shrift. The testing of these after-tax contributions is the reason why implementing them into a small plan sponsor plan is so difficult.
Participants in 401K and 403B plans have annual limits that go up as inflation goes up. The current 2021 limits are $19,500 and $6,500 as a catch-up if you are over 50. The annual cap for all sources of contributions (these don't include rollovers) is a much larger number however. That number is $58,000 or $64,500 for those over 50. For savvy employees who have a lot of spare money, they could have another $38,500 go into after-tax contributions. So far so good. Unfortunately these contributions face additional testing at the plan level. As you can guess, the participants who would take advantage of this feature frequently have a lot of disposable income and are commonly deemed to be highly compensated employees under the regulations.
This is where the size of the company matters. If I have a company of forty employees and if five of those employees are highly compensated, it is quite likely that the remaining 35 employees put in zero to the after-tax contributions. If one of the highly compensated employees chooses to maximize her after-tax contribution, this will likely create an issue with the plans ACP testing. Now if I have a company of 10,000 and 300 are highly compensated, suddenly the handful of folks who use the after-tax contribution is offset by the many that don't and that ACP number that failed when I had only five highly compensated employees comes down because I have hundreds more in my highly compensated group.
All of this is a way of saying the after-tax contribution can be great but the rules and regulations limit its utilization. For us and our clients, this is one instance where being small doesn't always work. It takes a very unique employee demographic to be able to utilize after-tax contributions and if you work with a skilled consultant, they can help you identify if your plan happens to be one of those unique few.