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After-tax plan funds following IRS Notice 2014-54: basic rules

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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.


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.

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 of a plan. The plan distribution rules are extraordinarily complicate. But if a client is still working for the company sponsoring their plan and they are under 59½, access to their pre-tax salary deferrals, Roth salary deferrals and their earnings is limited. Once a client leaves their job or turns 59½ that may change.

The same restrictions, however, do not apply to after-tax contributions and their earnings, provided 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 59½ and still working for the company offering their 401(k).

If their plan allows, they may be able to take a distribution of these funds at any time via “in-service distributions.” This opens the door to additional planning strategies 

(Note: There are slightly different rules for pre-1987 after-tax contributions. The rules for accessing those funds, however, are usually more favorable than the post-1986 after-tax rules discussed here.)

The “mega back-door Roth”

The ability of a client to take a distribution of after-tax contributions, along with the earnings on those funds, gives rise to a strategy dubbed by some as the “mega back-door Roth.” For a client to take advantage of the mega back-door Roth strategy, three conditions must be present:

  1. The client’s plan must allow them to make after-tax contributions.

  2. The client must have enough disposable income to make after-tax contributions to their plan.

  3. The plan must allow for periodic in-service distributions of the client’s after-tax money and their earnings.

Here’s how the strategy works: Notice 2014-54 doesn’t change the requirement that distributions from a plan must still be made on a pro-rata basis. Rather the rule allows the pre-tax and after-tax funds that were distributed from a plan on a pro-rated basis to be separated once a distribution is made. That said, the pro-rata calculation for the distribution can only include funds a client is eligible to take a distribution of at the time.

Thus, a young (pre-age 59½) client can make after-tax contributions to a plan on an ongoing basis. Then, periodically (and preferably before there are significant gains on those amounts) the client can take a distribution of those funds and convert them to a Roth IRA.

Since the pre-tax and/or Roth salary deferrals they have, plus their earnings, would generally be inaccessible, the pro-rata calculation would typically only consider the client’s after-tax funds and their respective earnings.  Therefore, the converted funds will be all or mostly after-tax money; and the conversion will be virtually tax-free.

Because many conditions must apply to leverage opportunity, it’s not likely to impact a large percentage of your clients. However, if any of your clients are affected, chances are they will be high-income, high-net worth clients.

Those clients tend to appreciate advice on how they can minimize their tax liabilities. So they are likely to be big fans of this strategy. 


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