Understanding Nondeductible Contributions to Qualified Retirement Plans
By Anna Noble, QKA, QPA, TGPC, CIP
Can nondeductible employee contributions be made to a qualified plan?
Yes, nondeductible employee contributions, otherwise known as after-tax contributions, are available in qualified plans like 401(k), 403(b), or money purchase pension plans. These can be set up as mandatory or voluntary contributions. Similar to Roth deferrals, these nondeductible contributions are withheld from the participant’s paycheck and contributed to the plan after payroll taxes are submitted. But unlike Roth deferrals, any increase in asset value is always subject to tax at the time of withdrawal.
What limits or compliance tests apply to nondeductible contributions?
Nondeductible contributions are subject to the annual additions limit under Internal Revenue Code Section 415. This limit includes the total amount of all employer contributions, elective deferrals, allocated forfeitures, and nondeductible employee contributions.
Nondeductible contributions are also subject to the actual contribution percentage (ACP) nondiscrimination test. This test compares all employer matching contributions and nondeductible contributions made by highly compensated employees to the same contributions made by non-highly compensated employees, and in some cases, limitations will apply
Is the back-door Roth strategy available in qualified plans?
The back-door Roth strategy allows individuals to increase their qualified plan Roth assets by making nondeductible contributions and then rolling over (i.e., converting) the assets to a designated Roth account within the plan. This strategy, however, requires a specific plan design. First, the qualified plan must allow participants to make Roth deferrals and nondeductible contributions. Second, the plan must allow participants to complete an in-plan Roth rollover of their nondeductible contributions.
Does the back-door Roth strategy work?
The back-door strategy generally works well in certain circumstances. The biggest issue that plan administrators run into is with compliance testing. This strategy is generally more appealing to highly compensated employees. If the non-highly compensated employees choose not to make any nondeductible contributions, the plan will fail the ACP nondiscrimination test. Therefore, this strategy may make sense for a plan that does not have any non-highly compensated employees, like an Individual(k) plan or solo 401(k) plan.
