Author Topic: Why add mega Roth to a 401k plan failing discrimination testing?  (Read 999 times)

ender

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Why add mega Roth to a 401k plan failing discrimination testing?
« on: December 15, 2019, 06:22:05 PM »
My company is adding the ability to do megabackdoor Roth in next year's 401k. However, as I understand for several years it has also failed discrimination testing on the 401k.

I am struggling to understand how adding the ability to do after-tax contributions will ever practically result in benefits for employees given if you are an HCE you cannot even contribute the the max elective deferral when you are failing discrimination testing.

Is this only beneficial for non-HCEs who are maxing elective deferrals? Or is there a way this benefits the HCEs somehow?

It feels like the only people it would benefit are non-HCEs who are already maxing out retirement.

dcozad999

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #1 on: December 15, 2019, 11:42:58 PM »
Not sure I understand this 100%, but perhaps this is their way around the HCE issue and allow earnings to grow tax free?

https://smartasset.com/retirement/after-tax-401k-contributions

My plan allows after tax contributions and you donít even have to max the trad/Roth before you use it. I know because I accidentally contributed to it for two pay periods before I realized what happened. They were nice enough to let me do an in service Roth conversion. Iím not an HCE.

 But I donít  think being an HCE excludes them from doing after tax contributions.
« Last Edit: December 16, 2019, 12:01:19 AM by dcozad999 »

ender

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #2 on: December 16, 2019, 05:45:13 AM »
Not sure I understand this 100%, but perhaps this is their way around the HCE issue and allow earnings to grow tax free?

https://smartasset.com/retirement/after-tax-401k-contributions

My plan allows after tax contributions and you donít even have to max the trad/Roth before you use it. I know because I accidentally contributed to it for two pay periods before I realized what happened. They were nice enough to let me do an in service Roth conversion. Iím not an HCE.

 But I donít  think being an HCE excludes them from doing after tax contributions.

Right.

But if a plan fails discrimination testing it means contributions from HCEs are refunded until they hit a specific threshold.

So enabling HCEs (who are most likely the group to take advantage of after tax contributions anyways) to add more doesn't seem to make sense.

dcozad999

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #3 on: December 16, 2019, 06:58:18 AM »
So then they do refund the after tax contributions as well?  That's where I thought they may come out ahead with this.

ender

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #4 on: December 16, 2019, 07:29:55 AM »
So then they do refund the after tax contributions as well?  That's where I thought they may come out ahead with this.

My understanding is the total $ amount is what matters.

Which is why I posted this, it seems silly to offer that benefit if the plan is already failing discrimination testing.

terran

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #5 on: December 16, 2019, 07:39:29 AM »
Yeah, that seems strange. I'm pretty sure I've read a that after-tax contributions have to pass discrimination testing even in a safe harbor plan where other contributions don't have to pass testing.

ender

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #6 on: December 16, 2019, 07:42:29 AM »
Yeah, that seems strange. I'm pretty sure I've read a that after-tax contributions have to pass discrimination testing even in a safe harbor plan where other contributions don't have to pass testing.

I had thought so too.

Maybe there are enough people who could take advantage who aren't in the top 20% by comp (which I believe is an option)?

idk.

terran

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #7 on: December 16, 2019, 09:41:49 AM »
Yeah, that seems strange. I'm pretty sure I've read a that after-tax contributions have to pass discrimination testing even in a safe harbor plan where other contributions don't have to pass testing.

I had thought so too.

Maybe there are enough people who could take advantage who aren't in the top 20% by comp (which I believe is an option)?

idk.

Right, if they could get "low" income employees to use the plan I think that would actually help the HCE's since it would increase the average contributions of the non-HCE's, but that seems like kind of stretch for someone at that income to contribute that much unless they're mustachians.

seattlecyclone

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #8 on: December 16, 2019, 12:06:14 PM »
Seems like this could be useful for the non-HCEs even if the HCEs can't take advantage. Surely someone who makes less than $120k and wants to save more than $19k for retirement isn't unheard of.

dcozad999

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #9 on: December 16, 2019, 12:26:57 PM »
That makes sense. This has piqued my interest this morning b/c I don't think I've ever really thought about the numbers. My co-worker, who is an HCE, was looking into the after tax contributions just last week, which is why I thought this may be a way around the audit.
 
Someone making around $126k, marking them an HCE, has to contribute 15% to get to the $19k limit. That means the average non-HCE contribution must be 12% correct?

Considering every article written about how lousy people are saving the last 10 years, that sounds like a really high average contribution. So how is it that last year was the first time the HCE's I worked with failed the test? I doubt the average contribution went down for non-HCE's. I'm thinking I'm missing some major component here.

It does make sense to me now why they have increased the match from 3% to 3.5% last year, and are increasing it for 4% in January. So the 4% match means most will contribute at least the 8% to get the full match, bringing the average up.

ender

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #10 on: December 16, 2019, 04:54:30 PM »
I'm wondering about this, bolding mine:

Quote
An employee is an HCE under the compensation test (as determined under IRC Section 415(c)(3)) if he or she received compensation from the employer in excess of $80,000 (as adjusted under IRC Section 415(d) - $120,000 for 2016-2018 and see COLA Increases for Dollar Limitations on Benefits and Contributions for other years) during the lookback year and, if elected by the employer, is in the top 20% of employees ranked by compensation (also known as the top-paid group election) for the lookback year. The employer may make the election for any year. Once made, the election applies for all subsequent years until it is revoked. There is no filing or reporting requirement with the Service. However, the plan document must be consistent with the election. Therefore, a plan amendment may be required to reflect the election, depending upon the terms of the plan. See Sections IV, V and VII of Notice 97-45.

from here.

It seems that means someone earning say $500k annually but who only earned $50k in their first year with the company could actually contribute in the following year and not be considered an HCE. Only the year following would they be considered HCE.

So for example, it means that anyone hired in 2019 who earns less than 80k at that employer will not be considered HCE for 2020 - only years afterwards.
« Last Edit: December 16, 2019, 04:56:46 PM by ender »

ender

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Re: Why add mega Roth to a 401k plan failing discrimination testing?
« Reply #11 on: December 24, 2019, 07:16:49 AM »
Reading into this more, only one type of testing includes after-tax contributions.

If a 401k is failing the ADP test but not ACP, your HCEs could still benefit from the after-tax 401k (as long as it doesn't start failing ACP as well). This is because the ADP test counts elective deferrals.

ACP is calculated differently though.

https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-the-plan-failed-the-401k-adp-and-acp-nondiscrimination-tests has a good guide