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Solo 401k - after-tax contributions

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  • Solo 401k - after-tax contributions

    Would love some input as I haven't found a clear explanation online. I have an S corporation, am the only owner/employee. I understand that for a solo 401k, I can make an employee deferral component, profit sharing, and an after-tax component. From what I've read, the after-tax does not grow tax-free, rather it is tax deferred (unlike a Roth IRA, eg, that would grow taxfree?). Does that mean that I would have to pay those deferred taxes when I retire?

    Or is the idea to somehow convert the after-tax component to a Roth, or is this for a mega backdoor roth? So that it would grow tax-free instead of tax-deferred?

    How much am I able to contribute to the after-tax? I know it's up to the ~ $58,000 limit, but I have read it cannot exceed 20% of compensation; what would that be for an S corporation, would it be 20% of my revenue (and no relationship or impact of expenses, which includes wages?)?

    Many thanks.

  • #2
    The after-tax contribution is only available if your individual 401k plan supports it. The standard plans from the typical custodian (VG, Fido, Schwab, ETrade etc) do not support this, it takes a custom plan. After-tax contributions that can be rolled into Roth is the MBDR. If not the accumulated earnings would be taxable. Without the Roth feature, a taxable account is probably a better place for AT funds.

    The 20% compensation limit applies to the employER contribution, not to AT contributions. Your compensation for an S-corp is your W-2 + employER contribution (25% of W-2) not revenue. Non-wage distributions are not included.

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    • #3
      Originally posted by GasFIRE View Post
      Without the Roth feature, a taxable account is probably a better place for AT funds.
      For both a taxable account and after-tax 401k contributions, I am paying taxes initially, but with the after-tax 401k the taxes are deferred to 59.5, and for the taxable account they are not. So even without the Roth feature, wouldn't the after-tax 401k be preferable?

      If the 20% compensation limit doesn't apply to AT contributions, what determines it? Do I subtract the rest of the 401k contributions from 58,000, and that's what's allowed?

      A MBDR sounds even better, so wouldn't I ideally choose an individual 401k plan that supports it? I suppose they must cost more. But my plan would be to max out the solo 401k, so I would think it would justify it if it was a one-time cost. What would be recommended options for individual 401k providers to support the above?

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      • #4
        Taxable account gains should be mostly capital gains with a small amount of dividends. An after-tax 401k account converts all the gains to income which is likely to be taxed at a higher rate.

        You can contribute AT up to the 401k limit of $58K as long as you have the income. I use a third party administrator (TPA) for my custom plan. There are a few threads here by some who've gone the DIY route which I don't recommend unless you are confident you know and can follow the rules. Either way, there are ongoing yearly costs besides the initial start up fees. Personally I wouldn't consider this now until there is a resolution on whether or not the BBB legislation passes and bans the BDR and MBDR.

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        • #5
          Originally posted by GasFIRE View Post

          You can contribute AT up to the 401k limit of $58K as long as you have the income.
          Correction (slightly over-simplified): As long as you have the w-2 income from the S-corp. It is really important to be specific about terms like "revenue, income, w-2 wages, etc." because the difference matters.

          e.g., S-corp has 60k in revenue from a part-time gig. No expenses other than the salary you pay yourself and the taxes on it.

          You pay yourself reasonable compensation as W-2 wages: 40k. You have to pay payroll taxes on that, and the employer share is deductible to the business. Leaving 16.94k as the business profit (let's ignore accounting fees, UI, etc.)

          That 40k is the maximum EmployEE contribution across pre-tax, roth, and after-tax combined. (Let's ignore OASDI and medicare deductions, etc.)

          The maximum that you can put in EE pre-tax + EE roth combined is 19.5k. So that means the remaining EE contribution limit of 20.5K must all go into after-tax, although it can be immediately rolled over into a roth. Make sure your reporting is correct on the 1099-R related to that transaction.

          The maximum employER contribution is 25% of that 40k and can only go into pre-tax: 10k

          The maximum combined EE +ER contribution is 50k in this example. Even if the wages and revenue were double above (120k & 80k), the maximum combined contribution could not go beyond 58k in 2021. In that case you would have discretion about how you split it.

          Not tax advice, just my understanding of how it works.

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          • #6
            Thanks both, wonderful descriptions, DAK that really makes after-tax contributions clear.

            Originally posted by GasFIRE
            You can contribute AT up to the 401k limit of $58K as long as you have the income. I use a third party administrator (TPA) for my custom plan. There are a few threads here by some who've gone the DIY route which I don't recommend unless you are confident you know and can follow the rules. Either way, there are ongoing yearly costs besides the initial start up fees. Personally I wouldn't consider this now until there is a resolution on whether or not the BBB legislation passes and bans the BDR and MBDR..
            I was thinking that if it might be outlawed then I would want to do it this year before that happens, but since you mention ongoing yearly costs, the idea is that it wouldn't be worth it for one year?

            Originally posted by [B
            DAK[/B]]
            The maximum that you can put in EE pre-tax + EE roth combined is 19.5k. So that means the remaining EE contribution limit of 20.5K must all go into after-tax, although it can be immediately rolled over into a roth. Make sure your reporting is correct on the 1099-R related to that transaction.
            That's the mega backdoor roth, correct?

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            • #7
              With only 2 weeks left in the year, I don’t think you have enough time to set-up a custom plan even if you wanted to. If the BBB legislation doesn’t come to fruition and BDR and MBDR remain available next year then you can decide whether or not to pursue a plan that allows AT contributions and is MBDR compatible. If you haven’t already done so, I would open an individual 401k to make sure you at least capture any pre-tax savings for this year.

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