How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
CoastalWinds
Posts: 1063
Joined: Sat Apr 06, 2019 8:28 pm

How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by CoastalWinds »

Hi BHs

I was going to “lobby” my company to modify its 401k plan to include the ability to do the mega-backdoor roth maneuver. This means it would need to do 2 things that it currently doesn’t: allow for after-tax contributions, and allow for in-service distributions or conversions.

However, upon running this idea by the BH community, I was told I might run into a snag b/c of “discrimination testing” for HCE. So I’m trying to understand this better before I lobby for something that I can’t even use. Some questions:

1. How would I know whether I would be eligible or not, should our company modify its plan? Our plan is a safe harbor 401k. When I try to put my year-end bonus into 401k each year, usually the plan administrator tells me they can only put some of it into the 401k b/c of discrimination testing rules.

2. Are after-tax contributions “counted” as it relates to HCE discrimination testing rules?

3. If I would likely be limited, how would the plan need to be modified so as to remove this discrimination testing?

4. Practically speaking, wouldn’t HCE’s really be the ones most likely to want to take advantage of the $56K total limit? (Its not like a lot of people making 80K are saving 56K?). If discrimination testing prevents the HCE from doing this, than who is able to do this?

4. Is there a work-around at all in my situation? What would others do if you were in my shoes? I really want to take advantage of this addtl tax-sheltered space as my taxable account is growing and suffering from tax drag.

Thank you for your time and input.

CW
DoctorPhysics
Posts: 154
Joined: Sun Jun 07, 2015 12:50 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by DoctorPhysics »

I think you can do a tIRA, then move it into a Roth IRA, no taxes in so far as I know if you have zero growth and zero initial balance in the tIRA before moving to Roth. This is called a back door Roth and you would only be able to do 5.5k for yourself and then for your significant other for a total of 11k.
Topic Author
CoastalWinds
Posts: 1063
Joined: Sat Apr 06, 2019 8:28 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by CoastalWinds »

DoctorPhysics wrote: Mon Jun 10, 2019 3:53 pm I think you can do a tIRA, then move it into a Roth IRA, no taxes in so far as I know if you have zero growth and zero initial balance in the tIRA before moving to Roth. This is called a back door Roth and you would only be able to do 5.5k for yourself and then for your significant other for a total of 11k.
This is the regular backdoor Roth. I’m talking about the MegaBackdoor inside 401k plans.
DoctorPhysics
Posts: 154
Joined: Sun Jun 07, 2015 12:50 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by DoctorPhysics »

CoastalWinds wrote: Mon Jun 10, 2019 4:06 pm
DoctorPhysics wrote: Mon Jun 10, 2019 3:53 pm I think you can do a tIRA, then move it into a Roth IRA, no taxes in so far as I know if you have zero growth and zero initial balance in the tIRA before moving to Roth. This is called a back door Roth and you would only be able to do 5.5k for yourself and then for your significant other for a total of 11k.
This is the regular backdoor Roth. I’m talking about the MegaBackdoor inside 401k plans.
Gotcha, I completely missed the mark then, I was thinking of an option for #4 in case there isn’t a satisfactory work around for your case.
bryansmile
Posts: 280
Joined: Wed Feb 12, 2014 10:14 am

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by bryansmile »

Have you read through your plan's "summary plan description"? It'll tell you the specific rules around HCEs contributions.

The reason some are able to max out is because their plan caps HCE contributions at a percentage of pay, and their pay is high enough. Think 250k*20% + company match.
THY4373
Posts: 1285
Joined: Thu Mar 22, 2012 3:17 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by THY4373 »

My plan is a weird one as I work for a somewhat unique organization (quasi government non-profit). In our entire plan document (I have read it) there is not one mention of HCE, fairness testing or safe harbor. Near as I can tell the rules just don't apply to my plan. Which is good because I make a enough to do a mega-backdoor Roth but not if I was limited to a fixed percentage.
Last edited by THY4373 on Mon Jun 10, 2019 5:19 pm, edited 1 time in total.
Pigeye Brewster
Posts: 422
Joined: Thu Oct 05, 2017 7:33 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by Pigeye Brewster »

CoastalWinds wrote: Mon Jun 10, 2019 3:44 pm 2. Are after-tax contributions “counted” as it relates to HCE discrimination testing rules?

3. If I would likely be limited, how would the plan need to be modified so as to remove this discrimination testing?

4. Practically speaking, wouldn’t HCE’s really be the ones most likely to want to take advantage of the $56K total limit? (Its not like a lot of people making 80K are saving 56K?). If discrimination testing prevents the HCE from doing this, than who is able to do this?

4. Is there a work-around at all in my situation? What would others do if you were in my shoes? I really want to take advantage of this addtl tax-sheltered space as my taxable account is growing and suffering from tax drag.
After-tax contributions are subject to ACP testing even in a safe harbor plan. This ACP testing requirement cannot be removed.

You are correct that HCEs are the ones who generally would be in a position to benefit from the mega backdoor Roth.

Sometimes non-HCEs will use after-tax contributions as sort of a savings plan to save for vacations, Christmas, etc. That is the case at my company.
Topic Author
CoastalWinds
Posts: 1063
Joined: Sat Apr 06, 2019 8:28 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by CoastalWinds »

bryansmile wrote: Mon Jun 10, 2019 4:43 pm Have you read through your plan's "summary plan description"? It'll tell you the specific rules around HCEs contributions.

The reason some are able to max out is because their plan caps HCE contributions at a percentage of pay, and their pay is high enough. Think 250k*20% + company match.
Yes, I read through our SPD. There is no discussion of HcEs or discrimination testing.
User avatar
whodidntante
Posts: 9289
Joined: Thu Jan 21, 2016 11:11 pm
Location: outside the echo chamber

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by whodidntante »

CoastalWinds wrote: Mon Jun 10, 2019 5:17 pm
bryansmile wrote: Mon Jun 10, 2019 4:43 pm Have you read through your plan's "summary plan description"? It'll tell you the specific rules around HCEs contributions.

The reason some are able to max out is because their plan caps HCE contributions at a percentage of pay, and their pay is high enough. Think 250k*20% + company match.
Yes, I read through our SPD. There is no discussion of HcEs or discrimination testing.
It will be described in the plan document, which is much longer than the SPD.

ACP/ADP testing is performed separately for after-tax contributions. As an HCE you'll be able to contribute something, generally at least 2% but possibly more.

In 2018 I contributed enough to approach the 415 limit of 55k. Most of my after-tax contributions were returned to me on March 15th because the plan failed testing. I also have a safe harbor plan.

You should lobby for it anyway. It's still good for you and maybe even better for others. For example, if you end up with an extra 4k per year in your Roth, isn't that good news?
JBTX
Posts: 7126
Joined: Wed Jul 26, 2017 12:46 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by JBTX »

CoastalWinds wrote: Mon Jun 10, 2019 3:44 pm Hi BHs

I was going to “lobby” my company to modify its 401k plan to include the ability to do the mega-backdoor roth maneuver. This means it would need to do 2 things that it currently doesn’t: allow for after-tax contributions, and allow for in-service distributions or conversions.

However, upon running this idea by the BH community, I was told I might run into a snag b/c of “discrimination testing” for HCE. So I’m trying to understand this better before I lobby for something that I can’t even use. Some questions:

1. How would I know whether I would be eligible or not, should our company modify its plan? Our plan is a safe harbor 401k. When I try to put my year-end bonus into 401k each year, usually the plan administrator tells me they can only put some of it into the 401k b/c of discrimination testing rules.
It is my understanding that if after tax contributions were heavily weighted to HCEs it could cause even a safe harbor plan to fail additional testing.

2. Are after-tax contributions “counted” as it relates to HCE discrimination testing rules?
They are counted in terms of testing - not sure if it is same testing or different test.
3. If I would likely be limited, how would the plan need to be modified so as to remove this discrimination testing?
I don't know. It would probably be more effort than worth it for employer
4. Practically speaking, wouldn’t HCE’s really be the ones most likely to want to take advantage of the $56K total limit? (Its not like a lot of people making 80K are saving 56K?). If discrimination testing prevents the HCE from doing this, than who is able to do this?

4. Is there a work-around at all in my situation? What would others do if you were in my shoes? I really want to take advantage of this addtl tax-sheltered space as my taxable account is growing and suffering from tax drag.

Thank you for your time and input.

CW


I would have thought so but apparently in some cases that isn't the case. I asked a similar question here and others more knowledgeable indicated that isn't always the case.

I doubt there is anything you can do. Either the plan can do it or it can't. I suspect the type of plans that will allow it are the exception and not the rule.
codedude
Posts: 70
Joined: Thu Jan 26, 2017 9:15 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by codedude »

When one is a HCE, there is a possibility of your contributions being returned in the next calendar year. This would be because of an ADP test failure or an ACP test failure. This testing usually happens in early March but could happen later till October 1. You can ask your plan administrator when these tests are performed for your plan. Because of this, I contribute after tax but don’t do the mega backdoor for the current calendar year’s contributions till October 1 of next year has passed.
JBTX
Posts: 7126
Joined: Wed Jul 26, 2017 12:46 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by JBTX »

You may find this thread helpful particularly posts from spirit rider.

viewtopic.php?t=258454
Spirit Rider
Posts: 13641
Joined: Fri Mar 02, 2007 2:39 pm

Re: How are “high earners” (HCEs) eligible for Mega-backdoor Roth?

Post by Spirit Rider »

CoastalWinds wrote: Mon Jun 10, 2019 3:44 pm 1. How would I know whether I would be eligible or not, should our company modify its plan? Our plan is a safe harbor 401k. When I try to put my year-end bonus into 401k each year, usually the plan administrator tells me they can only put some of it into the 401k b/c of discrimination testing rules.
You are an HCE if your plan compensation is >= the HCE compensation limit (2019 = $125K) or your plan uses the top 20% ranked by plan compensation and your are in that 20%.
2. Are after-tax contributions “counted” as it relates to HCE discrimination testing rules?
After-tax contributions are always subject to ACP testing, even if it is a safe harbor 401k.
3. If I would likely be limited, how would the plan need to be modified so as to remove this discrimination testing?
A plan can not be modified to exempt employee after-tax contributions from ACP testing. The plan could preemptively limit HCE contributions to avoid failure. Once a failure has occurred, the plan must either return the HCE excess contributions and earnings or make qualified nonelective employer contributions (QNEC) to NHCES to pass the testing. It is rare for a plan to do latter, unless the amount to do so is relatively small.
4. Practically speaking, wouldn’t HCE’s really be the ones most likely to want to take advantage of the $56K total limit? (Its not like a lot of people making 80K are saving 56K?). If discrimination testing prevents the HCE from doing this, than who is able to do this?
The HCEs will have more discretionary income, but since the testing is percentage based, a few NHCEs maxing the annual addition limit (2019 = $56K) can raise the NHCE average contribution percentage to help with ACP testing.
4. Is there a work-around at all in my situation? What would others do if you were in my shoes? I really want to take advantage of this addtl tax-sheltered space as my taxable account is growing and suffering from tax drag.
There is no avoiding of ACP testing, it is in the Internal Revenue Code 401(m), IRS regulations and guidance. Even if the plan fails ACP testing, you will be able to contribute something. Worry about testing after you are successful in lobbying for employee after-tax contributions and in-service rollovers. Then go into overdrive lobbying the NHCEs use the Mega Backdoor IRA instead of Roth 401k. They may have lower expenses at an Roth IRA than in the plan and they have full control over the funds and not have to wait until 59 1/2.[/quote]
Post Reply