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401k as an employee

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  • Avatar orthodoc2018 
    Participant
    Status: Physician
    Posts: 80
    Joined: 07/18/2018

    Scenario:

    As a W2 employee, let’s say salary of 250,000 and 4% employer match. So if I put in the 19k max, I’ll get a match of 10k and total contribution of 29k. I then qualify for let’s say a 100k bonus based on productivity.

    My two questions are:
    1. Is the 4% match then applied to the bonus as well usually? I won’t be surprised if the responses just say “this varies, read your plan’s documents”
    2. Is there a way to get to the 56k max by just having 27k of my bonus added to the 401k pre-tax having the remaining 73k paid out as taxable income?

    #233919 Reply
    mb(a)CPA mb(a)CPA 
    Participant
    Status: Accountant
    Posts: 27
    Joined: 04/01/2019

    On the match I will have to agree with your thinking that “this varies, read your plan’s documents”.

    As an employee there is a $19K pre-tax deferral limit (plus $6K if over age 50).  As such an additional $27K CANNOT be added pre-tax.  That said, depending on the plan document you might be able to put in said $27K as an after-tax contribution (no current deferral, but sheltering of investment growth). This is sometimes done as part of something colloquially referred to as a mega back door Roth since it is useful for being able to roll the money over to a Roth IRA such as a part of an in-service distribution or if you plan to switch employers in the next several years.

     

    #233927 Reply
    Avatar jhwkr542 
    Participant
    Status: Physician
    Posts: 1330
    Joined: 02/15/2016

    1. Typically yes but only up to the irs compensation limit ($280k for 2019)

    2. No for most plans

    #233933 Reply
    Avatar orthodoc2018 
    Participant
    Status: Physician
    Posts: 80
    Joined: 07/18/2018

    Thanks for the replies!

    So is it possible to get to the 56k max for 401k as an employee other than with a 13% employer match? Is the use of “profit sharing” only for partners?

    Is the post-tax 401k contribution only worth it if able to convert to Roth? I assume even if not converted, it would grow tax free and only the growth would be taxed upon withdrawal?

    If not able to covert to Roth, I imagine I’m better off just putting it in a taxable account, or in my specific situation I’d throw it at my student loans. Basically I’m looking to take advantage of all tax-advantaged retirement accounts and then the rest goes to loans.

    #233958 Reply
    Avatar ZZZ 
    Participant
    Status: Spouse
    Posts: 727
    Joined: 06/18/2018

    So is it possible to get to the 56k max for 401k as an employee other than with a 13% employer match? Either a larger match or post tax employee contributions could get you there, too.

    Is the use of “profit sharing” only for partners? No.

    Is the post-tax 401k contribution only worth it if able to convert to Roth? Depends on your present and future tax brackets, but probably not ideal for you unless inservice rollovers allowed.

    I assume even if not converted, it would grow tax free and only the growth would be taxed upon withdrawal? Correct.

    #233960 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1966
    Joined: 02/01/2016

    There are three types of employee contributions defined in IRS regulations; “pre-tax deferrals”, “designated Roth contributions” and “after-tax contributions”. It is best to use the term “employee after-tax contributions”. The use of “post-tax” can be confused with Roth 401k contributions.

    Employee after-tax contributions do not “grow tax free”. Earnings are subject to ordinary income tax. Therefore, it is generally not a good idea to make such contributions if you can not convert to Roth in a relatively short number of years. If you use tax efficient investments in your taxable accounts instead, capital gains are taxed at a much lower rate.

    The one exception is when you have insufficient room in tax-advantaged accounts for your tax inefficient investments. This generally only happens when you have a majority of your portfolio in taxable accounts and your asset allocation has a substantial percentage of bonds, etc…

    #233981 Reply
    Avatar ZZZ 
    Participant
    Status: Spouse
    Posts: 727
    Joined: 06/18/2018

    “Employee after-tax contributions do not “grow tax free”. Earnings are subject to ordinary income tax.”

    Isn’t it true that they ‘grow’ tax free as long as they’re in the 401k or rolled out to a traditional IRA? While the earnings are taxed, it’s not until they’re taken as a distribution, right?

    #233990 Reply
    Avatar jacoavlu 
    Moderator
    Status: Physician, Small Business Owner
    Posts: 2461
    Joined: 03/01/2018

    you could say they grow tax free, because dividends are not taxed along the way. You are correct that there is no tax on the earnings until distribution or Roth conversion

    but if you’re making after tax contributions and not converting to Roth, you’re essentially trading taxation at capital gains rates (if the funds were invested in taxable brokerage) for taxation at future ordinary income rates (within the tax deferred account).

    The Finance Buff's solo 401k contribution spreadsheet: https://goo.gl/6cZKVA

    #233993 Reply
    Avatar ZZZ 
    Participant
    Status: Spouse
    Posts: 727
    Joined: 06/18/2018

    Oh, I agree employee after tax contributions are dumb if they aren’t quickly rolled out to a Roth.

    #234000 Reply
    Avatar orthodoc2018 
    Participant
    Status: Physician
    Posts: 80
    Joined: 07/18/2018

    Okay great – thanks!

    So if profit sharing is not specific to partners, how would I go about seeing if this is something I could use to fill the rest of my 401k space? Is this something that can be negotiated specifically for me or is it a function of the plan that is currently in place?

    Also, where within the policy documents would I find whether “after-tax” contributions can be converted to an IRA and then to Roth IRA (or can this be done directly to a Roth IRA?)?

    So my plan for now is this:
    1. Roth IRA
    2. Max Employee 401k contribution
    3. Profit sharing or Mega-Backdoor Roth (if able to)
    4. Pay extra to student loans to have paid off in 4 years
    5. Taxable account to bring retirement savings to 20% (would already be there if able to do #3)
    6. Any leftovers go to loans

    Do those priorities look right?

    #234369 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1966
    Joined: 02/01/2016

    “Employee after-tax contributions do not “grow tax free”. Earnings are subject to ordinary income tax.”

    Isn’t it true that they ‘grow’ tax free as long as they’re in the 401k or rolled out to a traditional IRA? While the earnings are taxed, it’s not until they’re taken as a distribution, right?

    Click to expand…

    I realize it is semantics, but what you just described is tax-deferral. The term tax-free refers to earnings that are never taxed.

    #234430 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1966
    Joined: 02/01/2016

    Also, where within the policy documents would I find whether “after-tax” contributions can be converted to an IRA and then to Roth IRA (or can this be done directly to a Roth IRA?)?

    This should be in the Summary Plan Description (SPD).

    Direct rollovers to a Roth IRA are allowed, but the earnings will be taxable. You can do a split direct rollover of just the employee after-tax contributions to a Roth IRA and the pre-tax earnings to a traditional IRA with no tax liability. A single direct rollover is required by IRS regulations. A split rollover is allowed, but not required by IRS regulations.

    #234433 Reply
    Avatar jhwkr542 
    Participant
    Status: Physician
    Posts: 1330
    Joined: 02/15/2016

    So if profit sharing is not specific to partners, how would I go about seeing if this is something I could use to fill the rest of my 401k space? Is this something that can be negotiated specifically for me or is it a function of the plan that is currently in place?

    Generally non-negotiable.

    Also, where within the policy documents would I find whether “after-tax” contributions can be converted to an IRA and then to Roth IRA (or can this be done directly to a Roth IRA?)?

    Summary plan document. Someone in HR should know this, but the people I’ve worked with in some places won’t always know the minutiae.

    So my plan for now is this:
    1. Roth IRA
    2. Max Employee 401k contribution
    3. Profit sharing or Mega-Backdoor Roth (if able to)
    4. Pay extra to student loans to have paid off in 4 years
    5. Taxable account to bring retirement savings to 20% (would already be there if able to do #3)
    6. Any leftovers go to loans

    Do those priorities look right?

    Click to expand…

    #1 and #2 are switched in theory but in practice, I’m assuming you’ll be able to do both. I wouldn’t mess with a taxable until loans are gone unless you have a crazy low interest rate (like under 3%). But that’s debatable as some would.

    #234439 Reply
    Avatar spiritrider 
    Participant
    Status: Small Business Owner
    Posts: 1966
    Joined: 02/01/2016

    If you have an HDHP and eligible for HSA contributions, I would substitute the following initial general priority in theory:

    1. 401k up to the employer match
    2. Maximum HSA contribution
    3. 401k up to the max
    4. Roth to the max

    However, as @jhwkr542 said; in practice all 4 should be a given with $260K in W-2 wages.

    #234450 Reply
    Liked by Hank, Tim, jhwkr542
    Avatar orthodoc2018 
    Participant
    Status: Physician
    Posts: 80
    Joined: 07/18/2018

    Yes I’m for sure doing numbers 1,2, and 4. The only question is if I can do #3 and if not, then I’ll be doing #5 as well.

    #234501 Reply

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