Advantages of Backdoor 401(k) Contributions

To Find out What’s Wrong About Backdoor Roth 401(k) Contributions go to the Blog at https://nofees401k.com/blog/

To Find Out What’s Right About Back Door 401(k) Contributions, Read the Following:

1) People with higher incomes use a “Back Door 401(k) (BDC), which is a combination of their Roth 401(k)and their Roth IRA Rollover. The “Back Door 401(k) Contribution” (BDC) is a tax avoidance strategy.

2) To use a BDC, the employee’s company 401(k) plan must allow for (a) in-service withdrawals, (b) Roth 401(k), and (c) after-tax contributions. 401(k) Easy Plus allows these three features.

3) The BDC can increase a 401(k) participant’s total annual contribution to $58,000 for employees under age 50 and increase the total contribution to $64,500 for employees over 50.

4) Before a BDC can be deployed, the 401(k)participant must have contributed the maximum annual 401(k) contribution for the year. This can be a combination of regular traditional pre-tax contributions plus Roth post-tax contributions. For 2021 this maximum limit is $19,500 for persons under age 50 and $26,000 for persons over age 50.

5) The company’s 401(k) plan must pass the year-end compliance tests, including the ADP test, ACP test, and Top-Heavy tests, before BDCs can be made. Alternatively, if the company’s plan is a Safe Harbor 401(k), these compliance tests can be set aside. A Safe Harbor 401(k) requires an employer match of at least 3% for all eligible employees and not just those who have chosen to participate in the company’s 401(k).

BDC Example:

Employee A is under 50 years of age and is paid $60,000 in W-2 wages. This employee contributed a total of $19,500 in the 401(k). The 401(k) is a Safe Harbor 401(k), so the employer was obligated to contribute 3% (=$3,600) of the employee’s salary. The pre-BDC for Employee A is now $23,100. The employee can make an additional BDC of up to $34,900, resulting in a grand total of $58,000.

If Employee A leaves the BDC in the 401(k), gains on BDC money will be subject to capital gains taxes. Suppose the employee quickly withdraws the BDC using the 401(k) plan’s in-service withdrawal feature and transfers the BDC to a Roth IRA set up in advance. In that case, the employee may avoid these taxes until years in the future.