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What’s Right About Back Door 401k Contributions

Posted on August 6, 2021August 6, 2021 by 401kEasy

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

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

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

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

3) The BDC can increase a 401k 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 401k participant must have contributed the maximum annual 401k 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 401k 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 401k, these compliance tests can be set aside. A Safe Harbor 401k 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 401k.

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 401k. The 401k is a Safe Harbor 401k, 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 401k, gains on BDC money will be subject to capital gains taxes. Suppose the employee quickly withdraws the BDC using the 401k 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.

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