After-Tax Contributions

Do you need to have after-tax contribution options in your Solo-K? No. If you want to maximize your contributions to your Solo-K, should you consider having a plan with after-tax contributions? Yes! If you are interested in maximizing Roth contributions and creating the ability to have an additional source of Roth funds (explained in more detail below) in your Solo-K, should you consider having after-tax contributions? Without question.

While after-tax contributions can potentially provide significant contribution ability (especially if you like Roth), it may not be a fit for everyone. But, if you first certain situations (examples below), you would probably want to make sure after-tax contributions are part of your Solo-K!

Forget the History

They say history teaches us lessons…and that is true….but honestly, the old rules on after-tax contributions were so difficult to understand. So, I am not going to worry about explaining the old rules, rather what the new rules (since 2012) are.

Thanks to the American Tax Relief Act of 2012, these old, antiquated rules were changed to permit more freedom in the administration requirements of after-tax contributions. The change not only made sense, but made it desirable for people to now consider making after-tax contributions. PGI plan documents can be structured to permit after-tax contributions.

Contribution Limits

Most of you who have done research on how to maximize contributions to your Solo-K plan. As part of this research, you have heard of elective deferrals and employer matching/profit share. Your brain has been compartmentalized into thinking these are the options, so how does after-tax contributions enter it this equation. It is neither elective deferrals or employer matching/profit sharing. It is after-tax contributions that, if you qualify based on income, you put in to the plan. And, they do not “coordinate” with these other contribution limitations.

“415 Limit”

What? Yes, everyone who is a participant in a qualified retirement plan, has “this” limit. It is the maximum amount that can be contributed to a 401(k) plan on your behalf from any source. For 2019, this amount is $56,000, or 100% of your compensation.

If you qualify and want to get even more funds within the plan classified as Roth, keep reading.

And, if you are a W-2 employee but have a Solo-K for your side business, you definitely want to keep reading.

Example – Full-time W-2

In this example, Ronny, age 52, has a job as a full-time, W-2 employee and participates in the company’s 401(k) plan. Ronny, is making his full elective deferral (permitted under law) contribution of $19,000. His employer is also making a $15,000 employer matching/profit sharing contribution. The total of contributions on Ronny’s behalf is $34,000. But, remember, we discussed that his “415” limit, if he qualifies based on overall compensation, would be $56,000. IF Ronny had sufficient compensation, he could make an after-tax contribution of $22,000 to his plan ($56,000 total)

Example — Full-time W-2 and Solo-K

In this example, Suzy, age 53, is a full-time W-2 employee and also runs a very successful side business that has no affiliation of any kind with her W-2 job. Her side business sponsors a Solo-K. Suzy contributes the full elective deferral of $19,000 with her W-2 employer. Suzy, having qualifying income in her self-employed business, inquires whether she can make an after-tax contribution to her plan of $56,000?

Your initial belief may be that she cannot as her “415” limit is $56,000. Since she made a contribution of $19,000 to her W-2 plan, wouldn’t her “415” limit be $37,000 ($56,000 less $19,000 contribution)? Actually, no. In this example, we stipulated that Suzy’s side business has no affiliation with her W-2 position. In IRS lingo, it simply means her business and plan has no “controlled group” or “affiliated service group” issues. As a result, her “415” limit is separate from her W-2 employer. Pretty cool, correct?

Example 3 — Full-time W-2 and Solo-K (with a different twist)

In this example, Patti, age 55, is a full-time W-2 employee and also runs a very successful side business that has no affiliation of any kind with her W-2 job. Her side business sponsors a Solo-K. In this example, Patti not only contributes the full elective deferral of $19,000 with her W-2 employer, but her employer also contributes an additional $37,000 of employer matching/profit sharing contributions (total of $56,000).

Suzy, having qualifying income in her self-employed business, inquires whether she can make an after-tax contribution to her plan of $56,000?

Again, your initial belief may be that she cannot as her “415” limit has maxed out at $56,000. That is the full amount made in her W-2 plan. But, again, we stipulated that Patti’s side business has no affiliation with her W-2 position. It is a totally separate business with no “controlled group” or “affiliated service group” issues. As a result, she has a separate “415” limit. If she has qualifying income, after-tax contributions can be made as noted.

Back Door Roth Solo-K (it gets better)

Remember we touched on the old rules that were antiquated and difficult to understand? There were complicated rules on when and how after-tax funds could be distributed from the plan, and how/if/when earnings on the after-tax investments were taxable upon distribution. And, this is the easy explanation!

Here is what you need to know for now to get excited about the concept of after-tax contributions. Once the contributions have been made, and provided the following are true:

  1. your plan permits after-tax contributions being able to be contributed into the plan; and,
  2. your plan permits Roth conversions of any and all funds within the plan, inclusive of after-tax contributions; and,
  3. the earned income of the participant (e.g., business owner) must be qualifying to permit the amount of the after-tax contribution.

Now, it is just a matter if you elect to make this contribution.