Get to know your 401k plan rules

Your Guide to State, Local, Federal, Estate + International Taxation

Have you ever heard the quote by Peter Lynch, “Behind every stock is a company. Find out what it’s doing?” Well, I am going to alter that and say, behind every 401k there is a plan. Find out what is in it. Read it. I am speaking from experience here. Knowing your 401k plan rules can save you money and make you money, but you must read those documents and the amendments. (You know, those documents that HR sends out that you probably delete each year.)

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Two items I would like to discuss that people could benefit from, but most likely do not: Buy Back Forfeiture Clause and after-tax contributions. (And no, I am not talking about a Roth when I say after-tax contributions, so keep reading.)

Buying Back Forfeitures Clause

This clause may be in your 401k plan rules and relates to those employees who left a company and suffered a forfeiture of the nonvested portion of their account. Meaning you left the company and left money on the table, because you were not fully vested based on the 401k plan vesting schedule (you should know your vesting schedule as well!).

Well, you may be in luck, as you may be able to get that money back if five consecutive one-year breaks in service have not happened yet. Meaning you came back within that period then your nonvested portion would get restored, however if you rolled over or distributed your 401k with that company then you must also restore the distribution, hence “buy-back”.

You must restore it in full, think tax-deferred and Roth portion. Rolling a 401k to another 401k plan with a new company is not the issue here as you simply will roll it back and fully restore your previous distribution.

The issue here is if you rolled it into a Roth IRA instead of a Roth 401k. Now the problem arises in getting those Roth IRA funds back into the Roth 401k as you can’t roll it from one to the other and you must battle the Roth distribution rules (five year rule, 10% penalty, taxes on earnings etc.), however you may still be able to pull out that money if you clear all the obstacles that come with the Roth IRA distribution AND your 401k provider is willing to accept the funds coming from your personal account.

It may be best to keep rolling your 401k to a 401k plan in case you ever return to your previous employer, save yourself the headache here. Of course, you should weigh in all other items as well.

After-tax contributions

If you are lucky and your company 401k plan allows it, you may contribute more than the annual tax limit to your 401k plan. As mentioned above this is not referring to Roth contributions. This is referring to the traditional after-tax contributions meaning excess contributions you made to a traditional tax-deferred 401k plan over the tax-deferred limit ($20,500 for 2022 tax year and catch-up contribution of $6,500).

Yes, what I am saying is if your 401k plan allows it, you can contribute more into your retirement, with the caveat that these after-tax contributions will not grow tax-free like the Roth 401k and you will have to track your basis in these amounts.

Traditional after-tax contributions provide an opportunity for a “Mega Backdoor Roth.” After-tax contributions paired up with in service withdrawals can allow you to maximize your Roth 401k ($20,500 for 2022 + catch up amount) then contribute traditional after-tax contributions and immediately make an in-service withdrawal before the funds invest, converting your traditional after-tax contribution and rolling it into your Roth 401k. Majority of the time there will be tax from employer contributions that were tax-free or prior traditional 401k tax-deferred amounts that were in the account as the pro rata rule would still apply here.

The Mega Backdoor Roth is complex and there are caveats to take into consideration when planning this and most relate to tax limits and rules. Please reach out to your Henry+Horne advisor for a tax plan if this is something your 401k plan would allow. If it does not allow it, well at least you have read your 401k plan rules now and know what is allowed!

Chris Morrison, CPA MAFM