(b)lines Ask the Experts – Adding Roth When After-Tax Already Exists

“However the plan currently allows for employee after-tax contributions. Should I replace the after-tax contributions with Roth or simply allow them to exist side-by-side?” 

Michael A. Webb, vice president, Cammack Retirement Group, answers:     

A number of plan sponsors have struggled with this question as Roth accounts become more and more popular, though many 403(b) plans have never allowed for after-tax contributions, primarily due to the fact that such contributions are subject to average contribution percentage (ACP) testing, as explained in this prior Ask the Experts column comparing Roth and after-tax, and that annuity contracts generally have tax-exempt build-up on after-tax contributions even outside of a 403(b) plan.

For the 403(b) plans with existing after-tax contributions, many such plan sponsors have discontinued the after-tax contribution sources once a Roth feature was added. However, you will want to examine current after-tax utilization in your plan prior to making such a decision for the following reasons:

• In some plans, high-income earners utilize after-tax contributions as a tax-planning strategy, since they are subject to a much higher limit than elective deferrals: the 415 limit of $53,000, less other 403(b) contributions, in 2015, as opposed to the 402(g) limit of $18,000. If many employees are utilizing the plan in such a fashion, the elimination of after-tax contributions may create a significant employee relations issue.
• Participants must usually take action in order to elect Roth contributions if after-tax contributions are discontinued, and retirement plan participants generally suffer from inertia, so there may be a significant impact to retirement accumulations if after-tax contributions are eliminated.
• If, for some reason, the  utilization of after-tax contributions is primarily by non-highly compensated employees (unlikely, but possible) ACP testing in 403(b)plans with matching contributions could actually be negatively impacted if the after-tax contribution source is eliminated. Note that this is not an issue for plans without matching contributions, since the elimination of after-tax contributions would eliminate ACP testing entirely.

Thus, for some 403(b) plans, the decision may not be as simple as replacing employee after-tax contributions with Roth contributions. Finally, if you desire to retain both after-tax and Roth contributions you should confirm that your recordkeeper(s) is/are able to administer both contribution sources.

Thank you for your question!