Is the “Mega Backdoor” Roth strategy too good to be true?

Executive Summary: 

Recent articles in the Wall Street Journal and other media outlets including investment blogs and message boards have referenced a little-known strategy for adding to Roth savings within a 401(k) Plan.  This strategy, referred to as “Mega Backdoor” Roth funding, is technically sound but very difficult to put into practice for most 401(k) Plans.

401(k) Plan Sponsors should review IRS discrimination testing rules specific to their Plans and carefully evaluate plan demographics, plan participation and average deferral data before amending their plans to facilitate the “Mega Backdoor” Roth strategy.

Why?  The IRS annual discrimination testing (specifically the Actual Contribution Percentage or ACP) Test applies to voluntary after-tax plan deferrals which potentially reduce or eliminate “Mega Backdoor” conversion opportunities completely.

Additional administrative complexities associated with In-Plan Roth conversions should be reviewed with your plan’s recordkeeping partner, along with Participant communication efforts before amending your 401(k) plan to allow for this conversion strategy.

Aegis Retirement Partners is a third-party administration and consulting firm specializing in the qualified retirement plan marketplace.  When it comes to Plans sponsored by small to mid-size plan sponsors (under 1000 Participants), we have identified few viable scenarios that allow for Mega Backdoor” Roth strategy work successfully.

This white paper delivers in depth background on “Mega Backdoor” concept starting with some basics on Roth conversions, 401(k) plan savings limits, In-Plan Roth conversions, and discrimination testing challenges associated with after-tax contributions.  Have questions about this for your plan?  Call us we’d be happy to help.

Aegis Retirement Partners, LLC

86 Baker Ave Extension, Suite 309

Concord MA 01742

(781) 604-9007

Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC.  Aegis Retirement Partners and Cambridge are not affiliated.  The information in this email is confidential and is intended solely for the addressee.  If you are not the intended addressee and have received this email in error, please reply to the sender to inform them of this fact.  We cannot accept trade orders through email.  Important letters, email, or fax messages should be confirmed by calling (781) 604-9013.  This email service may not be monitored every day, or after normal business hours.  These are the opinions of Doug Norberg and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized advice. Please be sure to speak to your financial professional to carefully consider the differences between your company retirement account and investment in an IRA. These factors include, but are not limited to changes to availability of funds, withdrawals, fund expenses, and fees.  Please speak to your tax professional regarding your unique circumstances. Cambridge does not offer tax advice. These examples are hypothetical and for illustrative purposes only. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principal.


The term “backdoor” Roth was coined to describe a strategy to fund a Roth IRA by individuals who would otherwise be precluded from doing so based on their modified adjusted gross income (MAGI).  To contribute to a Roth IRA in 2021, single tax filers must have MAGI of $140,000 or less.  If married and filing jointly, total MAGI must be less than $208,000.  Individuals or married couples filing jointly with MAGI exceeding these levels are precluded from contributing to Roth IRAs in 2021.

Retirement savers who are precluded from contributing to a Roth IRA may still fund a Roth using a conversion method, i.e., the “backdoor” strategy which is permissible regardless of MAGI levels.  The “backdoor” Roth funding method is perfectly legal although individuals who are considering this strategy are strongly advised to consult with their investment and tax planning professionals before initiating.

Many sources may be used to fund a Roth using the “backdoor” method (traditional IRA, non-deductible IRA, rollover IRA).  This is not a tax dodge, amounts converted from any previously “untaxed” IRA to Roth will be taxed as ordinary income in the year of the conversion.  Here are two very simple examples of the “backdoor” conversion process.

Example 1: Mary does not qualify to contribute to her Roth IRA in 2021 because her MAGI is over $140,000 as a single tax filer.  Mary contributes to a traditional IRA (up to $6,000), and subsequently converts this to Roth using the “backdoor” method.  The entire amount of the contribution plus any earnings will be taxed as ordinary income in the year of the conversion.  Note, if the contribution to the traditional IRA is “non-deductible”, only investment gains in the account will be taxed as ordinary income.

Example 2: George is married and he and his spouse file jointly.  George does not qualify to contribute to his Roth IRA in 2021 because he and his spouse have MAGI is over $208,000 “married filing jointly”.  George has an existing IRA consisting of previously untaxed contributions and investment gains.  George converts the entire IRA to Roth using the “backdoor” method.  The entire amount of the conversion will be taxed as ordinary income in the year of the conversion.  George elects to convert only a portion of his pre-tax IRA to Roth using the “backdoor” method and only the amount converted will be subject to ordinary income taxes.

Both examples are very basic but accurately outline the “backdoor” method of funding a Roth IRA.

Another Roth conversion option may be available to individuals who participate in 401(k) Plans that include a Roth 401(k) deferral option and allow for In-Plan Roth conversions.  If applicable, Participants may convert pre-tax 401(k) monies to Roth 401(k) within their 401(k) Plan.  Amounts converted from pre-tax to Roth within the 401(k) Plan are subject to ordinary income taxes but not excise tax penalties.  Additional 401(k) savings may not be withdrawn to pay taxes unless the participant is otherwise eligible for the in-service withdrawal.

Example 3: Mary participates in a 401(k) Plan and has a pre-tax balance of $100,000 dollars.  In 2021, Mary elects to “convert” $20,000 of her overall balance from pre-tax to Roth.  Once the conversion is completed, Mary’s balance will still be $100,000 but it will consist of $80,000 of pre-tax and $20,000 of Roth assets.  Mary will pay ordinary income taxes on the $20,000 conversion in 2021.

There are no IRS limits on the amount of pre-tax monies that may be converted in the 401(k) Plan but Plan specific limits may apply.  Participants considering this conversion strategy are strongly advised to consult with their tax planning professional to pre plan for year-end tax implications.

The “Mega Backdoor” strategy conversion works the same way as the “backdoor”, but it involves a different funding source, namely voluntary “after-tax” contributions made to a 401(k) Plan.  The term “after-tax” contributions inside a 401(k) Plan is not a reference to Roth 401(k) which is a common misconception.  In this case, after-tax deferrals refer to a unique Participant contribution source.  After-tax deferrals are subject to different tax treatment and additional discrimination testing issues that will be outlined below. The term “Mega” is used because permitted after-tax contribution levels in the 401(k) may be significantly higher than annual contributions to an IRA, creating a larger “Mega” opportunity to fund the Roth401(k).  Since monies used to fund the Roth involve after-tax contributions the 401(k) this strategy, is desirable because it has less impact on taxable income.

For this to work, 401(k) Plans must include an after-tax deferral feature, a Roth 401(k) feature, and allow for In-Plan Roth conversions.  Aside from potential 401(k) Plan Amendments needed and the ability of a recordkeeper to account for additional sources, there are many other important considerations which are the focus of this paper.  A deeper dive on the “Mega Backdoor” conversion strategy is outlined below.

The 401(k) Plan Basics:

For the 2021 calendar year, IRS permits 401(k) Plan Participants to save up to $19,500 in their 401(k) Plan.  Participants who attain age 50 or older anytime during the calendar year may defer an additional $6,500 referred to as “catch-up contributions” provided this is permitted in their 401(k) Plan.  These savings are referred to as participant deferrals which may be directed into the plan either as traditional pre-tax deferrals, Roth after-tax deferrals, or in any combination.

The 2021 IRS annual 401(k) deferral limits are referred to simply as the IRC 402(g) limits.  These limits are tied to an inflation index and updated annually as needed.

Technical Point– Unlike Roth IRA’s which are a specific type of individual retirement account often used in coordination with, or as an alternative to a 401(k) Plan, there are no MAGI income limitations associated with Roth 401(k) deferrals.  All 401k Plan Participants regardless of their MAGI are permitted to contribute up to $19,500 or $26,000 as Roth 401(k) deferrals depending on their age.

In addition to the 2021 402(g) limits that pertain to Participant deferrals, another IRS limit called IRC 415 (a reference to the applicable code section) Annual Addition Limit applies to the total annual additions permitted each year.  The IRC 415 Annual Addition Limit for 2021 is $58,000 not including the age 50 catch-up.

Why have two limits?  The short answer is that Uncle Sam can’t afford for individuals and companies to shelter too much income when it comes to retirement savings as this reduces the tax revenue collected.  Common employer contributions included in the 415 Annual Addition Limit are employer match contributions, employer safe harbor contributions, and employer non-elective (profit sharing) contributions.

A 401(k) Plan may also permit Participants to make voluntary after-tax deferrals.  Voluntary after-tax deferrals are included in the 415 Annual Addition Limit but not in the 402(g) limit, creating an opportunity for savers to contribute more than $19,500 or $26,000 in 2021 for retirement.  401(k) Plan Participants may take advantage of this assuming income levels are sufficient to support higher savings.

Example 4: George participates in a 401(k) Plan.  George is under age 50 and may contribute $19,500 in 2021 (pre-tax and/or Roth after-tax) and save another $38,500 “after-tax” assuming George’s company does not make any company contributions (match, profit sharing) to reach the 2021 415 Annual Addition Limit of $58,000.

It is recommended that all Participants defer the maximum pre-tax and/or Roth after-tax contributions before saving after-tax money because of the preferential tax treatment as well as other potential advantages (such as being eligible for any company match).


After-Tax History:

Well before the concept of “Roth” was introduced as part of the Taxpayer Relief Act of 1997, many 401(k) Plans permitted voluntary after-tax deferrals to facilitate additional retirement saving opportunities for Plan Participants.  Back in 1997, the 402(g) limit was much lower ($9,500) and the age 50 catch-up contribution wasn’t introduced until several years later (2002).  Faced with less retirement savings capacity, opportunities to save more even with voluntary after-tax deferrals were desirable.

Although many 401(k) Plans delivered these additional savings opportunities, voluntary after-tax savings never achieved the same level of popularity as traditional 401(k) deferrals in large part because saving after-tax dollars is simply less affordable especially for non-highly compensated employees.  Unlike the Roth, which eventually replaced voluntary after-tax options in most plans, earnings attributable to voluntary after-tax contributions are taxed as ordinary income at distribution.

Perhaps the biggest detractor for 401(k) Plans offering voluntary after-tax deferral options is the annual discrimination testing requirement.  The specific test is referred to as the 401(m) Actual Contribution Percentage test (“ACP Test), which applies to company match contributions and voluntary after-tax deferrals.  As previously noted, typically very few non-highly compensated Participants can afford to max-out their 401(k) deferrals and save additional after-tax monies.  As a result, it’s common for ACP tests to fail resulting in after-tax deferrals having to be refunded back to highly compensated employees.

You might be saying, “Wait….our 401(k) Plan is a safe harbor plan….the discrimination test’s do not apply to us, right?”.  Unfortunately, the ACP test is not remedied by the safe harbor employer contributions that are used to satisfy the Actual Deferral Percentage Test (ADP Test).  Voluntary after-tax deferral contributions are ALWAYS subject to ACP Testing.

In summary, once Plan Sponsors were permitted to add Roth 401(k) deferral options to their 401(k) Plan, it immediately provided a better option for Plan Participants and the number of plans offering voluntary after-tax deferrals dwindled.  This brings us to the “Mega Backdoor” conversion strategy.

The “Mega Backdoor” strategy:

As mentioned previously, this conversion strategy works the same way as the “backdoor” Roth conversion but uses voluntary after-tax deferral contributions if permitted to a 401(k) Plan as the funding source.

A Participant in a 401(k) plan could maximize deferrals in 2021 by deferring up to $19,500 or $26,000 and save additional monies on a voluntary after-tax basis.  Once the voluntary after-tax deferral has been made, it is eligible for conversion to Roth assuming the 401(k) Plan permits In-Plan Roth conversions.

The income tax implications of this strategy could be minimal because the funding source was already taxed.  However, investment gains attributable to the voluntary after-tax source would be taxed as ordinary income at the time of conversion.  Depending on how long the voluntary after-tax monies remained invested in the plan prior to conversion, the taxation on the investment income may or may not be meaningful.

Here’s an example to illustrate why this is such an attractive strategy for Participants who can afford to save more for retirement:

Example 5: In 2021, a 401(k) Plan Participant named Mary, who is under the age of 50 and with a MAGI of $200,000, does not qualify to fund her Roth IRA.  Mary wants to save aggressively for retirement and is looking for additional opportunities.  Mary defers $19,500 in her 401(k) using either pre-tax and/or Roth after-tax deferrals.  In addition, Mary defers $20,000 into the plan as a voluntary after-tax contribution, and immediately converts this to Roth using the Mega Backdoor conversion strategy.

Mary has successfully contributed $39,500 into her 401(k) Plan, significantly exceeding her permitted 402(g) limit for 2021.  The entire amount Mary converted from voluntary after-tax to Roth will compound over time income tax deferred, and assuming the distribution is “qualified”, it will be distributed income tax free.

Technical Note– For distributions from any Roth source to be “income tax-free”, the distribution must be “qualified”.  A “qualified” distribution includes a two-part test:  part one is called the 5-year rule and part two is the age at distribution.  Assuming both parts are satisfied, monies distributed from Roth are income tax free.

Part One: The “five-year” rule is satisfied if the initial deposit into Roth remains invested in Roth (sometimes called a season-period) for a minimum of 5 consecutive calendar years.  For example, if an initial contribution into Roth is made anytime in calendar year 2021, the earliest an income tax free (“qualified distribution”) may occur is after January 1, 2026. Regardless of the timing of the initial contribution in 2021, the investor will be credited with the entire calendar year as the starting year for the 5-year rule.

Part Two: Individual must be over age 59 ½ for the distribution to be qualified (tax free)

 In-Plan Roth Conversion Tracking:

Every conversion from pre-tax or voluntary after-tax to a Roth 401(k) inside the 401(k) plan is required to have a separate five-year tracking period.  401(k) Plan Sponsors considering adding an In-Plan Roth Conversion feature should coordinate with their recordkeeper in advance to make sure all conversion amounts can be tracked separately.

Monies distributed from Roth 401(k) conversion sources that are not qualified distributions come with serious tax implications for Participants.  All earnings attributable to a Roth 401(k) distribution that is not a qualified distribution will be taxable.  If a participant requests a Roth distribution prior to age 59 ½, earnings are also subject to additional 10% excise tax penalties.

Example 6: In 2021, a 401(k) Plan Participant named George, who is 59 years old with MAGI of $200,000, does not qualify to fund his Roth IRA but wants to save aggressively for retirement.  George defers $19,500 into his 401(k) using either pre-tax and/or Roth after-tax deferrals.  In addition, George defers $20,000 into the plan as a voluntary after-tax contribution and immediately converts it to Roth using the Mega Backdoor conversion strategy.  The beginning year for the 5-year rule on this original $20,000 Roth 401(k) conversion is 2021, the first calendar year these monies may be withdrawn as a qualified distribution (tax free) is 2026.

Over the next three consecutive years (2022, 2023 and 2024) George converts additional voluntary after-tax contributions to Roth.  Assuming the George retires in 2026 when he attains age 65, only the first $20,000 Roth conversion that occurred in 2021 is a qualified distribution that satisfies the 5-year rule, thus eligible for tax free distribution treatment.  The other Roth conversions (2022, 2023, and 2024) can’t be distributed until each satisfy their own 5-year period before they become eligible for tax free distribution treatment.

ACP Test Implications:

As previously mentioned, voluntary after-tax contributions are subject to ACP Testing.  The ACP Test presents the biggest hurdle in terms of expected Mega Backdoor conversion strategy success because of the limitations placed on the voluntary after-tax deferral contributions made by highly compensated plan participants.

The ACP Test operates much the same as the ADP Test.  The ADP Test determines how much “on average” highly compensated employees (HCE’s) may defer each year relative to non-highly compensated employees (NHCE’s).  The ACP Test works the same way but applies to all voluntary after-tax employee deferral contributions and any employer match contributions. 

Example 7: ACP Testing Complications- In 2021, a 401(k) plan is amended to allow Participants to make voluntary after-tax deferral contributions into the plan.  There is no employer match.  During the calendar year very few NHCE’s defer using this voluntary after-tax feature.  This scenario is common as typically employees with income less than $130,000 (the IRS HCE threshold) cannot afford to save $19,500 or $26,000 plus additional voluntary after-tax monies.  For an ACP Test to pass, the average voluntary after-tax deferral rate among HCE’s is only permitted to be slightly higher than the average for NHCE’s

Sample Outcome- Assume only 1 employee who is a NHCE under age 50 can afford to save more than $19,500 in the plan and several employees who are HCEs utilize the voluntary after-tax savings option.  Because participation and average voluntary after-tax deferrals associated with the NHCEs is so low, the ACP Test fails, resulting in refunds of the voluntary after-tax deferrals made by HCE’s along with any investment gains.  The voluntary after-tax saving amounts HCE’s contributed to the plan to facilitate a Mega Backdoor conversion strategy are not permitted to remain in the plan.

If the HCE Participant converts voluntary after-tax contributions to Roth and later learns that these monies must be refunded because the ACP Test fails, all monies must be distributed from the Roth 401(k) source.

One retirement plan administrator shared a scenario that occurred further illustrating potential problems associated with a failed ACP Test.  A HCE made voluntary after-tax deferral contributions to their plan and converted these monies to Roth using the Mega Backdoor strategy.  Prior to the end of the year, the HCE terminated employment and initiated a direct rollover into their ROTH IRA.   At the end of the year the ACP Test failed meaning the rollover to the ROTH IRA was ineligible.  Technically all monies associated with the voluntary after-tax deferral contribution were required to be disgorged from the ROTH IRA rollover account.

If a 401(k) Plan allows for voluntary after-tax deferral contributions, it is possible the plan also permits these monies to be eligible for “In-Service” withdrawals, allowing Participants to rollover voluntary after-tax deferrals to a Roth IRA.  Same as the prior example, if there is a failed ACP Test, any voluntary after-tax deferral contributions rolled over to a Roth IRA would be ineligible and subject to disgorgement.

Plan Design Considerations:

Plan Sponsors interested in pursuing voluntary after-tax deferral contributions and a Mega Backdoor strategy could limit or completely restrict HCEs from utilizing the after-tax deferral feature to satisfy the ACP test.  Other ACP discrimination testing strategies such as using the “top paid” group election could also be used to promote better testing outcomes, but this will not guarantee “passing” results.

Either way, restricting participation in this strategy may be a difficult message for Plan Sponsors to send to their highly paid employees as these generally include key employees, executives, managers, corporate officers, etc.  Notably this is the target group of employees typically with “capacity” to save more using this strategy.

Lastly, administrative and communication considerations should be factored in when it comes to tracking HCE’s for “inclusion” or “exclusion” from one plan year to the next.  This is important to ensure that HCE’s who are not eligible for the after-tax deferral provision don’t “slip-in”, and other employees who are eligible for the provision understand their benefits and obtain prudent education.


Roth accounts may deliver significant benefits to individuals depending on their tax rates and financial planning goals.  Roth conversions can be initiated by anyone regardless of their modified adjusted gross incomes, making various conversion strategies very attractive especially to highly compensated employees looking for more “tax efficient” retirement saving capacity.

The recent press surrounding Mega Backdoor strategies within 401(k) Plans has garnered a lot of attention as a winning solution.  But given the restrictions noted in this paper, notably the ACP Test, it isn’t something that is easily achieved within a 401(k) Plan.

At Aegis Retirement Partners we specialize in designing and administering qualified retirement plans.  If you are interested in learning more about the Mega Backdoor strategy and other design features that could be a good fit for your business and your Plan’s Participants, please give us a call.

Aegis Retirement Partners, LLC

86 Baker Avenue Extension, Suite 309

Concord, MA 01742

(781) 604-9007

Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC.  Aegis Retirement Partners and Cambridge are not affiliated.  The information in this email is confidential and is intended solely for the addressee.  If you are not the intended addressee and have received this email in error, please reply to the sender to inform them of this fact.  We cannot accept trade orders through email.  Important letters, email, or fax messages should be confirmed by calling (781) 604-9013.  This email service may not be monitored every day, or after normal business hours.  These are the opinions of Doug Norberg and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized advice. Please be sure to speak to your financial professional to carefully consider the differences between your company retirement account and investment in an IRA. These factors include, but are not limited to changes to availability of funds, withdrawals, fund expenses, and fees.  Please speak to your tax professional regarding your unique circumstances. Cambridge does not offer tax advice. These examples are hypothetical and for illustrative purposes only. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principal.



IRS Announces 2021 Retirement Plan Limits

WASHINGTON — The Internal Revenue Service has announced that employees in 401(k) and 403(b) plans will be able to contribute up to $19,500 (unchanged from 2020) next year. The IRS announced this and other changes in Notice 2020-79, posted on This guidance provides cost‑of‑living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2021.

 Item  2021  2020  2019
401(k), 403(b), 457 Elective Deferral Limit  $19,500  $19,500  $19,000
Catch-Up Contribution Limit (age 50 and older)  $6,500  $6,500  $6,000
Annual Compensation Limit  $290,000  $285,000  $280,000
Defined Contribution Limit  $58,000  $57,000  $56,000
Defined Benefit Limit  $230,000  $230,000  $225,000
Definition of Highly Compensated Employee  $130,000  $130,000  $125,000
Key Employee  $185,000  $185,000  $180,000
IRA Contribution Limit  $6,000  $6,000  $6,000
IRA Catch-Up Contributions (age 50 and older)  $1,000  $1,000  $1,000


Highlights of Changes for 2021

The limit on contributions by employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan remains unchanged at $19,500.

The catch-up contribution limit for employees aged 50 and over who participate in these plans remains unchanged at $6,500.

The annual compensation limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan increased to $290,000 from the 2020 limit of $285,000.

The income ranges for determining eligibility to make deductible contributions to traditional Individual Retirement Arrangements (IRAs), to contribute to Roth IRAs and to claim the Saver’s Credit all increased for 2021.

Taxpayers can deduct contributions to a traditional IRA if they meet certain conditions. If during the year either the taxpayer or his or her spouse was covered by a retirement plan at work, the deduction may be reduced, or phased out until it is eliminated depending on filing status and income. (If neither the taxpayer nor his or her spouse is covered by a retirement plan at work, the phase-outs of the deduction do not apply.) Here are the phase-out ranges for 2021:

  • For single taxpayers covered by a workplace retirement plan, the phase-out range is $66,000 to $76,000, up from $65,000 to $75,000.
  • For married couples filing jointly, where the spouse making the IRA contribution is covered by a workplace retirement plan, the phase-out range is $105,000 to $125,000, up from $104,000 to $124,000.
  • For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $198,000 and $208,000, up from $196,000 and $206,000.
  • For a married individual filing a separate return who is covered by a workplace retirement plan, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

The income phase-out range for taxpayers making contributions to a Roth IRA is $125,000 to $140,000 for singles and heads of household, up from $124,000 to $139,000. For married couples filing jointly, the income phase-out range is $198,000 to $208,000, up from $196,000 to $206,000. The phase-out range for a married individual filing a separate return who makes contributions to a Roth IRA is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.

The income limit for the Saver’s Credit (also known as the Retirement Savings Contributions Credit) for low- and moderate-income workers is $66,000 for married couples filing jointly, up from $65,000; $49,500 for heads of household, up from $48,750; and $33,000 for singles and married individuals filing separately, up from $32,500.

Key employee contribution limits remain unchanged

The limit on annual contributions to an IRA remains unchanged at $6,000. The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.

*Cambridge does not offer Tax advice

Are You Aware of The New SECURE Act Provisions?

Aegis Retirement Partners is dedicated to keeping our clients up-to-speed on all of the latest SECURE Act news. Here’s the latest:

The SECURE ACT (Setting Every Community Up for Retirement Enhancement) was signed into law on December 20, 2019.  Recent CARES Act legislation passed to deliver relief to those impacted by Covid-19 may have upstaged the SECURE Act, but it is important to be aware of the new provisions.

Automatic Enrollment Deferral Limits Increase

Automatic enrollment (AE) plans were first introduced to plan sponsors in the Pension Protection Act (PPA) legislation passed back in 2006.  The popularity and utilization of automatic enrollment among 401(k) Plans continues to grow, and resulted in positive improvements in plan usage.

Under PPA, the maximum automatic enrollment deferral escalation was 10%.  The SECURE Act increases the cap to 15% of eligible compensation.  Plan Sponsors may take advantage of the new “maximum” cap for plan years beginning after 12/31/19.

Safe Harbor Adoption Timing Changes

A safe harbor plan is a great solution for Plan Sponsors looking to eliminate problems caused by testing failures.  One challenge, however, has been to identify potential testing issues early, because safe harbor plans are required to be adopted at least 30 days prior to plan year-end.  For testing problems identified after the end of a year, there has been no relief, until now!

To eliminate testing problems, The SECURE Act legislation permits Plan Sponsors to adopt a 4% nonelective safe harbor contribution as late as 12 months after the plan year ends.  It is important to clarify that this is not a safe harbor “match,” the 4% contribution must be made to all eligible plan participants.

Changes to Minimum Required Distributions (MRD)

The SECURE Act changed the age for MRD to Age 72. This regulation goes into effect on 01/01/2020. Participant’s under age 70.5 prior to 01/01/2020 will not be required to take their minimum required distribution until they attain 72 years of age.

If a participant is age 70.5 or older prior to 01/01/2020, and has already taken a MRD’s in a prior year, they are required to continue taking minimum required distributions (2020 CARES Act exemption not-withstanding).  Participant’s born after 07/01/1949 are subject to the new age 72 regulation.

Upcoming as of 01/01/2021– Long-term part-time employees will have a coverage requirement

This provision of the SECURE Act legislation is meant to provide some retirement plan access to long-term part-time employees who might otherwise be completely excluded from participation by the plan’s eligibility rules.

Beginning in 2021, employees who complete at least 500 hours of service for three consecutive eligibility (calendar year) periods are called “long-term part-time employees.”  Long-term part-time employees may not be excluded from making employee deferrals.  While they must be permitted to make deferrals, they may be required to meet traditional eligibility rules in order to qualify for any employer contributions.

If long-term part-time employees are permitted to receive employer contributions, separate vesting rules will apply using a 500-hour rule, instead of the traditional 1,000-hour requirement, which will require additional administrative & recordkeeping support for tracking.

Since the initial tracking period for long-term part-time employees begins in 2021, the first coverage period will not happen until 2024 (third consecutive eligibility period).

Withdrawal for birth or adoption of a child

The SECURE Act established a new form of distribution after 12/31/2019 for expenses related to Birth or Adoption of a Child.  The distribution must be taken within 1 year of the birth/finalization of an adoption. The maximum distribution amount is $5,000. This new provision applies to Defined Contribution, 401(k), 403(b), 457(b), Gov’t 457, and IRA’s.  The distribution would be exempt from the 10% excise tax penalty traditionally enforced on premature distributions.

Adoption of a Qualified plan up to tax return timeline change

The SECURE Act increases the length of time Employers may adopt a qualified plan and still deduct contributions, up to the due date of the employer’s tax return, including extensions.  Contributions are limited to employer contributions only, (no employee deferrals) prior to the adoption date of the plan.

Tax benefits for startups

The SECURE Act increased the Small Employer Startup Credit to entice more Small Employers (less than 100 employees) to sponsor a qualified retirement plan.  The new credit is the lesser of 50% of startup costs, the greater of $500, or the lesser of $250 times the number of Non-Highly Compensated Employees (NHCE), or $5,000.  The calculation is complicated, but here is an example:

A startup company with 30 Non-Highly Compensated Employees and startup costs of $12,000

Step 1. 30 NHCE’s X $250 = $7,500

Step 2. Lesser of Step 1 or $5,000 = $5,000

Step 3. Greater of Step 2 or $500 = $5,000

Step 4. Lesser of Step 3 or 50% of start-up costs = $5000


Please consult with your tax professional for additional details.

Updated Penalties

The IRS has increased its penalties for late filings.

  • Form 5500- increased from $25/day to $250/day, capped at $150,000
  • Form 8955-SSA- increased from $1/day to $10/day per participant, capped at $50,000
  • Withholding notice – increased from $1/day to $10/day per participant, capped at $50,000

The SECURE ACT clearly has a significant impact on the retirement world, and has broadened several plan provisions to add flexibility for plan sponsors.

Aegis Retirement Partners strives to provide the best customer service and the strongest plan design to our clients. If you are interested in more information on the SECURE Act, and what the new regulations will mean for you, please reach out to your dedicated account manager.

Questions about the Paycheck Protection Program (PPP)? Here’s the latest clarification:

The CARES ACT created a new small business loan program called the Paycheck Protection Program (PPP), which allows small businesses to obtain a loan to help cover payroll and business costs during the COVID-19 Pandemic. One of the main features of the PPP loan is that qualifying expenses incurred during the 8-week period provided by the PPP are eligible for full forgiveness as long as certain benchmarks are met. PPP funding that is not utilized during the eligible period, or falls into an ineligible expense category, is subject to loan provisions set forth by the Small Business Association (SBA), which include a 6 month delay period on the first repayment, and an interest rate of 1%.

The Paycheck Protection Program Flexibility Act (PPPFA) of 2020 was approved by the House on May 28, 2020, the Senate on June 4, 2020, and president on June 5, 2020. This Act is designed to enhance the Paycheck Protection Program (PPP) that was enacted under the CARES Act.

Highlights of the PPPFA are:

  • Extended forgiveness period – moving from 8 weeks to 24 weeks
  • Extend the June 30 rehiring and loan forgiveness deadline to December 31, 2020
  • Increases the current limitation of forgiveness on non-payroll related expenses from 25% to 40%
  • Extend the loan terms from two years to five years
  • Allow for full access to payroll tax deferment

Now that the PPPFA has been signed into law, the new SBA guidance will state that 60% of the total loan obtained through the PPP must be used towards authorized payroll costs to be eligible for full forgiveness. Included in these payroll costs is “The employer share of certain retirement benefits for employees.”  As of today, there has been NO guidance as to what constitutes the employer share of retirement benefits for employees, and not all retirement plan contributions are eligible.

Questions about whether this includes discretionary contributions, like certain match or profit-sharing plans, or only non-discretionary safe harbor types of contributions, are impossible to answer with certainty. New guidance based on the recently released PPP loan forgiveness form may allow certain 2019 employer contributions, made in the covered period, to be forgiven as part of the payroll cost. More information on this will be communicated as it becomes available.

Aegis Retirement Partners is continuing to monitor the situation as it unfolds and is committed to staying at the forefront of legislative changes to better serve our clients. In the meantime, we are happy to have this discussion with you if you are preparing your PPP loan forgiveness application. We also want to encourage you to contact your accountant and/or attorney for their interpretation if you plan to use PPP funding for qualified plan expenses.

If you have questions or would like to discuss specifics as it relates to your plan, please do not hesitate to contact your Aegis representative.

Partial Plan Terminations? Important Information For Plan Sponsors From Aegis Retirement Partners

With an increasing number of businesses currently being affected by the COVID-19 Pandemic, Plan Sponsors are facing new challenges. Many sponsors are taking unfortunate, but necessary steps to weather these events, such as suspending or reducing employer contributions, or laying off and furloughing employees. As a result, Partial Plan Terminations are becoming more common. If you are a Plan Sponsor who offers an employer contribution which is subject to a vesting schedule, there are important rules you should be aware of.

What is a Partial Plan Termination?

Though the Internal Revenue Code does not specifically define what constitutes a Partial Plan Termination, the Internal Revenue Service (IRS) will examine each case by the facts and circumstances looking for a significant reduction in the number of participants in the plan.

The two main factors that the IRS uses to make its determination are:

  • Percentage of reduction in participants
    • If the reduction is over 40%, it should be presumed that a partial plan termination has occurred.
    • If the reduction is less than 40%, but at least 20%, there is a rebuttable presumption that a partial plan termination has occurred. This determination has come down on both sides of the line.
    • If the reduction is less than 20%, there is a rebuttable presumption that a partial plan termination has not occurred.
  • Facts and Circumstances
    • Who is involved (vested and non-vested participants)?
    • Who initiated the terminations and what was the reason?
      • Even if an employee voluntarily terminated, they may still be counted toward the 20% benchmark if they did so with the belief they were going to be terminated.
    • What is the period of time?
    • Other significant facts or circumstances.


Consequences to a Partial Plan Termination

If your plan is deemed to have a Partial Plan Termination, all affected participants become immediately 100% vested in their funded benefits.


Why can this be an issue?

If an affected participant received a distribution from the plan prior to the determination, they may have been paid out with a portion of their employer contribution balance improperly forfeited.

These forfeited amounts, which may have been utilized to reduce employer contributions, or pay plan related expenses, are now due to the participant along with potential earnings assessed through the Employee Plans Compliance Resolution System (EPCRS).  See Fixing Common Plan Mistakes –  Vesting Errors in Defined Contribution Plans for more information.

What can be done to make sure this is handled the right way?

There are two widely accepted options:

  1. Immediately 100% vest all participants utilizing EPCRS for any participant affected with prior termination dates, and ensure that proper distributions are processed.
  2. Seek IRS determination. The IRS will review the relevant facts and circumstances to determine whether a partial plan termination has occurred. This involves filing the Form 5300, which also has a IRS filing fee, along with any preparation fees to your plan provider.

Are there any special changes or exemptions due to the COVID-19 Pandemic?

As of the date of this writing, there is no special relief due to COVID-19.

Many employers have asked whether rehiring all the participants who were laid off means a partial plan termination can be reversed. There are arguments for both sides of this issue. The conservative approach would be to fully vest participants, understanding the cost of doing so would be to forgo any forfeitures of non-vested employer contribution accounts, and follow EPCRS guidance if necessary.

Partial Plan Terminations can be very confusing, and the regulations surrounding them are vague.  Luckily, you are not alone. By engaging with your Third Party Administrator, Legal Counsel, and Tax Advisor, you can determine whether or not you have had a partial plan termination.  At Aegis Retirement Partners, we will work directly with our clients to ensure that whatever action is taken is appropriate in light of current legislation.

This document provides general information and shouldn’t be considered recommendations or legal advice.

For additional information, please visit the IRS website at

Helping Retirement Savers Affected by COVID-19

On March 27, 2020 the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was passed into law. The CARES Act is intended to deliver immediate relief to companies and individuals adversely affected by the pandemic COVID-19. Several provisions in the new law impact qualified retirement plans 401(k)/403(b), Gov’t 457, IRA’s, resulting in new withdrawal and repayment options, excise tax relief, and repayment holidays for new and existing plan loans.

What is the new withdrawal option provided by the CARES Act?

The corona-virus related distribution, referred to as a COVID-19 distribution, is the new withdrawal option included in the CARES Act legislation. COVID-19 distributions are intended to deliver immediate financial relief to participants negatively affected by the Coronavirus by permitting plan withdrawals subject to certain limits.

The COVID-19 distribution is unique because it comes with potential repayment options, relief from excise tax penalties, and flexibility on the timing of income tax payments. Participants must be qualified individuals to take advantage of the special provisions included in the CARES Act. Plan Sponsors must amend their plans to include the relief provisions designed in the CARES Act.

Who is a Qualified Individual?

A qualified individual is one who:

Was diagnosed with COVID-19 by a CDC recognized test.

Has a spouse or dependent diagnosed with COVID-19

Experienced adverse financial consequences as a result of being:

o Quarantined

o Furloughed or laid off

o Reduced work hours

o Unable to work due to lack of childcare as a result of COVID-19

o Reduced work hours due to the COVID-19 diagnosis of a business owner


COVID-19 Distributions

Are there limits to how much qualified individuals may request as a COVID-19 distribution?

Yes, there are limits. COVID-19 distributions may be as high as 100% of your vested account balance,

with a maximum withdrawal amount capped at $100,000. COVID-19 distributions must be taken on or before December 30, 2020.


Are there limits to the number of COVID-19 distributions qualified individuals may request?

No, if total COVID-19 distributions do not exceed $100,000 or 100% of the participants vested account balance, you can request as many COVID-19 distributions as you need including multiple plans/IRA’s.


Are COVID-19 distributions subject to taxes and/or penalties and if so when are they due?

A COVID-19 distribution is subject to ordinary income taxes unless it’s a qualified Roth withdrawal. It is NOT subject to excise tax (10%) penalties. COVID-19 distributions deliver flexibility on the timing of federal income tax payments. Guidance on state income taxes has not been provided so the following information pertains to federal income taxes only:

As a qualified individual, you may elect to receive COVID-19 distributions with no federal income taxes withheld. Normally, 20% must be withheld for federal taxes. The entire distribution will be subject to federal and applicable state income taxes at a future date.

Normally, distributions are subject to ordinary income tax during the applicable calendar year. But, if you need additional financial relief, you can elect to spread income tax payments over a three-year period. For illustration purposes let’s assume the COVID-19 distribution is $12,000, it is received in April 2020 and no monies have been withheld for taxes, here are your options:

Option 1. The COVID-19 distribution may be treated as ordinary income subject to federal and applicable state taxes in the year of the distribution (2020). Taxes on the $12,000 COVID-19 distribution will be payable on or before April 15, 2021 unless extensions apply.

Option 2. You may elect to spread income taxes on you $12,000 COVID-19 distribution over the next three years to reduce the amount of taxes due on or before April 15, 2021.

Your federal and certain state income taxes would include payment on one-third of the total distribution each year. Income tax on $4,000 ($12,000/3) resulting from the COVID-19 distribution will be due in 2020, 2021 and 2022.


Can I repay my COVID-19 distribution as soon as my financial situation improves?

YES! This is one of the most innovative features included in the CARES Act because qualified individuals who need money “now” for financial emergencies can get it and repay their accounts within a certain time frame to avoid taxation. This critical feature enables savers to keep their “nest eggs” intact and growing for their future retirement income needs. COVID-19 distributions are designed to provide immediate relief for what everyone hopes will be a temporary financial crisis.

You can repay COVID-19 distributions to your plan or IRA entirely or partially up to three years beginning on the day after you receive the distribution.

Here are some examples of receiving a $12,000 COVID-19 distribution on April 30, 2020:

On or before December 30, 2020 you may elect to repay the entire distribution back to the retirement plan or IRA to avoid paying income tax on the entire distribution in 2020.

If you need additional time to repay your account, you may choose to recognize 1/3 of the income over three years in equal payments. In this example, that means paying back $4,000 per year.

Any portion of the distribution you pay back in each tax year by the due date for filing (including extensions) reduces your taxable income for that year. Therefore, if in 2020, if you only repay $1,500, then $2,500 of income is subject to income tax in 2020 [$4,000-$1,500]. Special tax forms will be required to be filed and you should coordinate with a tax professional.

Special Note: If in 2021 or 2022 you make repayments in excess of $4,000, the excess amount can be used to adjust your 2020 income tax by filing an amended income tax return.


Loan Policy Changes

Does the CARES Act deliver relief for qualified individuals with existing loans or those who need additional loans?

YES! The CARES Act includes payment relief to qualified individuals with existing outstanding loans as well as additional loan capacity to reduce short term financial burdens.

These provisions deliver “relief”, but they do not eliminate or waive loan repayments entirely. Each provision requires Plan Sponsor approval and amendments which are considered on a plan by plan basis. Please contact your plan administrator to learn what options are available. The loan provisions are complicated, you are strongly encouraged to consult with your financial advisor and/or tax professional for assistance.

1. Loan Limits- The CARES Act loan limits for qualified individuals have been increased to the lesser of 100% of vested account balance or $100,000.

Plan Participants who are not “qualified individuals” are subject to traditional IRS loan limits which are the lesser of 50% of vested account balance or $50,000 respectively.

2. Loan Repayment Relief- The CARES Act provides a payment holiday for qualified individuals with existing loans of up to one year. Interest on all loans continues to accrue while payments are suspended, but the payment grace period offers participants a better chance to recover from the COVID-19 economic crisis. Here are some scenarios;

a. As a qualified individual and Plan Participant, you may request a loan in April 2020. Interest on the loan begins to accrue immediately. However, loan repayments will not start until April 2021.

b. Qualified individuals with outstanding loans may request to have their loan repayments suspended immediately for up to one year. When payments commence, the additional interest accrued will be amortized and added to your remaining payment schedule. For example, if you have three years of loan payments left, you will still have three years of loan payments this time next year.

3. Loan Defaults- Loans that are not fully repaid will become taxable and may be subject to the 10% early withdrawal penalty if defaults occur after December 30, 2020.


Common Plan Withdrawal Options

Does the CARES Act impact common “in-service” withdrawals?

NO The CARES Act has no effect on in-service withdrawal plan features. However, you should plan carefully if you have been impacted by COVID-19 because alternative distributions may be more favorable.

In-service withdrawals typically apply to actively employed participants who are age 59 1/2 or older. Not all plans offer these options. In-service withdrawals are subject to ordinary income taxes excluding qualified Roth distributions. But, they are not subject to IRS 10% early withdrawal penalty.

All in-service distributions are subject to mandatory income tax withholding (20% federal), and applicable state income taxes.

All in-service withdrawals are subject to taxes in the calendar year of the distribution.


Does the CARES Act impact Hardship Withdrawal?

NO The CARES Act has no effect on plan hardship withdrawals. However, you should plan carefully because alternative distribution methods may be more favorable.

Hardship withdrawals are only available to actively employed participants. The amount of the hardship is limited to what is required to satisfy very limited financial needs, for example, to prevent eviction or mortgage foreclosure from your primary residence. This is a taxable distribution subject to the  except in certain medical circumstances.

At the time of hardship distribution, a participant may elect to have NO federal or state income tax withheld. Absent an election, a default 10% federal tax and any applicable state income tax are required to be withheld.

Any hardship withdrawal is subject to ordinary income taxes plus excise tax penalty if applicable in the year of distribution.


Does the CARES Act impact Termination of Employment Withdrawals?

NO The CARES Act has no effect on terminated employees. Former employees may request their account balance anytime. If they are qualified individuals, they may avoid current taxation and penalties as described above. If they are not qualified individuals, distributions will continue to be subject to ordinary income tax and excise tax penalty if applicable as well as mandatory IRS withholding

Coronavirus Aid, Relief, and Economic Security Act (CARES Act) is Now Law

On Friday March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act is a stimulus package that provides financial relief to businesses and individuals during this unprecedented pandemic.

You can access the CARES Act in its entirety (800 pages) through the link provided at the end of this document. However, the paragraphs below outline the components that pertain solely to your retirement plan, and how Aegis is facilitating the necessary compliance for our clients.

1. COVID-19 Withdrawal: This is a NEW distribution option that deals specifically with the coronavirus. This new distribution is available immediately to a participant who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19); whose spouse or dependent is diagnosed with such virus; who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off or having work hours reduced due to such virus; being unable to work due to lack of child care due to such virus; or closing or reducing hours of a business due to such virus. A participant may take a distribution of up to the lesser of 100% of their vested account balance or $100,000. Unlike most distributions taken under the current hardship distribution rules, the 10% early withdrawal penalty DOES NOT apply to this distribution.

Two additional features meant to reduce the financial tax impact of this withdrawal have been included in the CARES Act.

  1. Unlike hardship withdrawals where the taxation applies in the year the withdrawal is taken, taxation for this distribution can be spread out over 3 year.
  2. If elected, participant withdrawals may be repaid PRETAX all or in-part within 3 years from the date of the withdrawal.

Notably, prior distributions taken since January 1, 2020 will qualify for this favorable tax treatment if all other conditions above are met. Finally, no documentation is required. A participant can “SELF-CERTIFY” that they are eligible for the withdrawal.

2. Participant Loans: The CARES Act enhances loan provisions; they apply to existing loans as well as to any new loan taken. The maximum amount that may be taken as a loan is now the lesser of $100,000 (previously $50,000) or 100% (previously 50%) of a participants vested account balance. If a participant meets the qualifications for a COVID-19 withdrawal (from #1 above), repay ments may be SUSPENDED for one year. Interest that accrues on the loan will simply be added to the outstanding loan balance and the payment will be re-amortized by adding on 1 additional year to the original loan end date. These repayment changes are OPTIONAL and may be applied on a participant by participant basis.

3. Required Minimum Distributions: Required minimum distributions (aka Age 70 ½ or 72 distributions, depending when the participant was required to begin taking) in 2020 are WAIVED. If a participant has already taken their 2020 required minimum distribution, this distribution is now eligible to be rolled over to an IRA or an eligible retirement plan (your Plan) if it can be rolled over within 60 days of the distribution.

When Aegis sponsors your Plan document, we prepare the necessary amendments to ensure compliance with any changes from Washington. All plans will need to be amended no later than the last day of 2022 Plan year. We are working closely with our record keeping partners to ensure the features included in the CARES Act can be accommodated on their systems as soon as possible.

Please let us know if you have any questions. We will get through this crisis, we always do. In the meantime, thank you for your support, please stay safe and be healthy.

The complete CARES Act is located at: