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Voluntary Contributions - Probably Not a Fit for Your 401(k) Plan

Eric Droblyen

March 13, 2024


Voluntary 401(k) contributions are a form of after-tax contribution like Roth elective deferrals, but subject to different ERISA rules. Under normal circumstances, the earnings on voluntary contributions cannot be distributed from a 401(k) account tax-free like Roth deferrals. However, thanks to IRS Notice 2014-54, voluntary contributions can be rolled into a Roth IRA, where future earnings can be distributed tax-free.

Notice 2014-54 got a lot of people excited about making voluntary contributions to their 401(k) plan. Why? They are subject to a much higher annual contribution limit than Roth deferrals ($69,000 vs. $23,000 for 2024). By utilizing this higher limit, a retirement saver can pump additional after-tax contributions into their 401(k) plan and then roll them into a Roth IRA for tax-free growth.

This tax saving strategy received lots of coverage in the media - including the New York Times and Morningstar. However, most of the coverage has just focused on the awesomeness of making larger after-tax contributions than Roth limits allow and then growing them tax-free inside a Roth IRA. The limited applicability of the strategy was rarely explained.

The “Mega Back Door” Roth IRA Contribution

Roth IRAs are subject to relatively low contribution limits, based on the income of the taxpayer. Rollovers from a 401(k) plan into a Roth IRA are a different story – they have no dollar or income restrictions. As such, these rollovers are often called a “back door” Roth IRA contribution.

Given the very high contribution limits attributable to voluntary contributions, their rollover has been coined a “mega back door” Roth IRA contribution.

Nondiscrimination Testing Can Severely Limit Voluntary 401(k) Contributions

Voluntary contributions are rarely viable in 401(k) plans that benefit both Highly Compensated Employees (HCEs) and non-Highly Compensated Employees (non-HCEs) due to their impact on the Average Contribution Percentage (ACP) test.

The ACP test compares the average contribution rate for plan HCEs to the non-HCE average. This test fails when the HCE average exceeds the non-HCE average by more than the legal limit. In a traditional (non-safe harbor) 401(k) plan, both employer matching and voluntary contributions are tested. In a safe harbor 401(k) plan, just voluntary contributions are (usually) tested.

Regardless of whether your plan meets the safe harbor provision or not, voluntary contributions are almost always included in nondiscrimination testing. Essentially, voluntary contributions negate the “free pass” you would otherwise receive in the ACP test, meaning your HCEs would very likely be significantly limited in their ability to do “mega back door” Roth IRA contributions.

Additionally, safe harbor 401(k) plans lose their top heavy test “free pass” when voluntary contributions are made. That could make additional top heavy minimum contributions to “non-key” employees necessary.

As such, voluntary contributions are rarely worth the trouble when a 401(k) plan covers non-HCEs due to their impact to annual IRS nondiscrimination testing.

Solo 401(k) Plans are the Best Candidates

Owner-only (or “solo”) 401(k) plans are generally the best candidates for voluntary contributions. Why? With no common law employees, they automatically pass ACP and top heavy testing.

“Mega Back Door” Roth IRA Contribution are exciting for those that can afford them, but unfortunately, most 401(k) plans can’t support the voluntary contributions to make the strategy work.

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