Previously we discussed the benefits of adding traditional after-tax contributions to retirement plans as a mechanism for high earners or high savers to build up Roth dollars in the plan. Another benefit to allowing after-tax dollars in the retirement plan is that it allows individuals in the plan to use the after-tax funds as emergency savings.
Emergency Savings: The New Must-Have Plan Design Feature?
How does it work?
First, the plan would need to be amended to allow for after-tax contributions (and high earners in the plan would need to understand the pros and cons of the feature).
Then, employees can contribute some money on an after-tax basis to their 401(k) plan, in addition to the pre-tax or Roth contributions they have been making. It can be invested in the same manner as the rest of their account (or if the recordkeeper can accommodate, it can be invested separately). Those contributions can be withdrawn at any time, i.e., if an unforeseen financial emergency occurs. Remember that the earnings will be taxed.
If the funds are not needed, they can be converted to Roth, allowing the earnings to grow tax-free.
Finally, it’s up to the plan sponsor to communicate to employees the after-tax contributions as an emergency savings feature. This feature can be a little confusing at first, but with focused education, employees can reap the benefits of this savings approach.
Take Action: It’s a Win-Win!
2020 has reinforced the need all Americans have for an emergency fund. Whether that be in a traditional bank account, a qualified retirement plan, or both, workers should have three to six months of expenses saved at any given time.
Studies have also shown that the more automated savings can be, the more likely employees are to utilize it.
As a plan sponsor, allowing ALL employees the ability to put money into the plan on an after-tax basis is a win-win! Here’s why:
- If the employees don’t withdraw the funds for an emergency, they can always convert them to Roth and they have that much more saved for retirement.
- Accumulating these after-tax contributions helps plan testing results for those high earners/high savers that are using after-tax as a backdoor Roth.
- Constructing the plan this way makes savings a simple payroll deduction. The more automated (and “painless”) the process, the better likelihood of improved savings outcomes.
Offering a retirement plan benefit is all about helping employees build a secure financial future. If you’re seeking ways to improve employees’ savings, reach out to the team of experts at Francis Investment Counsel. Our decades of experience in designing the best retirement plans possible is coupled with engaging employee financial education and advice. Working together, we can help employees make decisions that maximize their savings. Reach out to us directly or fill out the form below to get started.
