The BP Employee Savings Plan (ESP) is an excellent resource for savings, but if your goal is to max out contributions to it, you must closely monitor your contributions to the plan. Why?
The BP ESP has a unique feature that allows for contributions to spill over within the plan from one tax pool to another tax pool. In itself, this spillover is not a bad thing. However, if you do not monitor where your contributions are going, you may be missing an opportunity to maximize your savings benefit from the plan.
401(K) Contribution Sources: Pre-Tax, Roth, and After-Tax
There are three tax pools within the BP plan: Pre-Tax, Roth, and After-Tax.
Pre-Tax in the 401(K)
When contributing to the pre-tax 401(k) sources, your contributions go to the 401(k) before any taxes come out of your paycheck. The growth of this contribution grows tax-deferred. You pay ordinary income tax on the contribution and the growth when withdrawn.
Contributing to the pre-tax source is advantageous because you can defer taxes during your working years. You realize the tax benefits immediately because your effective tax rate discounts each dollar you contribute.
For example, if your effective tax rate is about 20%, a $1,000 contribution only costs you $800 after-tax.
Making pre-tax contributions can be tax-beneficial during your wage-earning years when your income is likely at its highest. And, because this amount is deducted pre-tax from your withholding, it can be beneficial for your current cash flow.
Roth in the 401(K)
When making Roth contributions in your 401(K), your taxes come out of your paycheck before any 401(K) contributions. The growth on this contribution is tax-free (as long as you hold it for five or more years). Contributing to the Roth source is advantageous because you are hedging against future taxes in your retirement years. The tax benefit is realized in retirement years, not immediately.
Your after-tax contribution is taxed immediately, so a $1,000 contribution costs $1,000 regardless of your tax rate.
%20Comparison.jpg?width=600&height=338&name=Pre-Tax%20vs.%20Roth%20Contributions%20to%20401(k)%20Comparison.jpg)
Non-Roth After-Tax Contributions in the 401(K)
The third contribution source in the BP ESP is after-tax. Like Roth, your contributions come from your paycheck after taxes have been withdrawn. However, the growth of your contributions is tax-deferred, like pre-tax. So, when withdrawing from this tax pool, your contribution will come out tax-free, but any growth from the contributions will be taxable at ordinary income rates. The tax advantage here is nuanced. You pay the tax up-front on contributions during your wage-earning years, and you pay taxes on the growth during retirement.
However, there is a strategy to improve this tax pool's tax advantage, which is why monitoring the contributions is essential.
BP 401(K) Contribution Limits
You must be aware of the IRS' annual contribution limits for each source to help monitor your contributions to the BP Employee Savings Plan.
- Pre-Tax & Roth - In 2023, the contribution limit for pre-tax and Roth contributions is $22,500. You can contribute up to $22,500, all pre-tax, all Roth, or any combination of pre-tax and Roth.
In 2022, the contribution limit was $20,500 for funds put towards the pre-tax or Roth sources in the 401(K). - Catch-Up Contribution (for pre-tax and Roth) – In 2023, those who are attaining the age of 50 this year or older can contribute and additional $7,500 in pre-tax or Roth contributions in any combination. In other words, those 50 years of age and above can contribute $30,000 to pre-tax, Roth, or a combination of pre-tax and Roth.
In 2022, the catch-up contribution limit was $6,500, which means those aged 50 and over could contribute up to $27,000 to the pre-tax or Roth source in the 401(K). - (Non-Roth) After-Tax – This contribution varies based on several factors, including age, your 401(K) contributions, and BP's company match amount to your 401(K).
The IRC 415(c) total contribution limit is the limit under the tax code that caps all contributions made to your 401(k) account by you and BP. 2023's limit is $66,000, not including the $7,500 catch-up contribution. With your pre-tax, Roth, or after-tax contribution and BP's 7% contribution, $66,000 can be contributed to your 401(k) account in 2023 ( or $73,500 for those 50 and older with the catch-up contribution.)
BP's 401(K) Match
Because one component of the contribution limits above is BP's contribution of 7% of your base and bonus cash compensation, the amount you earn can affect how much non-Roth after-tax contribution you can make to the plan.
BP will make a 7% match up to when an employee earns $330,000 of cash compensation (base and bonus compensation excluding Share Value Plan stock awards).
If you make $330,000 or more in 2023, BP contributes 7% of $330,000 or $23,100 to your 401(K).
If you made $305,000 or more in 2022, BP's 7% match would max out at $21,350 for the year.
Suppose you make more than $330,000 in cash compensation. In that case, BP puts the remaining contribution into another plan which we will discuss below. If you contribute $22,500 (net of catch-up contribution) to pre-tax or Roth, and BP contributes $23,100, $45,600 is being contributed to your 401(k) account. If the total 415(c) limit is $66,000, you can contribute $20,400 non-Roth after-tax to the 401(k).
What if your base and bonus compensation is less than $330,000? If your base and bonus are $230,000, then BP's 7% match is $16,100. If you contribute $22,500, your total 401(k) contribution is $38,600. That means you can contribute $27,400 non-Roth after-tax to your 401(k).
Spillover Effect in the BP ESP 401(K)
Here is where you need to monitor your contribution:
If you take a set-and-forget approach with the ESP, you may contribute to after-tax without electing to do so. You may also push BP's contribution out of your 401(k) account.
How Does a Spillover Happen in a 401(K)
If you hit the $22,500 limit for pre-tax or Roth ($30,000 with the catch-up contribution), your contribution does not cease.
Without an election adjustment, your contribution continues to be made to the after-tax pool. Why is this important? Tax planning.
As with Roth contributions, you contribute to the non-Roth after-tax pool with dollars on which you have already paid tax. However, your contribution will not grow tax-free.
On withdrawal, you will pay no tax on the contribution, but you will pay ordinary income tax on the growth of the after-tax contribution.
How To Fix an After-Tax Spillover in the BP 401(K)
- Refund.
Apply for and receive a refund of your after-tax contribution by the primary tax filing deadline – April 15, 2024. The refund must be issued by this date, or it will be deemed a penalty-effective withdrawal. As such, you must make the refund request before the deadline for Fidelity, the 401(k) administrator, to effect it in time. - In-Plan Conversion.
You can elect to have the after-tax amount converted to the Roth tax pool within the 401(k). You can contact Fidelity to convert the existing after-tax balance and create a plan to convert future contributions. These steps allow your after-tax contribution to receive tax-free growth in the future. - An After-Tax Rollover
When executed properly, the after-tax rollover can be a helpful way to clean up the after-tax source in a 401(K) so that growth funds go into a Roth IRA and contribution funds move into a traditional IRA. We discuss this strategy more at length below.
With each of these options is one significant caveat: If there is growth on the existing balance, you will have to pay tax on that amount immediately. For instance, if you have an accrued after-tax balance of $120,000 and your contribution to the pool was $40,000, you would immediately pay tax on $80,000. Avoiding this is crucial as it could throw you into another tax bracket during your earning years or subject you to net investment income tax.
Benefits of an After-Tax Rollover in the BP 401(K)
The third option for addressing an after-tax spillover is the one we often work with BP clients on. When our clients from BP come to us with excess after-tax funds, we work to ensure the after-tax rollover is executed properly to avoid a taxable event. While the steps seem simple at a glance, there are numerous nuances that require experienced attention to do correctly.
- Roll After-Tax Contributions to a Roth IRA & After-Tax Growth to an IRA
Instead of doing an in-plan conversion, you can roll your after-tax contribution to a Roth IRA. While the rollover may seem more difficult, it has two significant advantages comparatively. And we help our BP clients with this procedure frequently.
When doing the rollover, the after-tax pool can be bifurcated to separate the after-tax contributions and the after-tax earnings. The after-tax contribution rolls over to a Roth IRA when it is singled out. Meanwhile, the after-tax earnings roll into a regular, traditional IRA. Doing this rollover offers the opportunity to accrue tax-free growth on your after-tax contribution in the future, and you avoid the immediate realization of income tax on the transaction. - Additional Investment Options for the Funds
When your funds are in a Roth IRA or IRA account, you have more investment options than with the index and target funds available in the BP Employee Savings Plan platform. So, in addition to this rollover being more tax advantageous, it's an opportunity to diversify your investment pool.
Because of the advantages an after-tax rollover offers, we often encourage our BP clients to make after-tax contributions deliberately. Then, we assist our clients with rollovers on at least an annual basis. In doing this, they can maximize their pre-tax option in the 401(k), which provides current tax savings, and build a strategic Roth bucket for retirement.
Spillover Effect to a Non-Qualified Plan
As we mentioned earlier, you can push your BP match out of the 401(k) if you contribute too much. How?
In our example above, for someone earning $330,000, we showed that they could contribute $22,500 pre-tax or Roth and $20,400 after-tax maximum for a total of $42,900 total. BP contributes $23,100, or 7%, to the plan (exclusive of catch-up), bringing the 401(k) total to $66,000.
What if someone contributes more than $42,900 to their ESP account? BP still matches $23,100, but not all the contributions go to the 401(k).
Let's consider a BP professional, age 49, who makes a $260,000 base and $95,000 bonus for a total of $355,000 cash compensation. This professional elected an 18% pre-tax deferral to the BP ESP. After semi-monthly paychecks and the bonus payout in March, the employee would have contributed $22,500 (the limit of her pre-tax contribution and her allowable pre-tax catch-up contribution) to the 401(k) by mid-April.
She does not elect to change or stop her contribution, and her pre-tax election is now being made after-tax to the 401(k). Her take-home pay shrinks a little because her contribution is being taxed, but she is a busy BP professional and doesn't give much attention to the change.
After additional contributions, she has contributed a total of $44,400 pre-tax and after-tax by the end of April, just over the $42,900 aggregate contribution limit mentioned earlier. However, her contribution continues beyond this point. Instead, the 7% match BP is making to her 401(k) is pushed out of the 401(k) into a non-qualified plan called the Excess Benefit Plan (EBP). In short, this is not optimal because this plan is less flexible for planning purposes.
Additionally, because her cash compensation tops $330,000 in December, BP will contribute the additional funds to another non-qualified plan called the Excess Compensation Plan (ECP). The ECP has the same planning limitations as the EBP. While she cannot avoid the $4,500 (18% of the amount exceeding $330,000) going towards the ECP, she can monitor and adjust her elections throughout the year to avoid EBP contributions. Doing so would ensure that most of BP's contribution stays in the ESP instead of rolling into a non-qualified bucket.
Monitoring and Action
What can you do to make the most of your 401(k)?
As we have discussed, your contribution election for the 401(k) has several ramifications due to the spillover provisions of the BP ESP. Your actions can help you maximize the benefit of the BP ESP and be more efficient in your overall financial planning.
Action 1. Carefully set your initial contribution election based on your projected base and bonus for the year. You want to be sure to contribute to the plan fully, but you want to avoid unintended spillovers.
Action 2. Monitor your total contributions to the plan. A significant performance factor on your bonus or a pay raise could push your original contribution election out of line with your intentions. You can see your contributions on your pay stubs.
Also, in your NetBenefits portal, you can see the total of your contributions and your current election on the main page under the ESP.
Action 3. Take action.
- Adjust your elections as necessary.
- Roll your after-tax contributions to a Roth.
- Hire a professional to help determine the best strategy, monitor the plan, and help execute the actions needed
Not all financial advisors have experience with BP's various benefit plans. We've helped several BP professionals and guided them through the nuances of BP's ESP, ECP, and EBP plans. Willis Johnson & Associates demonstrates the leveraged advantage of engaging us for strategy, guidance, and action on your BP benefits.
Our advisors are fiduciaries working in your best interest and can provide you with a tailored plan to reach your financial goals. Contact us for a complimentary, hassle-free first meeting where our advisors can learn about your current goals and help you develop a tailored plan to achieve them.
