One of the most common New Year's Resolutions is to save more money or save more in a tax-efficient manner for retirement. If saving smarter in your Chevron ESIP 401(k) plan is on your mind this year, you can leverage a few crucial opportunities to get on the right track. So, let's dive into the most common pitfalls and opportunities in Chevron's ESIP.
Determine ESIP Contributions Early Based on Your Expected Salary & Bonus Compensation for the Year
With a full year ahead of salary and bonus, the beginning of the year is a great time to check in on your contribution percentages in the ESIP. We often recommend that our Chevron clients set their Pre-Tax or After-Tax contribution percentages at the beginning of the year using their known salary and expected bonus. But once you reach bonus season, it's important to re-evaluate how much you have contributed to the ESIP and determine if you need to change the percentages. In a year when bonuses are much larger than anticipated, like we expect 2023 to be, keeping an eye on contribution elections is even more important!
Setting Your Pre-Tax Contributions to Receive the Chevron Company Match
To illustrate, let's take the example of a 48-year-old Chevron employee, Alden, with a salary of $246,000 and a target bonus percentage of 30%, an expected total of approximately $319,800. Alden wants to maximize his 401(k) contributions this year and get the full Chevron match to ensure he is on track for retirement.
In 2023, he can contribute up to $22,500 to his ESIP's Pre-Tax source. To do so, he sets his Pre-Tax Basic contributions to 2% and his Pre-Tax Supplemental contributions to 10%, which he expects will get him to a total of $22,500 by year-end.
Learn more about Chevron’s 401(K) Match here >>
Determining Your After-Tax Contributions in the ESIP
Alden also feels good about his income and ongoing living expenses and wants to maximize his After-Tax contributions to the ESIP. He's heard about a financial planning strategy called the Mega Backdoor Roth that allows high-income earners like him to get additional savings into a Roth each year.
As such, Alden decides to set his After-Tax contributions to 10% to get as much money into his 401(k) as possible, up to the $66,000 limit for 2023. While Alden's efforts to save more in his 401(k) put him several steps ahead of many Americans in setting himself up for a secure retirement, it's more complex than it seems. Unknowingly, Alden also set himself up for mistakes we often see within the Chevron ESIP plan!
Avoid These Common Pitfalls When Planning an After-Tax Rollover
Let's start with the good: Alden maxed out his Pre-Tax contributions to the ESIP and got $22,500 into the plan. However, he does so by June. While in some other company 401(K) plans, frontloading contributions is advised, at Chevron, it means that Alden has made a substantial planning error.
1) Don’t Overcontribute to the After-Tax Source
By June, Alden has yet to receive the full Chevron match, so his Basic contributions automatically convert over to the After-Tax source. This way, Chevron can continue making contributions on his behalf. It's no big deal, right? Not quite. Since Alden contributes 10% of each paycheck to the After-Tax Supplemental source, he overcontributes to his ESIP Plan because his After-Tax Supplemental contributions do not automatically shut off when he reaches the 401(K) limits. The overall 401(k) limit in 2023 is $66,000 for an individual under 50, but Alden contributes $82,615, an over-contribution of $16,615.
Alden will have to notify the 401(K) plan immediately that he has overcontributed and have the excess removed (what a pain!). Additionally, even though the funds are After-Tax contributions, any growth on his contributions will be taxable to him. As a result, in his effort to save more, he incurs more taxes!
As if that wasn't bad enough, Alden also set himself up for another double-taxation situation. Alden set his Pre-Tax contributions high to max out early in the year. However, once he hit the 401(k) limit for an individual under 50 ($22,500), his Basic contributions switched to After-Tax Basic to keep collecting the Chevron match. Any growth on these funds is also taxable.
2) Time Your After-Tax Rollover to Avoid the 401(K) Contribution Freeze
As mentioned earlier, one of Alden's goals is to take advantage of the Mega Backdoor Roth strategy and start rolling his After-Tax 401(K) money over to his Roth IRA. After diligently building his after-tax source in 2023, Alden calls Fidelity at the beginning of 2024 to roll over his After-Tax. However, there's a catch. If Alden decides to roll out his Basic After-Tax source, Chevron's 401(K) contributions will freeze for 90 days! Alden wants to ensure that he receives all his company contributions to his 401(k), so he decides not to roll out his Basic source.
3) Prioritize Pre-Tax or Roth to Minimize After-Tax Contributions & Growth
Another strategy he could leverage is spreading his Pre-Tax Basic contributions more evenly over the calendar year to receive no After-Tax Basic contributions. While this approach would negate Alden's ability to use the Mega Backdoor Roth strategy, it also negates the headache of managing and watching the after-tax source in the 401(K). The ESIP is a complex and unique 401(K) plan, so checking in on contributions multiple times throughout the year is crucial to avoid unnecessary taxes or overcontributions!
4) Watch Out for the Pro-Rata Rule Rule to Avoid Extra Taxes
Let's suppose Alden decides ONLY to roll out the Supplemental After-Tax, as it does not freeze company contributions. He also chooses to roll the entire After-Tax Supplemental source to his Roth since the growth (taxable portion) was insignificant.
|
After-Tax Supplemental - Contributions |
$15,365 |
|
After-Tax Supplemental - Growth |
$2,305 |
|
Total Funds in After-Tax Supplemental |
$17,670 |
However, Fidelity gives him completely different numbers for which funds are taxable and non-taxable. Alden is perplexed. Here's what happened:
Alden and most Chevron employees don't realize that there is a pro-rata rule on 401(K) plans for After-Tax funds.
What is a Pro-Rata Rule?
The pro-rata rule says all After-Tax accounts are treated as one. Therefore, Alden's two after-tax sources (Basic & Supplemental) are treated as one. Let's take a look at the funds in Alden's After-Tax Basic source.
| After-Tax Basic Contributions | $2,551 |
| After-Tax Basic Growth | $382 |
| Total Funds in After-Tax Basic | $2,933 |
This pro-rata rule means that any funds Alden converts to Roth will be taxed proportionally according to the amount of pre-tax and non-deductible funds Alden converts. As a result, if done improperly, Alden could pay taxes twice on this conversion.
If we look at the funds across both of Alden's After-Tax sources, they break down as follows:
| Tax Treatment | After-Tax Basic Source | After-Tax Supplemental Source | Total Funds |
| Contributions (Non-Taxable) | $2,551 | $15,365 | $17,916 Non-Taxable Funds |
| Growth (Taxable) | $382 | $2,305 | $2,687 Taxable Funds |
| Total in After-Tax Funds |
$2,933 | $17,670 | $20,603 |
Tax Impact of the Pro-Rata Rule
Alden expects the rollover breakdown of the After-Tax Supplemental funds to be $17,670, with $15,365 being non-taxable and $2,305 being taxable, as reflected in our first chart. But the pro-rata rule states that you must include all After-Tax funds when calculating the taxes. If we look at the second table, he still has approximately $2,933 in unwithdrawn After-Tax contributions and growth left in the Basic source which contributes to the total value of the after-tax sources.
Therefore, the IRS will calculate his taxes as follows:
Unwithdrawn After-Tax Contributions / Total Value of After-Tax Source
$2,551 / $20,603 = 12% non-taxable/taxable ratio applied to non-taxable funds in the after-tax sources unless he rolls out ALL After-Tax Funds
Let's look at Alden's non-taxable and taxable split using this calculation. If he withdraws the entirety of his After-Tax Supplemental funds, totaling $17,670, the resulting split is as follows:
Of the $17,670 total in After-Tax Supplemental
12% is non-taxable: $2,120
Remaining taxable amount: $15,550!
He increased his tax bill by $13,245 because of the pro-rata rule on the money he already paid taxes on! However, his concern about rolling the After-Tax Basic source is that Chevron 401(K) contributions will freeze. What can he do?
Time 401(K) Contributions Around Income & Contribution Limits Each Year
There are a few things Chevron employees can do to ensure they get the total amount into the ESIP in a given year.
Max Out Contributions Before Reaching 401(k) Income Limits, then Perform After-Tax Rollover
Considering Alden's scenario, he can wait to roll out his After-Tax Basic source until he reaches the 415 income limitations ($330,000 in 2023) and fully maxes out 401(K) contributions. Once he reaches the income or 401(K) contribution limits, he won't receive additional company contributions, so the "ESIP freeze" has no effect if he performs the after-tax rollover.
Monitor & Control After-Tax Growth
If he wants to minimize growth in the After-Tax source, he could also invest the After-Tax contributions into a cash fund so they don't grow or wait until a negative year in the market to roll out After-Tax.
Again, taking advantage of After-Tax in the ESIP is more complex than it may be in other 401k plans. If you aren't carefully monitoring and rolling out the funds in the After-Tax source correctly, you can create a substantial tax headache for yourself. We often work with Chevron professionals to get this right using a systematic approach to managing the after-tax.
Learn more about how we help Chevron professionals here >>
Understand 401(K) Contribution Limits Before Making Elections
Let's consider another scenario we often see with many Chevron professionals. Let's consider Alden's 50-year-old co-worker, Audra.
In 2023, the maximum 401(K) contribution limit for pre-tax or Roth contributions is $22,500. However, for employees aged 50 or over, there is an additional $7,500 catch-up limit in the 401(K), which makes the maximum contribution amount for a 50-year-old employee $30,000 in 2023.
Audra, a diligent saver, planned to max out her ESIP for the 2023 year by making payroll deductions to get her to $22,500 by December. But, since she turned 50 this year, she unknowingly missed the additional $7,500 she could contribute to the ESIP!
Frontload 401(K) Contributions Before You Reach the Income Limit
The most common mistake we see from Chevron professionals is mismanaging 401(K) contributions that impact how much of the Chevron company match they receive. Let's consider Audra's scenario again.
Audra received a promotion last year and expected her new salary to be $300,000 with a target bonus of 30%, equaling a total cash compensation of $390,000 for the year. To get her full 2023 match from Chevron, $26,400, and her assumed maximum of $22,500 in pre-tax contributions, she sets her Basic Pre-Tax Basic contributions to 2% and her Pre-Tax Supplemental contributions to 5%.
To max out the After-Tax source, she needs to contribute $17,100 in 2023. However, Audra was so busy with work that she only checked in on her 401(k) in August to ensure she was on track. Therefore, while Audra received the full Chevron match because she had contributed her 2% to Basic, she made a big mistake.
Audra receives a bigger bonus than expected in March – instead of $90,000, she gets a $135,000 bonus. Therefore, her income significantly exceeded the section 415 limitation of $330,000 this year.
Because she failed to set her contributions early in the year, she missed out on getting most of her After-Tax contributions. By the time she checked in on her 401(k) contributions in August, with her large bonus this year, she was over the income limit, and all her 401(K) contributions were frozen. Neither she nor Chevron could make additional contributions. As a result, she missed out on $16,500 of ESIP contributions this year!
How to Check Your ESIP Contributions in NetBenefits
To avoid this, you can review your contributions in a YTD statement in NetBenefits. The statement breaks out the Basic and Supplemental sources and the Pre-Tax, Roth, and After-Tax Sources. You can create this statement at any time with updated numbers, and it is an excellent resource for tracking contributions.
How To Max Out Your 401(K) At Chevron
The moral of these stories is simple: Chevron's 401(k) is complicated. You can't just set your contributions on January 1st and forget them for the rest of the year. To max out the ESIP requires ongoing maintenance each year. If you are a Chevron employee who wants to max out your ESIP fully, it is crucial to understand how the plan works and check in regularly on your contributions to ensure you are on track.
Advisor Tip: Chevron employees should check their 401(k) contributions in January, after bonuses, and each following quarter to ensure they are on track to maximize the ESIP plan.
Work with a Financial Advisor Who Understands Your Chevron Benefits
At WJA, we rarely see Chevron professionals fully max out their 401(K) yearly. Many mistakes can be made in the ESIP plan simply because it's a more complicated 401(k) plan than most. However, those complexities are ripe with opportunity if leveraged effectively. We work with Chevron professionals to make the most of the ESIP by making the most of each contribution source, rolling out after-tax at the proper time, and effectively performing the Mega Backdoor Roth strategy to help get more savings into a tax-free retirement bucket. If you're interested in how we can help make the most of your 401(k) savings, contact us for a complimentary discussion of your financial picture.
