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A traditional 401(k) plan allows you to make tax-deferred contributions to the account. Your 401(k) plan might also allow for after-tax contributions, which enable you to save even more for retirement. However, there are restrictions and potential disadvantages to be aware of when it comes to contributing after-tax dollars to a 401(k) account.
When considering an after-tax 401(k) contribution, you’ll want to know:
After-tax 401(k) contributions refer to funds added to the plan after income tax has been applied.
In 2024, the tax-deferred contribution limit for a traditional 401(k) is $23,000 and $30,500 for those who are 50 and older. When you make tax-deferred contributions, you put off paying income tax on the deferral and investment earnings until you withdraw funds during retirement.
If you decide to contribute more than the tax-deferred 401(k) limit, the funds will be taxed as income in the year you make the contribution. The total contribution limit in 2024, including pretax and after-tax contributions, is $69,000 or $76,500 if you are at least age 50.
“For most people, the company match and employee contributions do not approach the limit of $69,000 or $76,500 (for those 50 or older),” said Jim White, founder of Great Oak Wealth Management in Pottstown, Pennsylvania, in an email. “That’s where the after-tax contribution comes in.”
Not all employers permit after-tax contributions to traditional 401(k) plans. For plans that allow them, “there could be the possibility to significantly increase 401(k) contributions through after-tax contributions to get you to the $69,000 or $76,500 max,” White said.
You won’t get an immediate tax break on the after-tax dollars you contribute to a 401(k) plan. “With after-tax contributions, the earnings will get taxed when taken out in retirement, but your contributions will never get taxed (again),” said Jamieson Hopp, a certified financial planner at Millennial Wealth in Seattle, in an email.
If you reach your tax-deferred contribution limit for the year, making an after-tax contribution creates an opportunity to save more for retirement. Companies that allow after-tax contributions may also make it possible to carry out Roth conversions.
“Some 401(k) plans allow you to take out these contributions as cash without penalty,” said Brian Dudley, a senior vice president and financial advisor at Wealth Enhancement Group in Burlington, Massachusetts, in an email. “If your plan allows this, you can do a mega backdoor Roth, which is where you roll after-tax contributions into an IRA outside of your retirement plan.”
Higher earners may use this planning tool to fund a Roth account. “A 401(k) has no income restrictions on after-tax contributions, but a Roth outside does,” Dudley said. “If you contribute funds to your after-tax account and then almost immediately distribute those funds via an in-service distribution to an outside established Roth IRA, you remove the income limit and put a large amount of savings into a Roth account.”
In a Roth account, the growth is tax-free and so are the distributions if certain criteria are met. Some 401(k) plans may permit the mega backdoor Roth to be done within the 401(k) too, rolling after-tax contributions into a Roth 401(k).
If you find it difficult to meet the $23,000 contribution limit in your 401(k), it could be hard to save an additional amount. You might need to first increase your income and then contribute more. You may also decide to look for ways to rework your budget and prioritize retirement planning.
If you can make the after-tax contribution, you’ll still have to pay income taxes on the funds you deposit. You may decide to review other savings options to see if another type of investment creates tax savings or other advantages.
Evaluate how much you have put into your 401(k) plan during the past year or more. “When you make pretax contributions to your 401(k), you are able to reduce your taxable income for the current year,” Dudley said. For this reason, if you are able to contribute up to the limit of $23,000 (or $30,500 if you are 50 or older), it’s often wise to do so. “This can be beneficial because it can lower the amount of taxes you owe for that year,” Dudley said. If your employer offers a 401(k) match, you’ll have additional funds to put into your long-term savings.
After this step, if you’re looking to save more, ask if the after-tax contribution is available for your 401(k) plan. “The limits of how much you can contribute after-tax might vary across plans,” Dudley said. You may also want to see if the IRA rollover is an option.
In addition, consider other investments and accounts. You could qualify for tax incentives to contribute to a health savings account or Roth IRA.