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Tax-advantaged retirement accounts have annual limits on contributions. But did you know after-tax contributions let you deposit even more money for retirement in your 401(k) account?
After-tax 401(k) contributions come from money that’s already been taxed. They’re a bit like Roth 401(k) contributions, and they can supercharge your retirement savings if your employer’s plan allows them.
What Is an After-Tax 401(k)?
An after-tax 401(k) is an employer-sponsored 401(k) plan that allows you to save beyond annual contribution limits using after-tax money.
After-tax contributions grow tax-deferred in your 401(k), just like pre-tax contributions. When retirement rolls in, you’ll enjoy tax-free withdrawals on your after-tax savings and only pay taxes on the earnings.
How Do After-Tax 401(k) Contributions Work?
Unlike contributions to a traditional 401(k), after-tax contributions are made after you’ve reached your pre-tax annual contribution limit. While not all employers allow after-tax contributions, here’s how they look in action.
Say you’re 35, earn $125,000 per year and have maxed out your pre-tax contributions to your 401(k) plan for a total of $22,500. If your employer offers a 100% match on up to 3% of your total salary, that’s an extra $3,750 added to your plan for a total of $26,250.
If your plan allows after-tax 401(k) contributions, you could stash an additional $39,750 in your 401(k) for 2023 to reach the total annual contribution limit of $66,000.
2023 After-Tax 401(k) Contribution Limits
Retirement savers got a hefty boost from the IRS in their 401(k) contribution limits for 2023 as opposed to 2022.
The total 401(k) contribution limit for 2023—including employer match and after-tax contributions—is $66,000. This is significantly more than the pre-tax limit of $22,500. In 2022, the total 401(k) contribution limit was only $61,000 with a pre-tax limit of $20,500.
Americans who are age 50 or older can add an additional $7,500 to their total 401(k) contributions in 2023. They can contribute a total of $73,500 in 2023.
Can You Make After-Tax Contributions to a Roth 401(k)?
If your employer’s Roth 401(k) allows after-tax contributions, you sure can. Like with a traditional 401(k), after-tax 401(k) contributions can contribute significantly more income to your Roth 401(k).
After-Tax 401(k) vs. Roth 401(k)
Although after-tax 401(k) contributions may sound like a Roth 401(k), there is at least one significant difference. Your withdrawals in retirement won’t all be tax-free. Instead, you’ll have to pay taxes on the earnings from your after-tax contributions—the same as you would when making after-tax contributions to a traditional 401(k).
Benefits of After-Tax 401(k) Contributions
If you’re a high earner and have extra money to put towards retirement savings, it’s tough to beat the benefits of after-tax contributions.
Tax-Deferred Growth
Your after-tax contributions to a 401(k) grow tax-deferred, offering an additional way to bolster your retirement fund.
No Capital Gains Exposure
When you save extra for retirement using a taxable investment account, you’ll enjoy tax-free growth the same as you would with after-tax 401(k) contributions. However, your earnings in a taxable account are subject to capital gains taxes—which can be as high as 37% for investments held less than a year.
With after-tax 401(k) contributions, you’ll only pay ordinary income tax on investment earnings—a considerable savings as most people expect to be in a lower tax bracket during retirement.
Withdrawal Flexibility
Unlike regular contributions to a traditional 401(k) plan which makes you wait until age 59 ½ for penalty-free withdrawals, you can withdraw your after-tax 401(k) contributions at any time without penalty.
No Income Limits
Roth IRAs have income limits, but after-tax contributions to a 401(k) plan don’t. Therefore, if your employer’s plan offers after-tax contributions, you can participate no matter how much you earn.
Potential Roth Conversions
Even if you earn too much to qualify for a Roth IRA, you can convert your after-tax 401(k) contributions to a Roth account in two different ways.
- In-plan Roth 401(k) conversion. If your 401(k) offers in-plan conversions, you can convert all or part of your after-tax contributions to a Roth 401(k). You’ll need to pay taxes on any after-tax contribution earnings you convert.
- In-service withdrawal to a Roth IRA. If your plan offers in-service withdrawals, you can use a mega backdoor Roth to roll your after-tax contributions over into a Roth IRA without paying the typical conversion taxes.
According to a 2022 Plan Sponsor Council of America report, nearly 58% of 401(k) plans offer in-plan conversions, and more than 60% of 401(k) plans now offer in-service withdrawals.
Drawbacks to After-Tax 401(k) Contributions
For all their benefits, using after-tax 401(k) contributions has some notable downsides—even for high earners with extra cash to spare.
Limited Investment Options
Most 401(k) plans come with limited investment choices, which means you’ll have less investment flexibility with after-tax contributions to your 401(k) than if you roll those contributions into a Roth IRA.
Limited Availability
Unfortunately, the Plan Sponsor Council of America report found that only 21% of 401(k) plans allow after-tax contributions. Even if you want to save more, your plan might not give you the opportunity.
Potential Tax Trouble
In-service withdrawals can be a tricky business if not done properly. Be sure to speak with a tax professional to avoid tax pitfalls if you’re considering a mega backdoor Roth conversion.
Who Should Choose After-Tax 401(k) Contributions?
If it’s not clear by now, after-tax contributions to a 401(k) are a strategy best suited for high earners with plenty of cash reserves and a healthy emergency fund. But this type of retirement savings won’t make sense for everyone.
You’ll want to seek out other ways to save if you:
- Haven’t already maxed out your IRA. Always top off your IRAs up to the annual limit, including catch-up contributions, before making after-tax 401(k) contributions.
- Don’t have a decent rainy day fund. If your emergency fund needs an infusion, shore up those savings before upping your retirement contributions.
- Want greater control over your investments. In this case, a taxable brokerage account might be a better choice since you can choose from a wide range of top brokerages and investment options.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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