What you need to know about after-tax contributions in 401(k) plans

For high-income earners looking to boost retirement savings, after-tax contributions to a 401(k) plan can be a powerful planning tool. 

However, after-tax contributions also come with rules and potential compliance issues that both employers and employees should know about before taking advantage of this strategy.

Unlike pre-tax or Roth 401(k) contributions, after-tax contributions are separate employee contributions that are not subject to the normal deferral limit. That means they allow participants to save beyond the annual employee contribution limit, up to the IRS maximum annual addition limit when combined with employer contributions. For individuals who have already maxed out their regular 401(k) contributions, this can provide an opportunity for more retirement savings.

One of the biggest advantages of after-tax contributions is the potential for a “mega backdoor Roth” strategy. If a plan allows in-service withdrawals or in-plan Roth conversions, after-tax contributions may be converted to a Roth account, allowing future earnings to grow tax-free under current tax rules. For investors focused on long-term tax diversification, this can be an attractive option.

However, these benefits are only available if the employer’s 401(k) plan is designed to support them.

And not every plan permits after-tax contributions or Roth conversions. Plan sponsors must ensure they comply. Highly compensated employees who contribute after-tax amounts may inadvertently cause the plan to fail required testing. In some cases, excess contributions may need to be refunded, creating unexpected tax consequences and administrative headaches.

For CPAs and others in the industry, caution should be used when advising clients. There needs to be coordination and confirmation – as well as communication to avoid compliance issues. 

The bottom line is that after-tax 401(k) contributions can be an excellent wealth-building strategy when implemented correctly, but they require some extra work. Before increasing contributions, review your plan’s provisions and consult with a qualified financial professional to ensure your retirement strategy is both tax-efficient and compliant with current IRS rules.

Do you still have questions about retirement planning options? 

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