401(k) After-Tax Contributions

Presented by Marc Aarons

I have noticed increasing interest in the benefits of after-tax 401(k) contributions among my general client base.

To get ahead of any questions you might have, I put together a succinct overview of after-tax 401K contributions. I encourage you to review the information below. As always, I am happy to answer any follow-up questions you may have.

How do after-tax 401(k) contributions work?

After-tax contributions allow you to save beyond the standard 401(k) limits by contributing money for which you have already paid taxes. As with a Roth IRA or Roth 401(k), withdrawals on contributions are tax and penalty-free.

However, unlike Roth IRAs, there are no income limits for making after-tax 401(k) contributions, making this a great option for anyone who has maxed out a Roth IRA.

Do they work with my 401(k) plan?

Unfortunately, only about one in five 401(k) plans allows for after-tax contributions, but it’s certainly worth contacting your 401(k) provider to determine eligibility if you are interested.

Just 10% of Americans with the option of making after-tax contributions did so in 2022, so it’s possible some of the other 90% were simply not aware it was an option.

What are the other key limits and conditions?

In 2024, the regular 401(k) contribution limit is $23,000, with an additional $7,500 catch-up for those 50 and older. You can put an additional $46,000 of after-tax dollars and employer match contributions (if applicable) into your 401(k) account. The maximum total contribution (employee plus employer) is $69,000, or $76,500 for those 50+. This is significantly higher than the Roth IRA contribution, which, this year, is $7,000 or $8,000 if you are 50+.

Why to Move After-Tax Contributions

As mentioned earlier, 401(k) after-tax contributions can be withdrawn tax and penalty-free. However, earnings on those contributions are tax-deferred, meaning taxes are due upon withdrawal, and early withdrawals (before age 59½) may incur a 10% penalty. By rolling those contributions into a Roth IRA, you can avoid paying taxes upon withdrawal in retirement.

Other reasons you may consider rolling your after-tax contributions into a Roth IRA include:

• Unlike traditional IRAs and 401(k)s, Roth IRAs do not require minimum distributions during the account holder’s lifetime, offering more flexibility in retirement planning.
• Since Roth IRAs do not have RMDs for the original owner, they can be a strategic tool for passing wealth to heirs more efficiently, potentially tax-free.

Rolling into a Roth

There are two primary methods for transferring after-tax 401(k) contribution dollars into a Roth account:

• In-Plan Conversion: This option allows you to convert all or a portion of your 401k into a Roth within the same plan. When you opt for an in-plan conversion, you need to pay taxes on the converted amount. However, like a Roth IRA, your future withdrawals from the Roth will be tax-free. Some plans even include an auto-convert feature that automatically transitions your after-tax contributions into your Roth account.
• In-Service Withdrawal: If your employer offers in-service distributions or withdrawals, you have the opportunity to perform a mega backdoor Roth. This involves rolling your after-tax contributions into a Roth IRA that is outside of your current retirement plan.

If you have any questions or would like to discuss how this strategy might fit into your financial plan, please don’t hesitate to reach out. I am here to help you navigate these options and make the best decisions for your financial future.

Marc Aarons may be reached at 714-887-8000 or marc@ocmoneymanagers.com

www.ocmoneymanagers.com

This communication is from Money Managers, Inc.; a Securities and Exchange Commission registered investment advisor.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities, and past performance is not indicative of future results.  Investments involve risk and are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here.