What to do with after-tax 401(k) contributions?
Many people know IRA, Roth IRA, 401(k) and Roth 401(k) that could save your money now and/or later. There is another option for some people whose employer may provide, which advantage may not be taken by all people.
After contributing up to the annual limit in your 401(k), you may be able to save even more on an after-tax basis. Fidelity Viewpoints has an article [1] to introduce the strategy that could make it worthwhile to keep saving above the annual limit [2].
Once you max out your contributions, you may want to consider making after-tax contributions as well. These are a third type of contribution to your workplace savings plan (provided by some employers), in addition to pre-tax and Roth.
The IRS allows a total of up to $66,000 of employer and employee contributions to be saved in a 401(k) for 2023 (and an additional $7,500 in employee catch-up contributions for people age 50 and over to get $73,500). Here’s what’s included:
1) Elective deferrals (either tax-deferred, Roth, or a combination): Up to $22,500 in 2023 ($30,000 including catch-up)
2) After-tax contributions to your workplace savings plan (if allowed by your employer)
Making after-tax contributions allows you to invest more money with the potential for tax-deferred growth. That’s a powerful benefit on its own—but that’s not the end of the story. You could then go a step further and convert your after-tax contributions to a Roth account. There are a couple of different ways to accomplish that, including rolling over your balances to an IRA or doing an in-plan conversion if it’s offered by your employer along with a Roth option.
After-tax contributions to your workplace plan can be withdrawn without taxes or penalties. Any earnings on those after-tax contributions are considered pre-tax balances—so taxes would have to be paid on withdrawals of the earnings (unless they are rolled over to an IRA) and there may be a 10% penalty if you’re under age 59½.
Once you have account for after-tax contribution, converting after-tax 401(k) contributions to a Roth account is an option. After converting to a Roth, earnings can grow and be distributed tax-free if certain requirements are met.
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Note
1, What to do with after-tax 401(k) contributions, Fidelity Viewpoints
2, In 2023, you can contribute up to $22,500 pre-tax to your 401(k). If you’re at least age 50 at the end of the calendar year, you can add a catch-up contribution of $7,500 pre-tax, that makes all of your contribution up to $30,000.