| If you have been a diligent saver and have reached your 401(k) plan annual contribution limit, there's a great strategy to use to save even more money for retirement.
It's an after-tax 401(k) plan contribution.
Basically, it's when you put money you've already paid taxes on into your 401(k) account to save more for retirement.
It's called "after-tax" because you owe income taxes on these contributions in the year you make them, similar to Roth 401(k) plan contributions. However, your earnings on these after-tax contributions grow tax-deferred, like traditional 401(k) funds.
When you withdraw the money in retirement or whenever you need the extra cash, you will owe taxes only on your earnings, not your contributions. This is true no matter your age or why you're withdrawing the funds.
Here's how after-tax 401(k) contributions work: Employees who have a traditional 401(k) plan at work can make contributions through payroll. Your annual contribution is capped at $19,500 in 2021 and $20,500 in 2022 (Those 50 and older can contribute an additional $6,500 in catch-up dollars). In some cases, an employer will match a percentage of your contribution.
This is where after-tax 401(k) contributions can be used. If your contribution, plus any employer match you get, doesn't add up to the overall annual limit — $58,000 in 2021 and $61,000 in 2022 — you may be able to make after-tax contributions to your 401(k) to get to that amount.
The primary advantage of after-tax 401(k) contributions is that you can contribute beyond the standard contribution limits every year. After-tax contributions are also a great option for those who need to withdraw funds before age 59½ and don't have a Roth retirement account.
In some instances, your company plan may not allow after-tax 401(k) contributions. So, it's important to confirm this is an option before exceeding the annual 401(k) contribution limit.
It's also key to remember that you still owe taxes on those earnings, even though you don't have to pay them right away. Money experts say you can minimize your taxable earnings by rolling the funds over into a Roth 401(k) or a Roth IRA. However, not all plans allow employees to do this.
While after-tax 401(k) plan contributions can be a great strategy, it's important to do your research and make sure you're eligible and then weigh all available options before putting that plan into action.
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