If your retirement plan offers after-tax contributions, you may be asking how they differ from Roth deferrals and if they are right for you. After-tax contributions can be confusing and are often mistaken for Roth contributions. Understanding how to effectively use after-tax contributions and whether they suit your savings needs can boost your retirement savings goals.

Let’s start with the basics. After-tax contributions are non-deductible voluntary contributions made by an employee to a retirement plan that permits this type of contribution. After-tax contributions are not elective deferrals and are subject to a different annual dollar limit than deferrals, which are capped at $23,000 in 2024 ($30,500 if over age 50 in 2024).  After-tax contributions are limited by the annual additions limit in effect for the plan year, currently $69,000 for 2024 ($76,500 if over age 50). Earnings on after-tax contributions grow tax-deferred;, withdrawals of earnings are taxable.

Breaking it down:

Non-Deductible: After-tax contributions are made with post-tax dollars; therefore, there is no tax deduction or upfront tax savings. For simplicity purposes, consider after-tax money as “pocket money” – already taxed money that can be spent, given, or saved – that is being contributed to a retirement plan.

IRC §402(g) Elective Deferral Limit: This is the limit associated with pre-tax and Roth elective deferrals. If a plan does not permit after-tax contributions, an employee’s contributions cannot exceed $23,000 for 2024 ($30,500 if aged 50 and older). The deferral limit is an individual limit and is always based on the calendar year. Even if an employee participates in more than one 401(k)/403(b) plan for the year, the individual’s personal deferral limit is capped at $23,000/$30,500.

IRC §415(c) Annual Additions Limit: This is the maximum dollar amount of all contribution types that can be contributed to an employer-sponsored retirement plan, like a 401(k) or 403(b), in 2024 on behalf of an employee. The annual additions limit includes all pre-tax and Roth deferrals, any employer contributions (including forfeiture reallocations), and any applicable after-tax contributions made for the plan year (typically the same as the calendar year but not always). In 2024, the annual additions limit is $69,000 ($76,500 if aged 50 and older).

NOTE: The $69,000 Annual Additions limit includes the $23,000 elective deferral limit. See the graphic below which illustrates the limit:

Matching is based on a $200,000 wage earner and assumes an arbitrary employer match of 3%. All contribution dollar amounts add up to $69,000 ($23,000 + $6,000 + $40,000 = $69,000).

Earnings grow tax-deferred, and withdrawals of earnings are taxable in retirement: Tax-deferred means no tax on investment earnings while inside the account. However, earnings are subject to income tax upon withdrawal in the future. We’ll talk later in this blog about how investors can avoid these taxes.

Contributions occurred post-tax, so withdrawals will be tax free.

Important Considerations When Using After-Tax

Before making voluntary after-tax contributions, consider the following:

After-tax and matching: After-tax contributions are attractive considering the additional savings capacity for retirement, so integrating after-tax into a savings strategy can be beneficial. However, investors should first consider whether matching is offered by their employer.

In many cases, after-tax contributions are not matched by the employer. Investors may prioritize pre-tax and Roth elective deferrals before electing after-tax contributions because the deferrals (pre-tax and Roth) are generally eligible for matching contributions. For example:

Davion is 35 and makes $200,000 as a software engineer for Big Tech Firm. As an employee of Big Tech, Davion is offered a $1 for $1 match up to 3% eligible compensation. Based on Davion’s compensation, he will receive an employer match of $6,000 as long as total deferrals are at least 3% of eligible compensation. Big Tech Firm’s 401(k) also permits after-tax contributions, which excites Davion because his goal is to save 15% of his pay, which comes out to $30,000 for the year. Big Tech does not match any after-tax contributions.

To maximize the match, Davion elects to defer 3% per paycheck towards his pre-tax 401(k) to ensure he obtains his full matching contribution. Knowing the match has been satisfied, Davion elects to contribute the remaining 9% ($18,000) to his after-tax 401(k).

In total, Davion saved $30,000 in 2024, meeting his goal, while only contributing $12% ($24,000) out of pocket.

Now, let’s see what happens when the match is not taken into consideration:

Assume Davion can only afford to save 12% (or $24,000) of his pay, which Davion elects all 12% as after-tax, and that Davion was unaware that the after-tax contributions were ineligible for match. Not only will Davion miss the free money offered by his employer, but his retirement trajectory will also be significantly impacted:

Assumes 7% investment growth annually with an increase in income of 2% per year making contributions bi-weekly.

Without matching, Davion would have 20% (or $758,575) less saved for retirement.

As illustrated above, maximizing matching contributions offered by an employer can have a significant impact on a long-term savings trajectory. Investors should consult with their HR, benefits, and total rewards teams to determine whether after-tax contributions are eligible for matching.

After-tax vs Roth, and In-Plan Roth Conversion: Ensuring that free money is capitalized upon is very important, but equally important is understanding the difference between after-tax contributions and Roth deferrals, and the significance of an In-plan Roth Conversion feature.

Both Roth deferrals and after-tax contributions are made with post-tax money. Given the similarity, after-tax and Roth are commonly confused; however, they differ on how the investment earnings are taxed.

Earnings on after-tax contributions grow tax-deferred and those earnings are taxable upon withdrawal in the future. On the other hand, earnings on Roth deferrals distribute tax-free, assuming qualified withdrawal rules are satisfied.^[1] See below:

On the surface, this might dampen the excitement associated with after-tax. However, tax on the earnings can be bypassed if the plan offers an In-Plan Roth conversion feature.

In-plan Roth conversions are similar to Roth conversions between IRAs: non-Roth dollars, like after-tax earnings or pre-tax dollars, are converted to Roth to capitalize on tax-free growth and distribution. Upon conversion, the amount that is converted becomes taxable but grows as “Roth” from that point forward. Investors typically leverage this strategy when saving for retirement to help maximize tax efficiency. Because Roth conversion is a taxable event, individuals should consult with their personal tax-advisor prior to conversion to discuss the impact on current taxable income.

To reduce, or eliminate, potential tax consequences associated with after-tax earnings, investors can exercise a Roth conversion immediately following the after-tax contribution. This is an effective strategy because the conversion takes place before earnings accumulate.

Example assumes the investment grows over the 6-month period and that the conversion takes place at $1,500.

In-plan Roth conversions must be offered under the specific retirement plan, and may be a manual process (recordkeeper must be contacted each at every pay period) or an automated conversion process (recordkeeper allows standing election online). Check with your plan administrator and your plan’s service provider to determine what action is required.

Cap on After-Tax Contributions: Employer-sponsored retirement plans are regulated to ensure the benefits offered are fair and equitable for all employees in an organization, both highly and non-highly compensated employees. As such, after-tax viability within a plan undergoes annual compliance testing to ensure a non-discriminatory status.

Consequently, retirement plans offering after-tax contributions may cap the amount an employee can make for the year below the $69,000 Annual Additions Limit. Caps can be a percentage or dollar amount (e.g., 10% per pay period, or $15,000), and vary from plan to plan. These limits are implemented to support the sustainability of after-tax contributions and are not intended to be restrictive.

Therefore, investors should familiarize themselves with these limitations, and consult with their HR and benefits leaders where necessary. Generally, limits are accounted for in payroll to prevent excess contributions being refunded.

Overall, after-tax can be an excellent option for those looking to save extra for retirement or looking to meet desired savings goals. However, investors should always consider their individual situation and investment goals prior to contribution.

For more information related to after-tax contributions and their availability, make sure to consult with your HR, benefits, and total rewards teams, or reach out to your retirement plan provider.

For additional financial wellness resources, you can access other Financial Fitness blogs here:

• 401(k) Tips and Tricks: Savings Rate

• Elevate Your Financial Literacy by Balancing Dollar Priorities: 5 Simple Steps

• How Financial Stress Can Impact Mental Health—and Steps to Achieve Peace of Mind

Disclosures:

This material is provided for educational purposes only and does not constitute investment advice. The information contained herein is based on current tax laws, which may change in the future. Newfront Retirement Services cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. The information provided in these materials does not constitute any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice.

Newfront Retirement Services, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration as an investment adviser does not imply any level of skill or training, and does not constitute an endorsement by the SEC. For a copy of Newfront Retirement Services disclosure brochure, which includes a description of the firm’s services and fees, please access www.investor.gov.

^[1] Qualified withdrawals from Roth satisfy a two-pronged test: the 5-year rule states that dollars must be in a Roth account at least 5 tax years from the initial contribution (including the first year of contribution). Also, one must be at least age 59 ½, permanently disabled, or deceased. If both rules are satisfied, then withdrawals from a Roth account are “qualified” and would be tax-free.