How to save above 401(k) deferral limits with after-tax contributions

If you’ve already maxed out 401(k) plan contributions for 2022 and you’re eager to save more for retirement, some plans have an under-the-radar option, experts say.

For 2022, you can defer $20,500 into a 401(k), plus an extra $6,500 for investors 50 and older. But the total plan limit is $61,000 per worker, including matches, profit sharing and other deposits. And some plans let you exceed the $20,500 deferral limit with so-called after-tax contributions. 

“It’s definitely something higher-income people may want to consider at the end of the year if they’re looking for places to put additional savings,” said certified financial planner Ashton Lawrence, a partner at Goldfinch Wealth Management in Greenville, South Carolina.

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After-tax contributions are different than Roth 401(k) plans. While both strategies involve saving money after taxes, there are some key differences.

For 2022, if you’re under 50, you can defer up to $20,500 of your salary into your plan’s regular pretax or Roth 401(k) account. The percentage of plans offering a Roth 401(k) saving option has surged over the past decade.

However, some plans offer additional after-tax contributions to your traditional 401(k), which allows you to save more than the $20,500 cap. For example, if you defer $20,500 and your employer kicks in $8,000 for matches and profit-sharing, you may save another $32,500 before hitting the $61,000 plan limit for 2022.

While the number of plans offering after-tax 401(k) contributions has been rising, it’s still less common among smaller companies, according to an annual survey from the Plan Sponsor Council of America.

In 2021, roughly 21% of company plans offered after-tax 401(k) contributions, compared to about 20% of plans in 2020, the survey found. And almost 42% of employers of 5,000 or more provided the option in 2021, up from about 38% in 2020.

Despite the uptick, after-tax 401(k) participation declined in 2021, dropping to about 10% from nearly 13% the previous year, the same survey showed.

Once you’ve made after-tax contributions, the plan may allow what’s known as a “mega backdoor Roth” strategy, which includes paying levies on growth and moving the funds for future tax-free growth.

“That’s a nice way to go ahead and start boosting that tax-free money for those future years,” Lawrence said.

Depending on the plan rules, you may transfer the money to a Roth 401(k) within the plan or to a separate Roth individual retirement account, explained Dan Galli, a CFP and owner at Daniel J. Galli & Associates in Norwell, Massachusetts. And with many details to consider, working with an advisor may be worthwhile.

However, “there’s a fair number of professionals — from CPAs, attorneys, wealth managers and financial planners — who don’t understand or are not familiar with in-plan Roth [401(k)] rollovers,” he said.  

While the “knee-jerk reaction” is to roll after-tax 401(k) funds out of the plan into a Roth IRA, investors need to “know the rules” and possible downsides, such as losing access to institutional pricing and funds, Galli said.

“There’s no right or wrong,” he said. “It’s just understanding the advantages, and my impression is most people don’t understand that you can do this all within the 401(k).”