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How To Make A Mega Backdoor Roth 401(k) Contribution

Looking to boost your retirement savings? Contributing above the limit through after-tax contributions into a traditional 401(k) can help you maximize your savings with potentially great tax benefits.

Articles by Andrew Westlin, CFP®
By Andrew Westlin Financial Planner, Betterment Published Mar. 27, 2019 | Updated Jun. 30, 2020
Published Mar. 27, 2019 | Updated Jun. 30, 2020
4 min read
  • Some 401(k) plans have more options for contributing than just employee elective deferral limits.

  • After-tax traditional contributions to your 401(k) allow you to dedicate even more of your earned income to retirement savings, and move more money into Roth-style accounts.

For most people that participate in a 401(k) plan through their employer, $19,500 is the maximum contribution (pre-tax and Roth) you can make to your 401(k) in 2020 (those age 50 and older get an additional $6,500 catch-up contribution). This “standard” contribution is considered to be an employee elective deferral. But what if your 401(k) plan could allow you to contribute more than this amount? And how much more?

Potentially up to $37,500 more in 2020.

After-tax traditional 401(k) contributions are less commonly offered by employers, but for heavy savers or high-income earners who do have this option, after-tax traditional contributions are a great way to try and maximize your overall retirement contributions.

“Super-size Me”: 401(k) 2020 Contribution Limits

401(k) plans are a type of defined contribution plan where you, as the employee, make your own contributions to your retirement. In 2020, the total annual contribution limit to defined contribution plans is $57,000 (or $63,500, if age 50 and older).

This $57,000 limit consists of your $19,500 contribution (combination of pre-tax and Roth), as well as any matching contributions your employer makes, employer profit-sharing, and after-tax traditional 401(k) contributions made.

Any employer match would potentially reduce the amount of after-tax contributions you could make into a traditional 401(k). But if your employer does not provide any matching contributions nor profit-sharing, you could contribute up to an extra $37,500 on an after-tax basis to your 401(k).

Tax alert – Even if your employer offers after-tax traditional 401(k) contributions, you may not be able to fully maximize the contribution due to plan limits and nondiscrimination testing for highly compensated employees.

How Do After-Tax Contributions Work?

Now that we’ve covered different types of contributions that could be made to your 401(k), how do they all work?

The $19,500 salary contribution can generally be made as either pre-tax (traditional), or post-tax (Roth):

  • When you make pre-tax contributions, the amount contributed to your retirement plan reduces your taxable income for that year, so that you get a tax break in the year contributing. When you withdraw in the future, you will pay ordinary income taxes on the full amount of the withdrawal, basis and earnings included.
  • With post-tax Roth contributions, the amount contributed does not reduce your taxable income for that year, as you pay tax on the money before it is contributed. As long as you meet general requirements, withdrawals will be free of tax, earnings included.

After-tax contributions into a traditional 401(k) are not tax deductible and grow tax-deferred, meaning that earnings will be taxed as ordinary income upon withdrawal. This is unlike general Roth 401(k) contributions, where earnings and withdrawals are tax-free.

You might be wondering what happens to after-tax traditional 401(k) contributions after you retire or leave your company. IRS Notice 2014-54 states that earnings from these contributions while they are in the 401(k) would be rolled into a traditional IRA, where you will pay tax upon withdrawal.

However, the original after-tax traditional contributions in your 401(k) are able to be rolled into a Roth IRA without paying taxes (since you already paid tax on the dollars contributed), where future growth and withdrawals are tax-free.

Benefit To After-Tax Contributions

For those who have the option and are able to make these contributions, it enables extra savings to be made into an account that grows tax-deferred rather than being saved to a taxable account, where you will owe annual taxes on dividends. After-tax traditional contributions allow you to indirectly contribute money to Roth-style accounts when you may not have been able to otherwise.

For example, your income may be too high to make direct Roth IRA contributions or you may choose not to make Roth 401(k) contributions with your elective deferral because you’d prefer to make pre-tax contributions to reduce your taxable income.

If that’s the case, the only other way you’d be able to get money into a Roth IRA for tax-free growth is to execute a Roth conversion, which may require you to pay income tax upon converting.

The In-Plan Roth rollover

Here is a strategy for how you can further amplify the benefits of after-tax traditional 401(k) contributions.

If your employer allows you to make In-Plan Roth rollovers (not all plans offer the feature) – where you can effectively convert your traditional 401(k) to a Roth 401(k) – you can start the tax-free growth on your after-tax contributions even earlier.

Any earnings on the after-tax traditional contributions would be considered taxable at the time of the In-Plan Roth rollover. The sooner this process is completed after the contribution is made, it would minimize taxable earnings.

In other words, you don’t have to wait until you retire to get your after-tax contributions into a Roth 401(k).

Steps To Take For Your Retirement Planning

To see if your 401(k) plan offers after-tax traditional contributions, we recommend contacting your plan administrator.

Note that Betterment for Business 401(k) plans currently do not offer the ability for you to make after-tax contributions to your Traditional 401(k), nor the ability to convert Traditional funds to Roth funds while the plan is active. Depending on each individual plan, these options could increase non-discrimination testing complexity and lead to unexpected refunds. Over time, we’ll continue to evaluate the value of these additional capabilities to our customers who hold Betterment 401(k) plans through their employer.

For those that do have this option, you will want to consider all of the retirement accounts you have at your disposal, the tax benefits each offer, and your overall savings plan and cash-flow needs. If interested, you can speak with a financial planner to help you make the best decision for your retirement plan.

Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.

Contributing Authors

Eric Bronnenkant
Head of Tax, Betterment

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