After-tax 401(k) contributions are not the same as Roth

While after-tax and Roth 401(k) contributions appear similar on the surface, they’re actually quite different. So I thought I’d expand on the topic.

In addition to traditional tax-deferred contributions, many 401(k) plans also allow you the option to make Roth contributions. Like Roth IRAs vs traditional IRAs, Roth 401(k) accounts are treated the opposite of tax-deferred 401(k) accounts. The money you contribute to a Roth 401(k) is after-tax, but all money eventually comes out tax-free (assuming you meet certain conditions).

The IRS sets limits on how much you can contribute to your 401(k) plan on a tax-deferred and/or Roth basis.  For 2020, that amount is $19,500 if you’re under 50 or $25,000 if you’re 50 or older. It’s important to note that these contribution limits are shared between tax-deferred AND Roth contributions. For example, you can’t contribute $19,500 to your tax-deferred 401(k) and then contribute another $19,500 to your Roth 401(k).

In addition to tax-deferred and Roth contributions, many 401(k) plans also allow for a third type of contributions…“after-tax” contributions.  After-tax contributions are made with after-tax money like Roth contributions, but they go into the tax-deferred account like tax-deferred contributions.

After-tax contributions do NOT count toward your $19,500 (or $25,000) annual contribution limit; they fall under a different limit. For 2020, when including after-tax contributions and money contributed by your employer, the IRS allows total 401(k) contributions of $57,000 if you’re under 50 or $63,500 if you’re 50 or older.

It’s important to note that the amount of the after-tax contribution itself won’t be taxable when withdrawn; only the gains attributable to that contribution will be taxable. For example, assume you contribute $55 to your 401(k) through a tax-deferred contribution and another $35 through an after-tax contribution. And then assume you have $10 of gains on the $90 contributed. In this case, 35% of the $100 in the account has already been taxed.  Therefore, when you take a withdrawal, only 65% of it will be taxable.

You should generally only make after-tax contributions if you’ve already used up your $19,500 (or $25,000) limit on tax-deferred and/or Roth contributions AND you still want to save more in your plan.

However, if you do fill up your $19,500 (or $25,000) limit and want to save extra, first consider contributing to a Roth IRA. If you max out your Roth IRA contribution and still want to save even more, then consider an after-tax 401(k) contribution.

After-tax 401(k) contributions can also allow you to do what’s called a “mega backdoor Roth contribution.” I’ll save that topic for another day.