Traditional 401(k)s use pre-tax dollars -- that is, your contributions reduce your taxable income for the year and y'all pay taxes on your withdrawals later on. Roth 401(k)south work the contrary mode: You lot pay taxes on your contributions in exchange for afterward tax-free withdrawals. Just there's a third, lesser-known blazon of 401(grand) contribution you may be eligible to make, known every bit an later-tax contribution.

Later on-tax 401(k) contributions alloy the features of traditional and Roth 401(k)south, enabling you to relieve a lot more than for retirement every twelvemonth. Let's look at how after-tax 401(k) contributions work and how to know if they're a smart move for you.

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How later-tax 401(k) contributions work

After-tax 401(k) contributions are known as "after-tax" because yous owe income taxes on these contributions in the year you make them, simply as with Roth 401(m) contributions. Withal, your earnings on later-revenue enhancement contributions grow tax-deferred, like traditional 401(chiliad) funds. When you withdraw the coin in retirement or whenever you lot need the actress cash, you lot will owe taxes merely on your earnings, non your contributions. This is truthful no matter your historic period or why you're withdrawing the funds.

If yous choose, you lot can convert your after-tax 401(k) funds to a Roth IRA later on, assuming your plan allows this. You won't owe taxes on the converted amount considering you already paid taxes the yr you contributed the coin, but time to come earnings volition grow tax-gratuitous.

Not all plans let after-tax 401(m) contributions, so information technology's of import to check with your employer before exceeding the annual contribution limit.

When subsequently-tax contributions are a practiced idea

Here are a few scenarios when making subsequently-tax 401(k) contributions might make sense:

  • You're a high earner: Loftier earners who max out their tax-deferred 401(k) contributions tin can use after-taxation contributions to set aside more money for retirement.
  • You want to increase your emergency savings: You can withdraw after-tax 401(k) contributions at any fourth dimension without paying taxes or penalties, so it's a dandy option for keeping extra emergency savings. Still, it'due south good do to limit how often you lot take coin out of your 401(thousand), as this hampers the growth of your savings.
  • Your income is volatile: Later-revenue enhancement 401(k) contributions make sense if your income varies significantly from one year to the next. In your higher-earning years, afterwards-taxation 401(k) contributions enable y'all to contribute more money to your 401(k), and if you lot need some extra cash in a lower-earning year, yous can draw upon your afterwards-tax contributions without worrying virtually penalties and taxes.

Pros and cons of subsequently-tax contributions

As with all types of 401(m) contributions, after-tax contributions take their pros and cons.

Pros of later on-taxation 401(grand) contributions

The master advantage of later-tax 401(k) contributions is that you tin can contribute beyond the standard contribution limits every year. In 2021, you are allowed to defer just upwardly to $19,500 (or $26,000 for those 50 or older) in salary to a traditional or Roth 401(k) for full tax benefits. Those amounts increase in 2022 to $xx,500 and $27,000, respectively.

However, the IRS allows you to contribute upward to a full of $58,000 (or $64,500 for those l or older) for 2021, or $61,000 (or $67,500 for those 50 or older). This includes salary-deferred contributions into your traditional and Roth 401(yard), whatsoever employer match contributions, and any later on-revenue enhancement contributions.

Afterwards-taxation contributions are also a slap-up option for those who need to withdraw funds earlier 59 1/2 and don't have a Roth retirement account. Traditional 401(k) withdrawals crave you to pay taxes plus a ten% early withdrawal penalty for doing this. If you withdraw just your after-tax contributions, you won't have to worry about those extra costs. However, later on-tax 401(g) earnings are still discipline to the usual taxes and penalties.

Cons of subsequently-tax 401(k) contributions

Your program may not allow later-tax 401(k) contributions. E'er check with your company whether this is an selection earlier exceeding the almanac 401(k) contribution limit.

The biggest downside to these contributions is that you nonetheless owe taxes on your earnings, even though you lot don't have to pay them correct abroad. Yous can minimize your taxable earnings past rolling the funds over into a Roth 401(k) or a Roth IRA, but not all plans let electric current employees to do this.

After-taxation 401(k) contributions can make sense for sure people, but information technology's important to first brand sure you're eligible and and then counterbalance all other options before doing so. If y'all accept access to an IRA, for example, y'all may prefer to stash extra savings at that place outset so y'all can reap the revenue enhancement advantages these accounts offer earlier putting extra money into your 401(k).