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If you’re on track to max out your 401(k) plan for 2023 and want to save more, your plan may have another option: after-tax contributions.
For 2023, you can defer up to $22,500 in a 401(k), and savers age 50 and older can add another $7,500. Some plans allow more through after-tax 401(k) contributions.
Remember, the total plan limit for 2023 is $66,000, which includes your deferment, company match, profit sharing and other deposits from your employer.
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About 14 percent of workers have expanded their 401(k) plans in 2021, according to Vanguard, based on 1,700 plans and about 5 million participants.
After-tax 401(k) contributions can be worth considering if you are a higher income looking for more ways to save, explains Ashton Lawrence, a certified financial planner and partner at Goldfinch Wealth Management in Greenville, South Carolina.
The difference between after-tax and Roth accounts
After-tax 401(k) contributions are different from Roth 401(k) savings. While both involve deferring a portion of your after-tax payments, there are some important differences.
For 2023, if you are under 50, you can defer up to $22,500 of your salary in your regular pretax plan or Roth 401(k) account. The number of plans that offer a Roth 401(k) savings option has increased over the past decade.
However, some plans offer additional after-tax contributions to a traditional 401(k), allowing you to save more than $22,500. For example, if you defer $22,500 and your employer spends $8,000 for matches and profit sharing, you can save another $35,500 before hitting the $66,000 plan limit for 2023.
While the number of after-tax 401(k) contribution plans is increasing, it is still not common among small businesses, according to an annual survey from the American Plan Sponsorship Council.
In 2021, about 21% of company plans offered after-tax 401(k) contributions, compared to about 20% of plans in 2020, the study found. And about 42% of employers of 5,000 or more offered the option in 2021, up from about 38% in 2020.
Despite the uptick, after-tax 401(k) participation is down in 2021, falling to about 10% from about 13% last year, the same study showed.
Consider the ‘mega backdoor Roth’ strategy
Once you make an after-tax contribution, the plan may allow what’s known as a “mega backdoor Roth” strategy, which involves paying taxes on growth and moving the money toward tax-free growth in the future.
“It’s a great way to continue to grow that tax-free income for years to come,” Lawrence said.
Depending on the plan’s rules, you can transfer the money to a Roth 401(k) within the plan or to a separate Roth retirement account, says Dan Galli, CFP and owner at Daniel J. Galli & Associates in Norwell, Massachusetts. . And with so many details to consider, working with a consultant can be beneficial.
However, “there are many professionals – from CPAs, attorneys, wealth managers and financial planners – who do not understand or are not familiar with the Roth plan. [401(k)] rollovers,” he said.
There are many professionals – from CPAs, attorneys, wealth managers and financial planners – who do not understand or are unfamiliar with Roth plans. [401(k)] rollovers.
Owner at Daniel J. Galli & Associates
While the “knee-jerk” option is to roll over after-tax 401(k) money from the plan into a Roth IRA, investors need to be aware of the rules and possible downsides, such as losing access to fees and charges, Galli said. .
“There is no right or wrong,” he said. “It’s understanding the benefits, and my opinion is that most people don’t understand that you can do all of this in a 401(k).”
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