User:LadyGeek/After-tax 401(k)

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An  is a type of 401(k) sub-account, with different rules from traditional and Roth 401(k) accounts. The rules, and even the availability, for this sub-account may vary considerably from one company to another. It is typically used in a strategy informally known as the mega-backdoor Roth, in order to rollover money to Roth accounts far in excess of normal contribution limits. (See the mega-backdoor Roth article for details.)

After-tax 401(k) limits
Assume that:

$$ \begin{align} \quad A &= \text{employee contribution to after-tax 401(k) account}\\ \quad TR &= \text{employee contribution to traditional 401(k) and Roth 401(k) accounts}\\ \quad E &= \text{employer match}\\ \end{align} $$

Then the 2021 IRS limits, for employees under age 50, are:


 * $$ TR \leq 19500 \quad \text{and} \quad A \,\leq 58000 - (TR + E) $$

Additionally, each of the above must be less than the employee's wages.

Said in words: Traditional and Roth accounts share an employee (under age 50) contribution limit up to $19,500 per person for 2020, $19,000 for 2019, or 100% of the employee's compensation, whichever is less. However, Section 415(c)(1)(A) limits total contributions to defined contribution plans to $57,000 in 2020 and $58,000 in 2021, or 100% of the employee's compensation, whichever is less. The limit for an after-tax 401(k) is the lesser of the difference between the amount already contributed by the employer and employee, and the Section 415 limit, or 100% of employee compensation.

To elaborate, consider an individual with an annual salary of $100,000. She maxes out her 2021 Traditional 401(k) contribution ($19,500) with a company match of 5%. How much can she contribute to the after-tax 401(k)?

This same individual has both a traditional and a Roth 401(k). She then makes equal contributions to each 401(k). Her 2020 individual contribution cap of $19,500 has not changed. Assuming the employer match is same for both the traditional and Roth 401(k)s, the calculation remains the same as outlined above.

Taxation
Post-1986 after-tax contributions to the after-tax subaccount are not tax deductible, they are not taxed upon distribution. The earnings however, are taxed as ordinary income upon distribution. Distributions from the account must have a pro-rata share of both contributions and earnings. (IRS Notice 87-13)

The IRS issued Notice 2014-54 which allows distribution sent to multiple destinations at the same time. An example of a distribution enabled by the notice is to have the contributions sent to a Roth IRA, and the earnings sent to an IRA.

Due to the lack of deduction and ordinary income taxation, the tax characteristics are similar to a nondeductible IRA. If the money grows over long periods of time, the tax characteristics might be less favorable then investing in a taxable account.

An investor might choose to to make after-tax contributions if they have a plan to convert them to Roth, ideally timing is yearly, but if an investor is leaving a company within a few years, it might still be beneficial to make contributions.

Pre-1987 after-tax contributions do not have the pro-rata distribution rule as long as the recordkeeper tracked these dollars. These types of after-tax contributions are not common, but can be found from time to time in older folks who have chosen to maintain their 401k at their previous place of employment.