Most retirement savers haven’t heard of an after tax 401k Roth conversion. It’s a pretty unique thing after all, and unfortunately it doesn’t apply to most 401k savers. If it does however, it’s an amazing deal!

For 2017, most 401k participants can contribute $18,000 to their plan. They can get a nice tax deduction for it too!

For the current tax year it’s like you never even earned that pre-tax contribution. This could save you thousands of dollars in current tax liability.

If the plan allows however, a 401k saver could forego the current tax break and contribute to a Roth component of the 401k plan. They wouldn’t get an immediate tax break, but they’d enjoy a tax free retirement later.

Some plans even allow after-tax contributions over and above the deductible or Roth limits. When handled properly, these contributions can become after-tax 401k Roth conversions.


Retirement Savings Recap

Remember, there are two MAIN types of retirement savings, pre-tax and Roth. Most investors forget about the ability to do after-tax contributions as well.

Here’s the quick recap:

  • Pre-tax 401k contribution. You get an immediate tax deduction as if you never earned the money for income tax purposes, AND your investment grows tax deferred. You pay taxes on the money when you withdraw it, typically in retirement. Withdrawals prior to age 59 and 1/2 will generally be subject to taxes and a 10% penalty.
  • Roth 401k contribution. You get NO immediate tax break. Your investment grows tax-deferred however, and can be withdrawn in retirement with no income tax due. There’s also NO requirement for age 70+ distributions.
  • After-tax 401k contribution. You get NO immediate tax advantage, however you establish “basis” of the contributed amount in your 401k plan. That basis can be withdrawn later as a pro-rate return of principle. Your earnings will grow tax-deferred, however you’ll pay ordinary income tax on them when you withdraw in retirement.


The Annual Defined Contribution Limit

One key to an after-tax 401k Roth conversion is the annual defined contributions plan limit. That limit is the ultimate maximum any defined contribution plan can accept for a particular year from employer contributions, employee contributions, and forfeitures.

If you’re age 50 or older, it’s important to know this limit is net of the “catch-up” provision. In other words, any catch up contribution the worker is eligible for is added on top of the annual defined contribution plan limit. For 2017 the maximum contribution is $54,000 (add another $6,000 if the employee is age 50 or older).


What Is An After-Tax 401k Roth conversion?

Not every 401k plan allows for voluntary after-tax contributions over the $18,000 limit. I’m specifically referring to after-tax voluntary contributions, NOT Roth contributions, and not tax-deductible contributions. Your 401k plan fiduciaries determine whether or not to allow them. If your plan doesn’t allow for them, you can always ask for it to be amended.

Some plans do however. Those contributions if made, can later be converted to a Roth IRA.


Here’s how an after-tax 401k contribution to Roth conversion works:

  • Jane has a 401k at work, she contributes the maximum $18,000 pre-tax because she’s in a high income tax bracket.
  • Jane is also 51 years old, so she contributes an additional $6,000 as her “catch-up” contribution.
  • The annual defined contribution limit for Jane is $60,000.
  • Assuming the company has no match and Jane is eligible, since Jane has already contributed $24,000 she can contribute an additional $35,000 ($60,000 minus $24,000).
  • The $35,000 contribution DOES NOT get a tax deduction, however the earnings will grow tax-deferred.
  • When Jane separates from service, the amounts contributed voluntarily after-tax (meaning the $35,000) can be separated and rolled into a Roth IRA under IRS 2014-54.


Of course, if Jane’s company is awesome and she has a match (or other contribution made for her) she’ll need to reduce the amount she can contribute after-tax. The absolute limit is $60,000 after all.

She must also be aware that if she’s an HCE (highly compensated employee), she may run into issues with ACP (average contribution percentage) testing. 401k plan testing is beyond the scope of this post however.


Does Your Plan Allow Voluntary After-Tax Contributions?

The key is does your plan allow for these contributions? Many plans do not, and if your plan doesn’t allow for them unfortunately you’re out of luck with this strategy.

Thanks to IRS 2014-54, you have an awesome opportunity to save a LOT of money both pre-tax and after-tax. Your after-tax contributions can later be converted to Roth IRA when you terminate employment.

Outside of the potentially triple tax-free Health Savings Account contributions, this is probably one of the best retirement savings tools I’ve ever seen! If your plan allows for after-tax voluntary contributions, you should take full advantage of them!