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If you’re eager to funnel as much as possible into your 401(k), some plans have a special feature to save beyond the yearly deferral limit.
The 2023 deferral limit for 401(k) plans is $22,500, plus an extra $7,500 if you’re age 50 or older. But an under-the-radar option, known as an after-tax 401(k) contribution, allows you to save up to $66,000, including employer matches, profit sharing and other plan deposits.
For those seeking tax-friendly ways to boost retirement savings, “it’s just a great opportunity,” said certified financial planner Dan Galli, owner at Daniel J. Galli & Associates in Norwell, Massachusetts.
However, most 401(k) plans still don’t offer after-tax contributions due to strict plan design laws, Galli said. But it’s more common among bigger companies.
In 2021, roughly 21% of company plans offered after-tax 401(k) contributions, compared to about 20% of plans in 2020, according to an annual survey from the Plan Sponsor Council of America. And almost 42% of employers of 5,000 or more provided the option in 2021, up from about 38% in 2020.
Still, employees who do have the chance to make after-tax 401(k) contributions may not take advantage due to “cash flow issues,” Galli said.
Only about 14% of employees maxed out 401(k) plans in 2021, according to Vanguard, based on 1,700 plans and nearly 5 million participants.
Tax-free growth is ‘absolutely worthwhile’
Another perk of after-tax 401(k) contributions is you can use the funds to complete the so-called mega-backdoor Roth strategy — paying levies on earnings and moving the money to a Roth account — for future tax-free growth.
By rolling the money into the same plan’s Roth 401(k) or a separate Roth individual retirement account, you can start building a pot of tax-free money, which won’t trigger levies upon future withdrawal.
“It’s absolutely worthwhile,” said Linda Farinola, a CFP and enrolled agent at Princeton Financial Group in Plainsboro, New Jersey, noting that tax-free withdrawals can be handy in retirement.
When it’s time to withdraw the money, these accounts won’t boost adjusted gross income, which can trigger other tax consequences, such as higher Medicare Part B or D premiums, she said.
Prioritize your 401(k) match first
Of course, you’ll want to take advantage of your employer’s 401(k) match via pre-tax or Roth 401(k) deferrals before making after-tax contributions, said Farinola.
The most common 401(k) match is 50 cents per dollar of employee contributions, up to 6% of compensation, according to the Plan Sponsor Council of America. Yet millions of Americans aren’t deferring enough to get the full company match.
Image and article originally from www.cnbc.com. Read the original article here.