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If given the opportunity to contribute after-tax dollars to your 401(k) and subsequently roll to a Roth IRA, back up the truck.

BLUF (Bottom Line Up Front)

Funding a 401(k) with after-tax contributions is the first step of a process that can potentially direct significant dollars into your Roth IRA.  It may be the best financial planning opportunity currently available. In this post I’ll walk you through:

a) how to determine if you are eligible

b) how to calculate your maximum after-tax contribution and

c) how to roll your after-tax 401(k) contributions into your Roth IRA for the potential of a lifetime of tax-free appreciation.

401(k) Contributions

First, a primer on the types of 401(k) contributions a plan participant can make:

  1. Pre-tax / traditional: You are likely familiar with pre-tax 401(k) contributions.  Sometimes these are referred to as traditional 401(k) contributions to distinguish them from the other types of contributions that I’ll address below.  The 2020 contribution limit is $19,500. Plan participants 50 and older are eligible for an additional $6,500 “catch-up” contribution for a total deferral of $26,000.  Contributions to a pre-tax, traditional 401(k) plan reduce your taxable wages. For example, if you earn $100,000, you may elect to contribute $19,500 to your pre-tax 401(k) in 2020. When you receive your W-2 at year-end, boxes 3 and 5 will show total wages subject to Social Security and Medicare of $100,000.  But box 1 – which is entered into your tax return to determine your current year tax liability – will be reduced by the pre-tax contribution and thus only be $80,500.  Note that the $19,500 contributed to your pre-tax 401(k) account has not been subject to tax so we refer to those contributions as pre-tax funds.  Any investment appreciation on your pre-tax contributions are also deemed pre-tax funds.  This distinction will be important later.

2. Roth:  In 2006, the IRS introduced the ability to fund a Roth 401(k).  Contributions to a Roth 401(k) are subject to the same contribution limits as pre-tax contributions: $19,500 with the potential for an additional $6,500 “catch-up” contribution for those ages 50 and older. However, unlike pre-tax 401(k) contributions, Roth 401(k) contributions are not eligible for a current year tax deduction.  Returning to the example above, if you earn $100,000 and contribute $19,500 to your Roth 401(k), you will receive a W-2 with $100,000 in Box 5, 3 and 1.  Why contribute to a Roth 401(k) if you don’t receive a tax deduction? More on that later.

I’m often asked, “Can I contribute to both a pre-tax 401(k) and a Roth 401(k)?”  It’s a good question.  The short answer is yes, but be aware that the $19,500 limit (or $26,000 with the catch-up) is a combined contribution limit for pre-tax and Roth savings.  For example, assuming you are age 55, you can contribute $26,000 to a pre-tax 401k or $26,000 to a Roth 401k.  Alternatively you could contribute $16,000 to the pre-tax 401k and $10,000 to the Roth 401k.  But you cannot contribute $26,000 to both a pre-tax 401(k) and a Roth 401(k), even if you have two jobs.

3. After-tax: First and foremost, don’t confuse Roth and after-tax contributions.  These are separate types of contributions. The annual contribution limit is different for Roth and after-tax contributions.  And the tax treatment of distributions is significantly different.  How much can you contribute to your 401(k) via after-tax contributions?  That depends. Some plans have a limit.  I frequently see a contribution limit imposed by the plan (not the IRS) of 5-25% of compensation. There may also be a plan-imposed limit on the total amount that you can defer from your paycheck.  A limit such as 75% is likely in place to ensure that you don’t contribute so much to your 401(k) that you can’t cover your payroll deductions or taxes.  Again, note that these are plan-specific limits that may (or may not) exist.  Regardless of whether the plan has a percentage deferral limit for after-tax deferrals, IRS contributions limits apply. I’ll review those limits in detail below.

Tax Deferral

Pre-tax, Roth and after-tax 401(k) contributions share one thing in common: earnings on your contributions is tax-deferred.

What is tax deferral?  It means that earnings (appreciation, dividends and/or interest) that would ordinarily be subject to tax is postponed until a later date.  Regardless of the type of 401(k) contribution that is made, if you contribute $1,000 and the value appreciates to $1,100 over the course of the year, you will not be subject to tax on the $100 of earnings unless there is a triggering event, usually a distribution.  If left alone, the tax on the $100 of earnings is deferred to a later date.  $1,100 remains in the account to hopefully earn additional earnings.

Taxation Upon Distribution 

Tax deferral sounds great.  You avoid annual taxation on your earnings and thus allow for your savings to accumulate more rapidly over time.  But at some point doesn’t the IRS want a piece of that? Absolutely. And now we’ll see how the three types of 401(k) contributions are taxed upon distribution in retirement.  

  • Pre-tax: The entire amount of a distribution is subject to ordinary income tax.  Again returning to the earlier example, you contributed $19,500 to your pre-tax 401(k) and thus reduced the income subject to taxation in the year of the contribution.  The $19,500 hypothetically appreciates to $29,500.  $29,500 is withdrawn in retirement. The IRS will deem the entire $29,500 as income subject to ordinary tax rates.  This is understandable as no taxes have been paid on the contribution or the earnings previously.


  • Roth: Roth 401(k) distributions are tax-free.  Big difference. Returning to the example, $19,500 is contributed to a Roth 401(k).  No tax deduction is taken for the contribution. $19,500 hypothetically appreciates to $29,500 and $29,500 is withdrawn in retirement.  The entire $29,500 can go in your pocket tax-free.  I think that answers the earlier question of “why would I contribute to a Roth 401(k) if I don’t receive an immediate that deduction?”


  • After-tax: Be careful here. Though we haven’t reviewed contribution limits in detail yet, let’s assume $25,000 is contributed after-tax.  Again, this is not a Roth contribution.  This is separate, after-tax contribution.  You’ll recall that earnings are tax-deferred, just as they are with pre-tax and Roth contributions. We’ll further assume appreciation of $10,000 for a total balance of $35,000.  Upon the a total distribution in retirement, $25,000 is essentially treated as a return of your initial after-tax contribution and is not subject to tax. The $10,000 in earnings is taxed as ordinary income.  Note that this example conveniently assumes the entire amount is withdrawn in a single year. If distributions are taken out over time, quantifying the applicable taxation is more complicated.

A quick review:

  • Pre-tax contributions reduce current year taxation, grow tax-deferred and are taxed as ordinary income upon distribution in retirement (after age 59 1/2).
  • Roth contributions do not reduce current year taxation, grow tax-deferred and are not taxed upon distribution in retirement.
  • After-tax contributions do not reduce current year taxation and grow tax-deferred.  If withdrawn as a lump sum in retirement, after-tax contributions are not subject to tax but the earnings are subject to tax.  Your 401(k) provider will keep careful records to distinguish between prior contributions and the associated earnings.

Are After-tax 401(k) Contributions Advantageous?

Based upon what we’ve discussed thus far, the short answer is “not really.” Tax deferral is somewhat attractive, but subjecting the earnings to  taxation at ordinary income rates upon distribution is certainly not appealing. Many have concluded they would prefer to direct additional savings beyond their pre-tax or Roth 401(k) contributions to a brokerage account in which earnings are subject to more favorable capital gains tax rates.  That’s a reasonable conclusion. Or probably better said, that was a reasonable conclusion.

The Game Changer

Everything changed with the issuance of an IRS notice on September 18, 2014.  While I had waited for years for guidance, I was shocked that the notice issued by the IRS blessed a related strategy that many had previously believed was a loophole.

IRS Notice 2014-54 states that in certain circumstances, after-tax 401(k) contributions can be rolled into a Roth IRA.  

Think about that for a minute.  Roth IRA contributions are limited to $6,000 annually (with a $1,000 catch-up provision) and income must be below the threshold set by the IRS annually.  Roth 401(k) limits are more generous at $19,500 (with a $6,500 catch-up). But still, there are contribution limits in place for good reason.  Without them, an investor could shelter an unlimited amount of money in an account and completely avoid taxation on the earnings if withdrawn after 59 ½.  

But with Notice 2014-54 the IRS paves the way for individuals to contribute significant amounts to their after-tax 401(k) and subsequently roll the money into their Roth IRA.  It’s a simply phenomenal opportunity that I have to illustrate further:

And yes, I recognize I have still yet to quantify how after-tax contribution limits are determined but let’s proceed with the earlier example suggesting you make annual after-tax 401(k) contributions of $20,000 that are subsequently rolled into a Roth IRA.  If we assume a 30 year time period and 5% appreciation, the result is a nest egg of over $2,000,000.  And according to current law, the IRS never forces the account owner to take a distribution from this supersized Roth IRA. And any voluntary distributions are entirely tax-free.  

The Catch

What’s the catch?  It’s not so much of a “catch” as it is somber recognition that the opportunity is limited to only those who can make after-tax contributions to their 401(k).  And for those who can make after-tax 401(k) contributions, the relative attractiveness of this strategy is determined by how frequently the plan allows for a rollover of these after-tax contributions into your Roth IRA.  And here’s where you have to be really careful.

The most straightforward example occurs after retirement or a job change.  We call that “separation of service.” Once separated a former employee can roll their 401(k) plan into an IRA.  At that time particular attention is given to the types of money within the account. These are called “money sources.”  Pre-tax 401(k) funds are usually rolled into a Traditional IRA. Roth 401(k) funds can be rolled into a Roth IRA. But what happens to after-tax funds?  

Notice 2014-54 allows for the after-tax funds to be split assuming the proper request is made at the time of the rollover/distribution.  Per the previous example, assume you make $25,000 in after-tax contributions and accumulate $10,000 of earnings.  Thanks to Notice 2014-54, when you request a total distribution of your former 401(k) at one time you can also direct your former 401(k) provider to split the distribution into two parts: $25,000 to your Roth IRA and the $10,000 of earnings to the Traditional IRA.  Note this if for total distributions only!  The rollovers are not taxable events. The ultimate distribution from the Traditional or Roth IRA will follow the rules previously discussed. Note that the $10,000 of earnings will be subject to ordinary income tax.  The ability to move $25,000 into the Roth is pretty attractive. But you may be able to do better.

What if you (hypothetically) contributed $25,000 after-tax to the 401(k) on one day and rolled the funds into the Roth the next day – before any earnings could accrue?  Then the hypothetical $10,000 appreciation occurs over time within the Roth IRA.  Thus the eventual Roth IRA balance is $35,000.  See the difference from the prior example?  

If a plan participant waits until retirement to roll the after-tax funds into the Roth, $10,000 is subject to ordinary income tax upon withdrawal.  If a plan participant rolls the $25,000 and experiences appreciation within the Roth, the entire $35,000 is tax-free. 

The question becomes how often can you request a full distribution of your after-tax funds while still employed.  The technical term is a full “in-service distribution.”  The IRS doesn’t meddle with this.  The answer is found in your 401(k)’s (or 403(b)) Summary Plan Description (SPD).

Most plans do not allow for the distribution of pre-tax contributions (or the associated earnings) prior to a “separation of service.”  But many plans have a different provision governing the distribution of after-tax contributions.

If your plan:

a) allows and separately accounts for after-tax contributions and

b) allows for in-service distributions of the full account balance held within the after-tax account

you can request a full distribution of the after-tax account and simultaneously request that the distribution be split with after-tax funds directed to your Roth IRA and the earnings directed to your Traditional IRA.  Assuming the plan allows, the request could be repeated annually to successfully direct significant dollars into the tax-advantaged shelter of a Roth IRA.

Step by Step Instructions

If you’ve determined that this strategy will work for you, here are the step-by-step instructions.  There may be some variance depending upon your 401(k) plan rules.

  1. Determine if you are going to make pre-tax or Roth 401(k) contributions.  For most people using this strategy, they opt for pre-tax contributions of $19,500.
  2. Determine the amount of your employer contribution.  This may include a matching contribution, a profit sharing contribution and/or a transitional payment if your pension was recently terminated.  For this example we’ll assume $5,000.
  3. Using some simple math, determine the amount of your after-tax contribution.

For 2020 the IRS will allow up to $57,000 to be deposited into your 401(k).  If you want to get technical, this is the deferred compensation 415(c)(1)(A) limit.

To determine the amount of your after-tax contribution, subtract your pre-tax and/or Roth contribution and your employer contribution from the $57,000 limit.  For example:

  $57,000 contribution limit
– $19,500 pre-tax contribution
– $12,500 hypothetical employer contribution

 $25,000 maximum after-tax contribution

As noted the employer contribution is simply an assumption.  It will differ for everyone, even for two people working at the same company.  And you don’t want to contribute so much after-tax such that you may cannibalize the employer contribution.  While this strategy is great, it certainly doesn’t beat the free money offered by your employer.  Also, don’t over-contribute by exceeding the $57,000 deferred compensation limit.

4. Translate the contributions from dollars to percentages.  Most 401(k) plans require a participant to determine the amount of their contributions as a percentage of their gross pay.  We’ll continue with the assumption of $100,000 of gross income.

If the intention is to maximize the pre-tax contribution of $19,500, a 20% pre-tax deferral rate is needed.  Assuming you only have one employer, the plan will stop further contributions once you hit the $19,500 limit.

In this example the Roth 401(k) contribution would be 0%.

To contribute an additional $25,000 after-tax, the after-tax deferral rate would be 25%.  The online request may be appear similar to this:

After Tax Deferral Example

After Tax Deferral Example

The total contribution is thus 45%.  Gulp.  

Um, how do I eat?  I assume you answered this question for yourself long before now but if not, the answer is likely a) other savings, b) a spouse’s income or c) the soup kitchen.

Is it advantageous to live on other savings and maximize after-tax 401(k) contributions?  Most of the time, yes. There could be some exceptions but usually the ability to shelter all future appreciation from taxes is highly desirable.

5. Assuming the plan allows, let’s assume you request a distribution after one year.  Total hypothetical after-tax contributions are $25,000. Earnings on those after-tax contributions are $1,000.  When you request a full distribution, the plan will a) limit your request to just the segregated after-tax account and b) force you to withdraw both the after-tax contributions and the associated earnings.  You’ll want to clearly instruct the plan provider to issue two checks: the after-tax contributions of $25,000 to your Roth IRA and the $1,000 of earnings to your Traditional IRA. If done correctly, neither rollover request is a taxable event.  The checks will likely be mailed to your home but payable directly to your IRA custodian (for your benefit). For example, “Charles Schwab FBO Brendan Willmann.” Ideally the account number will be listed on the memo line.  Forward the checks to your custodian for deposit into the Roth IRA and Traditional IRA, respectively.

Investing Your Rollovers

6. $25,000 will be deposited into your Roth IRA.  Invest those funds as desired.  

7. $1,000 will go into your Traditional IRA.  You have three options: 

7A) Leave the funds in the Traditional IRA and invest as desired.

7B) Convert the Traditional IRA to your Roth IRA (at which time the $1,000 conversion is taxable).

7C) Roll the $1,000 from your Traditional IRA back into your 401(k).  Most every plan allows for a “roll-in” after certifying that the $1,000 represents only pre-tax funds.  This is usually the best option because it allows you to maintain a $0 balance in your Traditional IRA keeps the door open for a related strategy for higher income earners: the annual conversion of your Traditional IRA contributions to your Roth IRA.

Wash, rinse, repeat.  Max out your 401(k) contributions for the next year, request the distribution and address the Traditional IRA balance as desired.

Final Considerations

  1. Don’t overfund.  I know I already mentioned this but it is an easy mistake to make and a mess to fix.  Don’t exceed the IRS maximum contribution limit. Don’t cannibalize your employer contribution.  And don’t contribute so much that you don’t cover your payroll deductions like health insurance.


  2. Don’t leave money in a Traditional IRA and then attempt a conversion of your after-tax Traditional IRA contributions.  This won’t work out as expected. The IRS aggregates IRA assets for the purposes of determining the taxation of a Traditional IRA conversion.  If you leave $1,000 (per the example above) in a Traditional IRA, you’ll have to report it to the IRS even if you convert a totally separate account.

The usual parting advice is especially applicable as failure to follow the IRS guidelines can result in a significant amount of unexpected taxation.  Consult with a qualified tax advisor to ensure that your plan allows for this strategy and that your actions are in accordance with IRS rules.


The articles presented on this blog are general in nature and should not be assumed to be applicable to your situation. In addition, tax law changes daily and the articles on this blog are not updated to reflect these changes. Anyone receiving any part of the information on this blog should not rely on or act or refrain from acting on the basis of any matter or information contained in this blog without seeking appropriate tax, legal or other professional advice. The transmission and receipt of information contained on this blog does not form or constitute a client relationship. Nothing in this blog constitutes legal advice. Opinions rendered by tax professionals are not authority. You agree to hold Brendan Willmann, CFA, CFP®, CPA, EA, forever harmless from any liability for your use or failure to use the information, advice, referrals, or suggestions provided by this blog at any time.