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What is Voluntary After-Tax Contribution?

401k Plans are the fastest growing way to save for retirement. The most common types of 401k accounts are “Traditional” and “Roth.”
  • A Roth 401k is funded with after-tax dollars up to the plan's contribution limit. This type of investment account can be used by persons who think they will be in a higher tax bracket after retiring, as withdrawals are tax-free.
  • In contrast, a Traditional 401k is funded with pretax money, which results in a tax on future withdrawals.
However, there is a lesser-known third option that can be added to some employer 401k accounts; the After-Tax Contribution. This type of account consists of contributions that are after-tax, like a Roth account, and allow you to contribute much more than the regular annual limits.

Under the 2020 and 2021 guidelines, participants have the ability to contribute up to $19,500 of earnings to a 401k Plan If you are 50 years of age or better, the amount increases to $26,000. However, utilizing the After-Tax Contribution modification it is possible to contribute up to $58,000 if you are under age 50, or $64,500 with the 50(+) catch up contribution.

Here is an example: Andrea, who recently turned 38, works for Great Company. She had already contributed $19,500 to her plan. However, with the After-Tax Contribution, she is able to put away another $38,500 after taxes (less employer contributions, such as matching, profit sharing, and reallocated forfeitures).

However, there can be a downside to allowing After-Tax Contributions, including IRS testing and administrative issues. Companies with non-highly compensated employees (employees who earn less than $130,000) face the greatest number of challenges because they are less likely to pass IRS non-discrimination testing. If a plan fails, the plan sponsor may have to force highly-compensated employees to remove contributions.

This can be solved with a Safe Harbor Amendment. Safe Harbor modifications to a 401k Plan allow a company to avoid IRS non-discrimination testing. Highly compensated employees are then free to contribute the maximum amount (including After-Tax Contributions) regardless of what non-highly compensated employees contribute.

The After-Tax Contribution is a great way to maximize the benefits of a 401k Plan and help employees plan for a better tomorrow.

*Wells Fargo Advisors is not a legal or tax advisor.

Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly-owned subsidiary of Wells Fargo Bank, N.A.