After-Tax 401(k) Contributions

After-tax 401(k) contributions are employee contributions made with money that has already been taxed, into a separate account inside the plan, and they are a different animal from the two contribution types most people know — the pre-tax deferral and the Roth 401(k). The name causes genuine confusion, because a designated Roth contribution is also made with after-tax dollars — so "after-tax contributions" sounds like a category that includes Roth. It does not. In plan terminology these are non-Roth after-tax contributions, tracked separately from both pre-tax deferrals and Roth deferrals, and they are also distinct from a nondeductible traditional IRA contribution, which is a different regime reported on Form 8606 that happens to share the phrase.

The mechanical difference from Roth is one sentence long and it is the whole point of the page: your contributions become basis you eventually recover tax-free, but the earnings on them remain pre-tax and are taxed as ordinary income when they come out. A Roth contribution, by contrast, makes both the contribution and its growth tax-free in a qualified distribution. So after-tax contributions left sitting in the plan for decades produce the worst of both worlds — no deduction on the way in, and taxable growth on the way out. Their value comes almost entirely from being converted to Roth, promptly.

Why the room exists. Two separate limits govern a 401(k). Section 402(g) caps what an employee may defer — $24,500 — and section 415(c) caps everything going into the plan for one participant in a year, employee and employer money combined, at $72,000, with catch-up contributions sitting on top of that figure rather than inside it. After-tax contributions count against the 415(c) limit but not against the 402(g) deferral limit. For most participants the two limits are far apart — deferrals plus an employer match rarely approach the overall ceiling — and after-tax contributions are the only employee money that can fill the gap. What to do with that gap is the mega backdoor Roth strategy, which has its own page and its own walkthrough; this page is about the contribution type itself.

Basis and earnings, and why the split is unforgiving. The plan tracks the after-tax sub-account as contributions (basis) plus earnings. A distribution from it is allocated proportionally between the two under section 72(e)(8) — you cannot elect to take only the basis and leave the earnings behind. This is a separate mechanic from the IRA pro-rata rule that complicates a backdoor Roth, though the intuition is similar: the tax code resists letting anyone cherry-pick the untaxed slice. What keeps the proportion from being measured against your entire plan balance is section 72(d)(2), which permits employee contributions and their earnings under a defined contribution plan to be treated as a separate contract — so where the plan accounts for them separately, the denominator is the after-tax sub-account rather than the whole account. Without that separate accounting the arithmetic would be far less favorable.

Notice 2014-54 is what makes clean conversions possible. IRS Notice 2014-54 allows simultaneous distributions to more than one destination to be treated as a single distribution for allocation purposes. That means the after-tax basis can be directed to a Roth IRA while the associated pre-tax earnings go to a traditional IRA, with the basis converting free of tax and the earnings staying deferred. Before that guidance the allocation rules made this considerably messier. The practical corollary is that speed matters: convert soon after contributing and there is barely any earnings sliver to deal with; wait years and the taxable portion grows with the market.

Why so few plans offer them. After-tax contributions can be subject to the actual contribution percentage (ACP) test, one of the nondiscrimination tests that compares what higher-paid employees put in against what everyone else does. A plan where only a handful of highly compensated employees use the feature can fail the test, forcing corrective refunds — so many sponsors simply do not offer it, and some that do restrict it by percentage of pay. A plan can also permit after-tax contributions without permitting either in-plan Roth conversions or in-service withdrawals, which leaves the money stranded in the least attractive tax treatment available. Both features have to be present for the contribution type to be worth using.

The mechanics: you elect an after-tax contribution percentage separately from your pre-tax or Roth deferral; the plan credits it to a distinct sub-account and tracks basis and earnings separately; and from there the money either gets converted to Roth — inside the plan or by rolling it out — or it stays put and accumulates taxable earnings.

A hypothetical example of the basis-and-earnings split. Priya contributes $30,000 of after-tax money over three years, and the sub-account grows to $34,000. The $34,000 − $30,000 = $4,000 of growth is the pre-tax piece. If she converts the whole sub-account to Roth, the $30,000 of basis converts free of tax and the $4,000 of earnings is ordinary income in the year of conversion. If instead she had converted each contribution within weeks of making it, the earnings sliver would have been a few dollars rather than four thousand.

Now a partial withdrawal, to show why the earnings cannot be left behind. Suppose she takes $8,500 out of that $34,000 sub-account instead of converting it. The basis fraction is $30,000 ÷ $34,000, so the basis portion is $8,500 × ($30,000 ÷ $34,000) = $7,500 and the taxable earnings portion is $8,500 − $7,500 = $1,000. That $1,000 is ordinary income, and if she is under 59½ the additional 10% tax on early distributions generally applies to it as well. The basis portion is neither taxed nor penalized, because it was already taxed once.

Pros

• Creates a large amount of additional annual contribution capacity for a saver who has already maxed out the regular deferral, since the ceiling is the overall plan limit rather than the deferral limit.
• The contributions themselves become basis, recoverable tax-free.
• Paired with an in-plan Roth conversion or an in-service rollover, the basis converts to Roth at little or no tax cost.
• Unlike a Roth IRA contribution, there is no income limit standing in the way.

Cons

• Earnings stay pre-tax and are taxable on distribution, so unconverted after-tax money is genuinely worse than either a pre-tax or a Roth contribution.
• Withdrawals from the sub-account come out proportionally, so the taxable earnings cannot be isolated and avoided.
• Most plans do not offer the feature, and some that do lack the conversion mechanism that makes it worthwhile.
• Nondiscrimination testing can force refunds to higher-paid participants, which makes the available amount uncertain until testing is complete.
• It only makes sense after the regular deferral is fully used, so it is a supplemental tool rather than a starting point.