Why Some Plans Allow After-Tax Contributions Beyond The Usual Limit

Workplace retirement plans operate under more than one contribution limit. The gap between them is why some plans accept after-tax money that is neither pre-tax nor a designated Roth contribution.

Two limits govern the same account

One limit applies to what an employee may defer from salary in a year. A separate, larger limit applies to everything credited to the account, including employer contributions.

An employee who reaches the deferral limit has therefore not necessarily reached the overall limit, and the difference varies with how much the employer contributes.

After-tax contributions are one way plans allow employees to use that remaining space, which is why the feature exists at all.

After-tax is a third category, not a Roth contribution

Designated Roth contributions are made with taxed money and grow with distinct treatment attached under the plan's Roth rules.

Plain after-tax contributions are also made with taxed money, but the earnings on them are treated as pre-tax within the account.

The result is a single account balance containing components with different treatment, which the plan's recordkeeper tracks separately.

Not every plan offers it

The feature is optional, and a plan document either permits after-tax contributions or does not. No employee election can create the option.

Plans that do offer it may cap it well below the theoretical maximum, and the cap can differ from the plan's other limits.

Checking the summary plan description, or asking the plan administrator directly, is the only way to establish what a particular plan permits.

Nondiscrimination testing can force refunds

Plans are tested annually to ensure benefits do not skew toward highly compensated employees, and after-tax contributions fall inside one of those tests.

A plan that fails may be required to return contributions to affected employees after the year has closed, which arrives as an unexpected distribution.

Some plan designs avoid the test through safe harbor structures, which is one reason the availability of this feature varies so much between employers.

What happens to the money afterward

Plans differ in whether they permit in-plan conversions or withdrawals of the after-tax component while employed, and those provisions are again set by the plan document.

The treatment of the associated earnings is a separate matter from the treatment of the contributions themselves, and the two do not move identically.

This area is governed by detailed rules that change, and the interaction with an individual's overall tax position is not something a general description can settle. A qualified tax professional and the plan administrator are the appropriate sources.