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If you can afford to max out your 401(k) and there’s still wiggle room in your budget, your plan may have a special feature to save even more.

Although the 401(k) deferral limit for 2022 is $20,500 if you’re under 50, you can use after-tax contributions to save up to $61,000, including employer matches, profit sharing and other plan deposits.

And you can use the funds for the so-called mega-backdoor Roth maneuver — paying levies on earnings and moving the money to a Roth individual retirement account — for future tax-free growth. 

An estimated 12% of employees maxed out 401(k) plans in 2020, according to Vanguard, and 10% of workers with access to after-tax 401(k) contributions participated.

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“It can be a really really powerful technique for the right individual,” said certified financial planner Dan Galli, owner at Daniel J. Galli & Associates in Norwell, Massachusetts.

By rolling the money into a Roth IRA, investors may start building a tax-free pot of money for retirement, without rules to take the money out at a certain age.

“If they’re young enough and have years of tax-free growth ahead of them, it could be a game-changer,” said JoAnn May, a CFP and CPA with Forest Asset Management in Berwyn, Illinois.

After-tax vs. Roth 401(k)

It’s easy to confuse after-tax 401(k) contributions with a Roth 401(k) account since both allow you to save money after taxes, but there are key differences.

For 2022, employees under age 50 may defer up to $20,500 of their salary into their company’s regular pretax or Roth (after-tax) 401(k) account.

However, you can make additional after-tax contributions to your traditional 401(k), which allows you to save more than the $20,500 cap.

For example, if you defer $20,500 and your employer kicks in $8,000 for matches and profit-sharing, you may save another $32,500 before hitting the $61,000 plan limit for 2022.

If they’re young enough and have years of tax-free growth ahead of them, it could be a game-changer.

JoAnn May

financial planner at Forest Asset Management

The other twist is how earnings are taxed. While Roth 401(k) withdrawals (including earnings growth) are tax-free in retirement, any earnings on those “bonus” amounts added to traditional 401(k) plans are taxed. Yes, it’s confusing.

“That’s why it’s important to get [after-tax contributions] out of the 401(k) plan periodically,” said May.

Once per year, her clients withdraw after-tax contributions and earnings and roll the money into a pretax or Roth IRA. The downside of the Roth IRA option is there may be a tax bill on growth at the conversion.

Keep in mind the feature isn’t available for all plans.

While many 401(k) plans offer Roth accounts, after-tax contributions are less common. Fewer than 20% of 401(k) plans provided after-tax contributions in 2020, Vanguard reported

Moreover, plans with after-tax 401(k) contributions may not educate employees about the option. In some cases, advisors may discover the feature buried deep within a client’s benefits paperwork.

“The most important thing is to read your employee benefits handbook and pass it on to your advisor,” said May.

Tax-free retirement income

Some retirees may also pay more for Medicare premiums. While most retirees don’t pay for Medicare Part A, the base price for Medicare Part B starts at $170.10 for 2022.

Depending on their income, retirees may have to pay more for Medicare Part B, with top earners paying monthly premiums of $578.30.

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