Roth IRA vs. After-Tax 401(k) Contributions: What's the Difference?

Your specific financial situation will determine which is best

A man calculates his after-tax 401(k) contributions
Photo:

SrdjanPav / Getty Images

Roth IRAs and 401(k)s are both types of retirement accounts that help you build your nest egg. 401(k)s are sponsored by employers while you can open your own Roth IRA. Roth IRAs are funded with money you've already paid tax on or after-tax dollars, which may allow you to make tax-free withdrawals in the future. 401(k)s are typically funded with pre-tax money, but in some cases, you might be able to use after-tax dollars to contribute towards a designated Roth 401(k) or after-tax 401(k). Unlike Roth IRA plans, 401(k)s have large contribution limits, no income restrictions for contributions and may require a minimum distribution from the account.

Key Takeaways

  • Roth IRA and after-tax 401(k) are both funded with money you've already paid tax on which leads to tax-free withdrawals under certain conditions.
  • A Roth IRA can be opened by an individual while your employer has to offer an after-tax 401(k) plan
  • An after-tax 401(k) plan is also called designated Roth 401(k) plan
  • Roth IRAs have smaller annual contribution limits and income eligibility requirements. After-tax 401(k) plans have not income restrictions.
  • Roth IRAs require no minimum distributions while after-tax 401(k) plans mandate distributions after age 72 with a few exceptions.

What's the Difference Between Roth IRA and After-Tax 401(k) Contributions?

While both Roth IRA and after-tax 401(k) plan allow you to save for retirement using money you've already paid tax on, there are some key differences.

IRS Rules Roth IRA After-Tax 401(k)
Contribution Limits $6,000 or $7, 000 for ages 50 and up. ($6,500 and $7,500 respectively in 2023) $20,500 or $27,000 for ages 50 and up. ($22,500 and $30,000 respectively in 2023)
Income Eligibility You can contribute fully or partially towards the contribution limit based on your modified adjusted gross income. No income eligibility requirements
Tax Liability Tax-free if withdrawals meet qualified distribution criteria. Tax-free if withdrawals meet qualified distribution criteria.
Withdrawals No required minimum distributions Mandatory distributions required after age 72, unless you're still working or are a 5% owner in the business.
Roth Rollover Eligible n/a yes

Who Can Open the Account?

A Roth IRA is a type of an individual retirement account, which as its name suggests can be opened up by an individual. A 401(k) plan, on the other hand, is sponsored by an employer. So while you contribute towards your 401(k) the plan itself is offered by your employer. Typically, 401(k) plans are funded with pre-tax money, but some employers may offer an after-tax 401(k) plan sometimes also called a Roth 401(k) or a designated Roth plan.

Contribution Limits


Designated Roth contributions to a 401(k) or after-tax 401(k) contributions are contributions made from compensation with dollars that have already been taxed. These contributions don't reduce your income, so you can't deduct them on your tax return. Putting money into your 401(k) account with after-tax contributions can also help maximize your contributions, lower your tax burden, and streamline your contributions.

The aggregate limit for 401(k) pre-tax elective deferrals and designated Roth contributions for 2022 is $20,500 ($22,500 in 2023), plus another $6,500 ($7,500 in 2023) in catch-up contributions if you are 50 or older.

Granted, many people aren't able to max out their pre-tax and designated Roth contributions, and if this describes your situation, this limit may not seem restrictive. However, if you have the financial means and the desire to save more than the limit, you can do so with after-tax contributions if your 401(k) allows them.

Note

One of the greatest benefits of employer-sponsored retirement plans is the convenience and simplicity associated with automatic contributions. Every time you get a paycheck, you save for retirement automatically without having to think about it.

The combined annual contribution limit for IRAs (both traditional and Roth) is $6,000 in 2022 ($6,500 in 2023). If you're age 50 or up, you can contribute an additional $1,000 as a catch-up contribution, making your 2022 limit $7,000 ($7,500 in 2023.) That means, you can contribute up to that amount if you meet the income eligibility criteria and do not have any other IRA contributions in the year.

Income Eligibility

After-tax 401(k) plans do not have any income-based restrictions for contributions. Roth IRAs, on the other hand, have income eligibility criteria that determines if you can contribute fully, partially or not at all towards the annual contribution limit.

Filing Status 2022 modified AGI 2022 maximum contribution 2023 modified AGI 2023 maximum contribution
married filing jointly or qualifying widow(er) < $204,000 up to the limit < $218,000 up to the limit
married filing jointly or qualifying widow(er) > $204,000 but < $214,000 a reduced amount > $218,000 but < $228,000 a reduced amount
married filing jointly or qualifying widow(er) > $214,000 zero > $228,000 zero
married filing separately and you lived with your spouse at any time during the year < $10,000 a reduced amount < $10,000 a reduced amount
married filing separately and you lived with your spouse at any time during the year > $10,000 zero > $10,000 zero
single, head of household, or married filing separately and you did not live with your spouse at any time during the year < $129,000 up to the limit < $138,000 up to the limit
single, head of household, or married filing separately and you did not live with your spouse at any time during the year > $129,000 but < $144,000 a reduced amount > $138,000 but < $153,000 a reduced amount
single, head of household, or married filing separately and you did not live with your spouse at any time during the year > $144,000 zero > $153,000 zero

Tax Liability Upon Withdrawal

Your retirement plan account balance includes two important components: your original contributions and the earnings on those original contributions. Depending on the type of contribution you make, either, both, or neither of these amounts may be taxed.

Note

Given that both after-tax 401(k) and Roth IRA are funded with money you've already paid tax on, both the contributions as well as the earnings in those accounts can be withdrawn tax-free if they are qualified distributions that meet certain conditions.

Roth IRAs do not have any required minimum distribution but you may be subject to a 10% early withdrawal penalty if you withdraw your funds before the age of 591/2 years.

However, after-tax 401(k) plans require mandatory distributions after age 72 unless you're still working or are 5% owner in the company.

Eligibility for Rollovers

After-tax contributions also mitigate your tax burden in retirement in another way. At the time you leave your company or retire, you will have the ability to roll the tax-deferred earnings growth into a traditional Individual Retirement Arrangement (IRA) and roll your after-tax 401(k) contributions into a Roth IRA.

This means that your earnings can continue to grow on a tax-free basis if you leave the money in the traditional IRA until after reaching age 59 1/2. That’s because the IRS considers the earnings associated with the after-tax contributions as pre-tax amounts.

The Bottom Line

In most cases, your retirement plan investment options for after-tax contributions are identical to those in pre-tax and designated Roth accounts. If your 401(k) plan offers after-tax contributions, consider this option if:

  • You're a high earner. While many people aren’t able to max out their pre-tax retirement plan contributions, if you are fortunate enough to earn a salary that causes you to regularly hit the annual contribution limit, you can save more through after-tax contributions to a 401(k) plan or another defined-contribution plan.
  • You want to maintain emergency savings. Since you can withdraw your after-tax contributions tax-free, you can dip into them to cover unplanned expenses.
  • Your income fluctuates. If you work a seasonal job, for example, your income may change each year. In years when you earn a lot of income, you can boost your savings potential through after-tax contributions. When times are lean, you can make pre-tax or designated Roth contributions within the contribution limit.

Frequently Asked Questions (FAQs)

What is the Rule of 72, and how does it affect my retirement goals?

The "Rule of 72," is a common approach for calculating how long it will take your investment to double in value. Divide 72 by the expected rate of return to figure out how long it might take for your investment to double.

How is a 401(k) different from an IRA?

401(k) are more typically offered by employers while individual retirement accounts (IRAs) as their name suggests are opened by individuals. Employees can take withdrawals whenever they want to, although a federal tax penalty can apply if they haven't yet reached age 59 1/2 and if the withdrawal isn't for one of several approved reasons. However, the annual contribution limit is much lower for an IRA.


Was this page helpful?
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. IRS. "Roth Comparison Chart."

  2. Internal Revenue Service. "Retirement Topics - Contributions."

  3. IRS. "FAQs - Auto Enrollment - What Is an automatic contribution arrangement in a retirement plan?"

  4. IRS. "Amount of Roth IRA Contributions That You Can Make for 2022."

  5. IRS. "Amount of Roth IRA Contributions That You Can Make For 2023."

  6. IRS. "Early Withdrawals From Retirement Plans."

  7. IRS. "Rollovers of After-Tax Contributions in Retirement Plans."

  8. Save First Financial Wellness. "What Is the Rule of 72?"

  9. Congressional Research Service. "Individual Retirement Account (IRA) Ownership: Data and Policy Issues," Page 3.

Related Articles