As income and equity compensation grow, your financial landscape becomes more complex, presenting unique challenges and opportunities. We’ve helped many tech professionals, including those from Apple, Google, Meta and other tech companies, navigate the complexities of compensation and benefits packages to optimize their financial and tax situations.
One powerful tool employees can consider is an after-tax 401(k), complemented by a mega backdoor Roth conversion. This strategy can be particularly valuable for high earners who have maxed out their contributions to a traditional 401(k) and want to continue saving in a tax-efficient account. With federal and high state taxes for those who work and own real estate in tech hubs like California, it’s worth exploring available options to enhance your financial planning strategy.
How Do Traditional and Roth 401ks Work?
The benefits of saving in a “traditional” 401(k) can be powerful. By contributing pre-tax dollars, you reduce your taxable income and will lower your tax bill (e.g., if you make $100,000 and contribute $15,000 to a 401(k), you are only taxed on $85,000 of earnings). These 401(k) contributions can be invested, with the taxes deferred until you withdraw. You may also receive a company match (i.e., free money).
Some 401(k) plan providers also offer a “Roth” option, which has been available since 2006. Roths allow you to contribute money with after-tax dollars. The benefit is that, under current tax law, this money will never be taxed again. The downside is that you pay the income tax upfront at what may be high state and federal income tax rates. High-income earners don’t typically choose the Roth option, as they tend to focus on lowering their current tax bill.
Roth 401(k) Example
Let’s say you have contributed $20,000 to a Roth 401(k), which has grown to $30,000 over time. Now you have left your company and want to roll over the money to a Roth individual retirement account (IRA). You can transfer 100% of the money to a Roth IRA. This means the total account value (contributions + investment gains) will never be taxed again:
For 2024, the maximum allowed contribution for a traditional or Roth 401(k) is $23,000 ($30,500 if you are 50 or older).
After-Tax 401(k)s: Benefits & How They Work
Some employers, such as Google, Microsoft, Nvidia, and Apple, offer an “after-tax” 401(k). This option allows employees to contribute additional post-tax money on top of the limits mentioned above. The benefit is this allows you to save more. While your contributions are never taxed again, the investment gains from those contributions are tax-deferred and taxable at your ordinary income rate upon withdrawal in retirement. Using the same contribution example above, you can see how an after-tax 401(k) differs from a Roth 401(k):
When you roll over an after-tax 401(k), the contributions are deposited into a Roth IRA, while the investment gains are deposited into a traditional IRA. You do not have to worry about tracking your contributions versus gains, as the plan sponsor typically handles that.
The maximum contribution to a 401(k) in 2024 is $69,000 (or $76,500 if you are 50 or older), including the employer’s contribution. For an employee younger than 50, that means if you maximize your “traditional” tax-deferred contribution of $23,000, there is still the opportunity to contribute up to an additional $46,000 using the after-tax option.
It Gets Better! The Mega Backdoor Roth
Certain 401(k) providers offer “in-plan rollovers” or a mega backdoor Roth. These features allow you to convert money you have contributed to the after-tax 401(k) into the Roth 401(k), where future growth and withdrawals are tax-free. This is an amazing opportunity to contribute up to $46,000 per year to a Roth 401(k) in addition to the original tax-deductible $23,000 for traditional 401(k) for 2024!
It’s important to note if there are gains on the after-tax contributions, those will be taxable at ordinary income rates when you convert. That is why we recommend you initiate the conversion shortly after making the after-tax 401(k) contribution.
Do you still have questions about these options? We’d love to help! Here are a few FAQs.
Which Tech Companies Offer a Mega Backdoor Roth?
As of 2024, many prominent tech companies, like Apple, Google, Microsoft, and Meta, offer plans with after-tax contribution options, which are required for the mega backdoor Roth strategy. To determine if your company allows a mega backdoor Roth, contact your HR or benefits team or review your plan details for after-tax contributions and in-service rollover options.
Can I Withdraw After-Tax Contributions from a 401(k) or Roth IRA?
Depending on your plan, you can typically withdraw or roll over after-tax contributions from your 401(k) to a Roth IRA tax-free, using a mega backdoor Roth, for example. Keep in mind that earnings on after-tax contributions may be subject to taxation at the time of conversion.
After-tax contributions and earnings can be withdrawn tax-free from a Roth IRA after meeting certain age and holding requirements, meaning they can be a significant income source in retirement. There are different tax implications when withdrawing from a traditional IRA, where pre- and after-tax contributions may be subject to taxation via the pro-rata rule.
What Is the Pro-Rata Rule for 401(k)s with After-Tax Contributions?
In traditional 401(k)s and IRAs, with both pre- and after-tax contributions, the pro-rata rule requires you to withdraw a proportionate amount of both after-tax (non-taxable) contributions and pre-tax (taxable) funds. The specifics can get rather complicated and we suggest working with your advisor to navigate the rules.
Is an After-Tax 401(k) Right for Me?
For tech employees already maximizing their traditional or Roth 401(k) contributions who do not need the additional cash flow, an after-tax 401(k) can be a powerful tool. It allows you to contribute additional retirement funds in a tax-efficient way while providing a path to strategies like the mega backdoor Roth, which can significantly boost your retirement savings. If you receive stock compensation and bonuses, this can be an effective way to manage your tax exposure and build tax-free wealth. We encourage you to consult your HR or benefits team, financial advisor, or retirement plan specialist to review your plan details and comply with current tax laws.
Please contact us if you have questions about your after-tax 401(k). We are happy to help guide you through the details so you can make more informed financial planning decisions. You may also take our wealth assessment to learn more about your financial situation.
