Maximizing retirement savings is a key goal for many employees. While traditional pre-tax and Roth 401(k) contributions are well-known, a powerful but often overlooked feature exists: the after-tax contribution. This option can allow high-income earners to save significantly more for retirement, but it comes with specific compliance rules that employers must understand.
This post will explore the benefits and considerations of offering after-tax contributions in a 401(k) plan. We will cover the crucial compliance tests involved and explain why this plan design is particularly effective for companies with a specific employee demographic.
What Are After-Tax 401(k) Contributions?
After-tax 401(k) contributions are funds an employee adds to their retirement plan from their paycheck after income taxes have already been paid. These are different from Roth 401(k) contributions. While both are made with post-tax dollars, they are subject to different rules and limits.
This approach has gained traction in recent years, thanks in large part to major tech companies like Google, Salesforce, and others. These industry leaders have popularized after-tax contribution programs, increasing awareness and driving broader adoption among employers seeking to offer competitive retirement benefits.
The primary advantage is that after-tax contributions allow employees to save beyond the standard employee deferral limit. This can be a significant benefit for those who have already maxed out their pre-tax or Roth contributions and want to continue building their retirement nest egg. Surprisingly, while 25% to 30% of 401(k) plans offer this feature, many employees and employers are unaware of its potential.
Understanding the Annual Additions Limit
All contributions to a 401(k) plan—including employee deferrals, employer matches, profit sharing, and after-tax contributions—are subject to an overall limit set by the IRS. This is known as the IRC Sec. 415 annual additions limit.
This limit is the total amount that can be contributed to a participant's account from all sources in a single year. It includes:
- Employee pre-tax and Roth deferrals
- Employer matching contributions
- Employer profit-sharing contributions
- After-tax contributions
For an employee to make after-tax contributions, there must be room left under this overall annual additions limit after all other contributions have been made. If a participant exceeds this limit, the plan must take corrective action, which typically involves refunding the excess contributions.
Example for 2025:
Suppose the annual additions limit for 2025 is $69,000 (not including catch-up contributions for those age 50+). Let’s say an employee contributes $22,500 in pre-tax deferrals, receives $10,500 in employer matching, and $6,000 in profit sharing. This totals $39,000. The employee could then contribute up to $30,000 in after-tax contributions before reaching the $69,000 annual additions limit.
If, however, the employee accidentally contributes more—say, $35,000 after-tax for a total of $74,000—the plan would need to refund $5,000 to the participant to correct the excess and comply with IRS rules.
The Compliance Tests You Can't Ignore
While offering after-tax contributions provides a great benefit, it also introduces complexity. These contributions are subject to specific nondiscrimination tests to ensure the plan does not unfairly favor high earners.
1. The Actual Contribution Percentage (ACP) Test
The ACP test is a mandatory annual review for plans that allow after-tax contributions. It compares the average contribution rates of Highly Compensated Employees (HCEs) to those of Non-Highly Compensated Employees (NHCEs). For 2025, an HCE is generally defined as an employee earning more than $160,000 or owning more than 5% of the business.
The test ensures that the contributions from the HCE group do not exceed the NHCE group's contributions by more than a specified percentage. Even "safe harbor" 401(k) plans, which are normally exempt from other types of testing, must perform the ACP test if they permit after-tax contributions. If a plan fails the ACP test, the most common solution is to refund the after-tax contributions to the HCEs until the test passes.
2. The Top-Heavy Test
After-tax contributions are included as plan assets when determining if a plan is "top-heavy." A plan is considered top-heavy if more than 60% of its total assets are held in the accounts of "key employees." Key employees typically include owners and certain officers of the company.
If a plan becomes top-heavy, the employer is required to make a minimum contribution to the accounts of all non-key employees. This ensures that rank-and-file workers also receive a benefit. This requirement can add an unexpected cost for the employer, so it's vital to monitor the plan's asset distribution.
Is This Plan Design Right for Your Company?
The compliance hurdles associated with after-tax contributions can be challenging. Constant ACP testing failures and corrective refunds can be an administrative burden. Plans can also become top-heavy, triggering mandatory employer contributions.
So, who is this feature best suited for?
The ideal scenario for a 401(k) plan with an after-tax contribution feature is a company where the employee demographic consists largely of high earners. If most or all of your employees earn above the HCE threshold ($160,000 for 2025), the challenges of nondiscrimination testing become much less significant. When everyone is an HCE, there is no NHCE group to compare against, making it easier to pass the ACP test.
For these companies, offering after-tax contributions becomes a powerful tool for attracting and retaining top talent. It provides a strategic advantage by enabling employees to save far more for retirement than they could with a standard 401(k) plan.
Conclusion: A Powerful Tool for the Right Audience
Allowing after-tax contributions in your 401(k) can be a game-changer for employee retirement savings. However, these contributions are "testy" and require careful administration to ensure compliance with IRS regulations.
If your company's workforce is primarily composed of employees who qualify as HCEs, this plan feature is worth serious consideration. By implementing it, you can provide a valuable benefit that helps your team secure their financial future while positioning your company as a top-tier employer. Work with your plan administrator or financial advisor to determine if adding an after-tax contribution feature is the right strategic move for your business.
Ready to explore whether after-tax 401(k) contributions are the right fit for your company?
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