Most employees are aware they can contribute to their employer’s retirement plan through pre-tax and Roth contributions. Employees can contribute up to $18,500 a year ($24,500 if age 50 or older) from their paychecks. What people are less aware of is whether their retirement plan allows for additional after-tax contributions beyond this limit.

It turns out that many retirement plans permit you to contribute an additional $20,000 after-tax a year to the plan, which can be converted tax-free to Roth at your convenience. This more than doubles what most individuals can contribute to their retirement plan to $38,500, which goes much further in working toward replacing your income in retirement. This benefit is even greater when both spouses have this option available.

Why contribute extra after-tax?
The benefit of contributing to your employer’s after-tax retirement plan is those contributions can subsequently be converted to Roth tax-free. This is sometimes called a “mega backdoor Roth IRA,” whereby you can contribute and convert up to $20,000 a year versus the much lower limits of Roth IRAs ($5,500 + $1,000 catch-up if 50 or older). Once converted, these Roth assets can grow tax-free and be distributed in retirement tax-free. If taken advantage of over several years, you can amass a meaningful amount of wealth in a tax-free retirement account.

How do I contribute?
1. Log in to your employer’s retirement plan through their provider website, such as Fidelity.
2. Find the area where you change your paycheck and bonus contributions (i.e., deferrals).
3. Find “after-tax” on the list that shows how much you elected to contribute to pre-tax or your Roth 401(k).
4. Enter a percentage to have withheld from your upcoming paychecks and bonuses that works for your budget.
5. Select an automated conversion schedule, such as quarterly. If your plan doesn’t list this automated periodic conversion option, contact your retirement plan provider on a periodic basis to convert the assets.
6. Select the investment allocation that’s appropriate for these assets that aligns with your overall investment plan.

Is any part of the conversion taxed?
Since each contribution to the after-tax portion doesn’t convert to Roth instantly, there may be growth in the account prior to the conversion. This growth is subject to taxation at ordinary income tax rates. For example, if you converted $22,000 ($20,000 contributions + $2,000 investment growth over the period), you’ll owe income tax at tax time on the $2,000.

We suggest speaking with an advisor to determine if your retirement plan allows additional after-tax contributions, how to fit it within your budget and its impact on your retirement savings goals.