With my very last paycheck of 2020 I hit and slightly exceeded the IRS limit on 401K contributions. At that time I mistakenly assumed that the limit only applied to pre-tax contributions, so for 2021 I changed things to contribute 15% pre-tax and 5% Roth, as opposed to just 20% pre-tax as I’d been doing before. But I was wrong, and since Roth contributions count towards the limit as well, and I got a raise last year, I hit the limit much sooner in 2021.
With my employer’s payroll system, when you hit the limit any additional contributions automatically become after-tax contributions, but they continue deducting the money from your pay and depositing it in your 401K account. Now, I see a lot of articles that say if you overcontributed to your 401K you should contact HR and have the money returned to you, or else you’ll face extra taxes and penalties. But do those after-tax contributions count as an overcontribution? Or is that just for pre-tax and Roth contributions?
And for future retirement saving, I know the limit has increased for 2022, but if I do the math and realize I’ll go over the limit again this year, what would the best thing to do be? Put less in my 401K and open an IRA and put the rest there?
But if you want to max your contributions this year just divide the max by your number of pay periods and have a flat amount taken out each paycheck instead of a percentage.
I think I found the answer myself. According to this, you can make after-tax contributions to your 401k beyond the $19,500 annual limit, as long as the total contributions plus the employer’s matching doesn’t exceed $58,000 for 2021. I’m sure I didn’t come close to that limit.
Good idea; I don’t know why I didn’t think of that. I’d previously had it set up to automatically bump up my contribution percentage every year, but I guess that no longer works once you’ve hit the limit.
Not everyone lets you pay a flat amount, they ask for a % of your income. When you factor in overtime and bonuses, it can be hard to make sure you are close to the contribution limit but not over it.
Are you eligible to contribute to a Roth IRA (there are higher-level income restrictions)? If you are, that’s where I’d be putting my excess contributions.
Well drat, I was wrong about that. My plan does indeed as for a % of your income; they don’t allow you to contribute a flat amount. So now I have to do the math to to figure out what percentage of my income I need to contribute to get as close as possible to the limit without exceeding it. I’ll probably wait until I find out what sort of raise I’ll be getting this year before I do that.
Why would you do an after tax Roth-style contribution to a 401k? Because, holding tax rates constant, the amount you can contribute is effectively higher.
If you want to take $10 of your income and put it into a 401k, you can take $10 pretax dollars. Let’s say tax rates are 50%, you grow your $10 to $100, take the money out and get $50 back (0.5*100, because the whole thing is taxable).
You can get the same result by putting $5 of your after tax income into a Roth style account, growing that to $50 and keeping it all.
So, after tax money growing tax free ($5 ->$50) is the same as pre-tax money growing tax-deferred ($10->$100*.5).
However, the limits are dollar amounts, so you can actually put in $10 after tax, which grows to $100 and you can keep all of it.
That is, by setting the limit to a dollar amount, not an after-tax equivalent, Roth limits are effectively higher than regular 401k limits.
To the OP, I’m stunned that your company will continue contributing after you’ve reached your limit. I put away 50% of my income, which severely reduced my paycheck for a while, but it stops when I hit the limit.
My company likewise stops withholding money after I hit the limit. Usually my last paycheck of the year is bigger than the rest since they don’t withhold any 401K money.
Looking at the plan rules, apparently they do it so you can keep getting the company match, since if contributions stop, the company matching stops, too.
My paycheck actually got slightly smaller the last few paychecks of the year, since the 401K contributions turned into after-tax contributions, and thus more tax was withheld.
My company matches throughout the year based on what you’ve put away. I think they match up to 6% of my income, up to 50% of what I’ve saved.
Let’s say I put away 100% of my income, and I max out my 401k over X months. My company looks at what I’ve put away, and continues to match what I’ve saved by putting away 6% of my income until they’ve matched 50% of what I’ve saved. The timing of my savings vs. theirs doesn’t matter.
So, when I look at my statement, I see large deposits over the first X months by me, and regular deposits by the company throughout the year.
I should correct this – I took a look at the deposits last year, and it looks like the company trues up everything right before the last payment in month X.
My company had an option - if you hit the pre-tax limit you could either automatically stop contributing, or they would change to after tax contributions. I don’t remember if they did matching on after-tax, but I aimed for all pre-tax on the theory that the later in time calculations of what distributions were already taxed were a headache I’d just as soon avoid, even if it meant missing some small amount of matching funds.
When someone refers to “a Roth” account, they are 99.9% of the time limit referring to a Roth IRA. But an employee can set up their 401k plans to allow post-tax contributions to it. These are also called Roth contributions, and are treated as such at retirement. After-tax contributions to a 401k are different - they happen in situations like the OP, when you’ve reached your contribution limit. These contributions are treated differently at withdrawal - the earnings are taxed.
I do it for the exact same reason that anybody would choose a Roth IRA – I prefer to deal with the tax issue upfront, rather than down the road when I withdraw the money.