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Your 401(k) is maxed out — now what?

Cash Flow and Retirement

What should retirement savers do if they’ve maxed out their 401(k) contributions? As this article explains, some plans allow participants to make after-tax contributions to their traditional or Roth 401(k) plans. Another option is to contribute to a traditional IRA, Roth IRA or annuity. Savers may also want to consider their health savings plan. A sidebar discusses a “back door” Roth IRA option for high-income earners.

Saving for retirement

A 401(k) plan is an attractive employee benefit, allowing you to set aside significant savings for retirement on a tax-deferred basis. And if your employer offers matching contributions, the benefits are hard to ignore. But what if you’ve maxed out your 401(k) contributions?

For 2022, you can defer up to $20,500 per year in pretax salary to a 401(k) plan, plus $6,500 in “catch up” contributions if you’re 50 or older. For many people, this amount is enough to enable them to achieve their retirement goals. But if you wish to invest more in tax-advantaged savings vehicles, you have several options.

After-tax contributions

Some 401(k) plans allow you to make additional, after-tax contributions after you’ve maxed out your pretax contributions. Currently, the total contribution limit — which includes both employee and employer contributions — is $61,000 ($67,500 if you’re 50 or older).

Let’s say you’re 40 years old and you’re currently contributing the maximum — $20,500 — in pretax dollars to your 401(k) plan. If your plan permits after-tax contributions, you can set aside up to an additional $40,500 per year, reduced by any employer matching contributions. Even though these additional amounts aren’t deductible, earnings on contributions grow tax-free and aren’t taxed until they’re withdrawn.

Also, many 401(k) plans allow participants to make Roth contributions. Contribution limits are the same as for traditional 401(k)s.

Traditional and Roth IRAs

Another option for boosting your tax-advantaged retirement savings is a traditional or Roth IRA. For 2022, the combined maximum contribution to traditional or Roth IRAs is $6,000 ($7,000 if you’re 50 or older).

Depending on your income level, contributions to a traditional IRA may be only partially deductible or even nondeductible, but they still provide tax-deferred earnings. Higher income earners are ineligible to contribute to a Roth IRA, although there may be ways to circumvent this restriction. (See “Back door Roth IRAs for high-income earners” below.)

Annuity contracts

An annuity is an investment contract, typically with an insurance company. Annuity holders invest a lump sum or make annual premium payments in exchange for a guaranteed income stream for life. This income stream either begins right away (with an “immediate” annuity) or at a later date (“deferred” annuity).

Annuities don’t offer current tax deductions. But their earnings grow on a tax-deferred basis, so they can be an attractive supplement to your 401(k) and other savings vehicles. Rates of return on annuities typically are modest, but the benefit of guaranteed income can make them valuable. There are several types of annuities — including fixed, variable and equity-indexed — so be sure you understand their terms before you invest in one.

Health savings accounts

A health savings account (HSA) can be an effective way to fund medical expenses while supplementing other retirement savings vehicles. Like a traditional IRA or 401(k), an HSA — which must be coupled with a “high-deductible health plan” — is funded with pretax dollars. Currently, the maximum annual contribution is $3,650 (self-only coverage) and $7,300 (family coverage), plus an additional $1,000 if you’re 55 or older.

An HSA’s earnings grow tax-free. And you can withdraw funds tax-free at any time to pay for a range of qualified medical expenses. Withdrawals used for other purposes are taxable, but there are no penalties for those age 65 or older.

An HSA can boost your retirement savings by funding medical expenses with pre-tax dollars, freeing up other funds that can be invested. Also, if you don’t use your HSA for medical expenses, it acts much like an additional IRA or 401(k) account.

Unique plan

These are just a few examples of the many retirement saving tools available to supplement your 401(k) plan. Even if you haven’t maxed out your employer-sponsored account, you may want to consider one or more of them. However, it’s usually best to first invest enough in your 401(k) plan to secure the maximum employer matching contribution.

Be sure to work with your advisor to develop a plan that takes into account your risk tolerance and retirement income needs. Also make sure you have put funds aside for emergencies and shorter-term financial goals.

Back door Roth IRAs for high-income earners

If your 2022 modified adjusted gross income will be more than $144,000 ($214,000 for joint filers), you’re ineligible to contribute to a Roth IRA. However, you may be able to use a “back door” Roth. To take advantage of this technique, you make nondeductible contributions to a traditional IRA (assuming you’re eligible) and immediately convert it to a Roth account. There are no income limits for Roth IRA conversions, and because you’re converting after-tax dollars, there’s no tax.

Back door Roth IRA contributions are subject to the usual limits on IRA contributions ($6,000 per year; $7,000 if you’re 50 or older). Also, this technique is less effective if you own any traditional IRAs funded with pretax dollars. That’s because a portion of the converted funds will be deemed to have been withdrawn from those accounts and subject to tax.

Another possible option is a “mega back door” Roth IRA. This works like a back door Roth IRA. However, the converted amounts come from nondeductible contributions to a 401(k) plan, up to

the $40,500 maximum (less employer matches). But this option is only available if your 401(k) plan permits after-tax contributions and rollovers or withdrawals while you’re employed.