December 10, 2023

Most advice with 401(k) plans starts and stops with, “contribute at least enough to get your employer match.” While that is good advice you should implement, it’s a tiny piece of what could be a very complex puzzle.
Simply contributing enough to your 401(k) to get the match leaves you a long way from maximizing the financial power your employer-sponsored plan could offer you. And failing to fully leverage your 401(k) could cost you millions of dollars in the future.
Many people know the 2022 contribution limit for 401(k)s: it’s $20,500. The nuance that you might miss, however, is that limit considers the employee contributions. There are other contributions you can make, depending on how your plan is set up.
An employee cannot contribute more than a combined $20,500 into a traditional and/or Roth 401(k) plan. But the true maximum that can go into a 401(k) plan in a year is $61,000.
That leaves room for $40,500 more above what most people think of as the “limit,” through a combination of employer contributions and after-tax employee contributions.
Before we break down how those additional contributions work, let’s consider what truly maxing out your 401(k) could do for you:
Let’s assume you could contribute at least $61,000 per year to your 401(k) (and realistically, you will be able to put more in over time as the IRS adjusts the employee maximum periodically to keep pace with inflation). If you maxed out the plan’s capacity starting at 30 years old, then at the end of your 50th year, assuming a 6 pecent average rate of return, you’d have about $2.4 million in the plan. If you made a more aggressive return assumption of 8 percent, you’d have around $3 million.
Don’t feel down if you’re 40 instead: that same 21-year contribution period would get you to millions in your 401(k) by the time you were 60. Not a bad way to pave the road to retirement.
Of course, all of this assumes that your 401(k) plan is set up for you to take the utmost advantage of it… and unfortunately, not all 401(k) plans are the same. That’s another mistake most people make, in addition to assuming $20,500 is the absolute limit you can get into these plans: that every 401(k) plan looks exactly alike.
There are broad based rules created by the ERISA (Employee Retirement Income Security Act of 1974), which is a Federal law that sets minimum standards for retirement plans in the private sector. All retirement plans must follow these baselines. However, employers still have a lot of choice in what they allow or how they construct the plans offered to employees, and that’s where you get a wide variation across companies.
If you want to power up your 401(k) and leverage it for all its worth, you first need to take a look under the hood and see what your plan provides and allows.
Your starting point to fully understand your 401(k) is your plan document. Your 401(k) provider or a member of your employer’s management team (specifically your HR department if your company has one) should be able to provide that to you.
Read through this carefully. This is your single source of truth to knowing what you can or can’t do with your 401(k). In working with our financial planning clients, we often find that they believe a lot of falsehoods about their plans based on coworker heresay, or because they’ve gotten the wrong information from HR.
That’s not a knock on fellow employees or HR — neither are financial professionals, and it’s easy to misunderstand or misinterpret what a plan document is saying.
(This is a huge value of having a personal financial planner on your side: to review these documents with you and address any confusion, clear up misinformation, and help you drill down to the facts.)
If you want to take advantage of the potential additional $40,500 you could contribute on top of the employee maximum of $20,500, then you have to review your plan document to understand:

Now that you know what to look for within a plan document, here’s what you might be able to do with that information to contribute up to $61,000 per year to your 401(k).
Already maxed out your employee contributions to a traditional and/or Roth 401(k) at $20,500 for the year? Some plans allow employees to contribute more of their own money above the $20,500 limit.
This bucket is only funded with after-tax contributions. Similarly to Roth contributions, taxes are taken out first and then the money is deposited in the 401(k). However, unlike Roth contributions, this money doesn’t automatically grow tax-free.
The contributions themselves will never be taxed, but the growth will be taxed in full when you distribute the funds later on (most likely in retirement).
There is a way to avoid this taxation on growth though. It’s a huge loophole for those who have access to this functionality and can afford to contribute over the $20,500 maximum: a mega-backdoor Roth strategy.
This move allows you to contribute money into the after-tax bucket of your 401(k) — and then immediately convert that money into a Roth account.
For this to work, the plan must allow for in-plan conversions. If the plan does allow you to do this, all of the growth on those after-tax contributions will be tax-free in retirement, just like it is for contributions directly to Roth 401(k)s or Roth IRAs.
This is a great way to get more tax-free growth in your investment accounts.
Bear in mind that the maximum you can contribute into the after-tax bucket within your 401(k) is combined with the employer contributions, outlined below. The combination cannot exceed $40,500 for 2022, assuming you max out your employee contributions at $20,500.
So far, we’ve covered the heavy lifting that you can do with your 401(k). But employers can help out too, depending on how they set up their retirement plans. Here’s what to look for within your plan document:
Employer Match: This is the standard that most people know about: employers can choose to provide a company contribution that matches the amount employees contribute, up to a certain percentage of pay or specific dollar amount.
Safe Harbor Non-Discretionary Contributions: Some employers will offer a non-discretionary contribution in addition to a match. This means they commit to contributing a certain percentage of an employee’s salary — regardless of what the employees themselves contrubte to the plan. You typically find this within safe harbor 401(k) plans.
Discretionary Profit-Sharing: Employers can also contribute a discretionary profit-sharing amount in any year when they may have excess profit they want to give back to employees as a benefit.
If your 401(k) is checking all these boxes, you likely have an excellent company benefit in your retirement plan and can truly max out its use. But there may be a few catches to be aware of, especially around vesting schedules.
Some plans require that a certain period of time go by before any employer contributions to the 401(k) are “vested,” meaning, fully yours. If you were to quit or face termination, the money the employer contributed to your 401(k) that was not vested goes back to your employer. It’s not yours to keep!
(The exception here is for safe harbor contributions; those are fully vested on day one.)
Vesting schedules can be graded. This means a percentage of employer contributions vest each year up to a maximum of 6 years — at which point all contributions to date and going forward are vested.
Or, they can offer a cliff, which means that nothing vests until a specific date up to 3 years from the employee start date. Other employers will allow money to be vested immediately, with no scheduling requirements to meet. It’s a choice the employer makes when setting up the plan.
Another potential issue to plan ahead for applies if you have goals like early retirement. In this case, you might want to access your money before age 59 and 1/2… and normally, if you did so, you’d have to pay taxes and penalties for getting your “retirement” money early.
But there are a couple ways to avoid those penalties. The most commonly referenced strategy is 72(t) distributions, which refers to the IRS rule around substantially equal periodic payments.
72(t) distributions are allowed for traditional IRAs, 403(b)s and 401(k)s. Essentially, you are allowed to take substantially equal payments from your 401k) at least annually for 5 years or until you are age 59.5, whichever is longer.
If you retire at 50 and need your 401(k) funds to live on, you’d need to take substantially equal distributions for about 10 years to avoid the 10% penalty on those distributions.
You can’t just make up a number for your “periodic payment.” You have to use set formulas to determine what you have to withdraw. There are three ways to get to an acceptable amount:

Of course, the best way to get access to your money is to build a long-term, comprehensive plan that takes into account goals like early retirement.
We help our clients build an investment funding strategy that offers a way around being forced to implement the 72(t) distribution strategy. There are times, however, when it does make sense to use.
Depending on what your 401(k) plan allows, there’s also the “rule of 55” to help you get access to your money before age 59 and 1/2. You have to meet several criteria to avoid the normal 10 percent for early withdrawals:

Not all employers allow these early distributions and if they do, some only allow a lump-sum distribution — which is usually not a good idea for those who have high balances due to the tax implications of receiving that money all at once in a single year.
Distribution strategies from your 401(k) — or investment accounts in general — is a huge piece of the planning puzzle that most people miss. You can argue that it’s relatively easy to contribute and that you don’t need professional support to get that right (although all the nuance in this article might help you understand there’s always value in professional advice!).
But when it comes to looking at your entire financial picture and strategy and knowing exactly when and where to start pulling from your nest egg to fund your life after work — that’s typically another story.
Messing up your distribution strategy, whether you need early withdrawals or not, greatly impacts the taxes you pay and can influence the longevity of your assets.
A 401(k) plan can be deceptively powerful — but only if you know what to look for, and how to use it fully.
And if you check out your plan document only to find your current plan doesn’t offer you any ability to contribute more than the standard employee maximum of $20,500?
Bear that in mind the next time to consider a job change, and remember to consider the company’s retirement plan as you evaluate your overall compensation and benefits. A 401(k) plan could be the tiebreaker when evaluating new opportunities, or comparing one position to another.
As wonderful as a 401(k) can be as a tool to use to grow your wealth, it’s only one piece of the puzzle; it’s just one way to build assets.
This is where getting a comprehensive financial plan into place is so critical, because that takes all your options into account. A great plan knows how to organize every opportunity you have, and then fully optimize it for maximum results.


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