401(k) Plan Highlights

Welcome to Cornerstone Clips. I’m Joel Ockey, and today we’re going to be talking about 401(k) plans and how to maximize them.

The 401(k) is the most common type of employer-sponsored retirement plan available today. It has three opportunities to defer income into it. Those are the sources: traditional pre-tax, Roth, and post-86 after-tax. They also have a company match. The company match varies from plan to plan but, generally speaking, is between 4% and 7%. The company match is either a 100% match or a 50% match in most cases, meaning if it’s a 100% match and you put in 5%, the company puts in 5% on your behalf. If it’s a 50% match and you put in 5%, the company puts in 2.5% on your behalf.

Let’s look at the sources specifically.

Traditional Pre-Tax Contributions

Traditional pre-tax contribution is the first source available to you. This is the most common way people use 401(k) plans.

These contributions are made on a pre-tax basis, meaning you get to deduct what you put into the 401(k) plan from your taxes today, thus saving you taxes today. However, the earnings grow tax-deferred and then ultimately, when you take them out after retirement, they are taxed as ordinary income, meaning you get your tax help today and you’ll pay the tax implications at a future date.

Withdrawals are allowed on a penalty-free basis after age 59½. There is also a Rule of 55 that allows, under certain specific circumstances, these contributions to be taken out without a penalty as early as age 55.

Roth Contributions

The next contribution type is Roth contributions. These are made on an after-tax basis, meaning you do not get to deduct them from your taxes today. Instead, you earn money, pay tax on it, and then defer it into the 401(k) plan. The earnings on Roth contributions grow tax-free and the distributions, when taken in retirement, are also taken out on a tax-free basis. Thus, it’s the opposite of the pre-tax contributions, meaning you get no tax help today for putting it in, but you do not have to pay any tax on what it grows to in the future when you take it out after retirement. This creates a valuable source of tax-free income and provides flexibility in your income plan as you get to retirement.

After-Tax Contributions

The third type of contribution is a little lesser known. It’s post-86 after-tax contributions. These contributions are made on an after-tax basis, meaning you get no tax help for putting them into the plan today. The earnings grow tax-deferred, not tax-free.

In this case, you put money in, you do not get a tax deduction for the money you put in, the earnings grow tax-deferred, and then when you take it out in retirement, the cost basis comes out with no tax implication, but the growth is taxed as ordinary income at that point. There’s also a special provision, or loophole, that allows you to roll over these contributions to a Roth IRA. This is commonly known as a Mega Backdoor Roth. It’s a lesser-known strategy, but a very valuable technique in creating more opportunity for you to save on a tax-advantaged, tax-free basis in the future.

Annual Contribution Limits

Let’s look at the annual contribution limits on 401(k)s. These are the 2025 annual contribution limits. You can see the maximum deferral amount you’re allowed in a 401(k) is $23,500. This can be a combination of pre-tax and Roth contributions, or all pre-tax, or all Roth. However, the total can only be $23,500. There’s also a catch-up provision. If you’re between the ages of 50 and 59 or age 64 and older, there’s a $7,500 catch-up provision that allows you to add an additional $7,500 to your 401(k) plan.

If you happen to be in the small band of ages 60 to 63, there is a higher catch-up provision allowing you to save $11,250 in addition to the $23,500 base contribution. You also have the company match that we spoke about earlier. Again, this varies from plan to plan but generally speaking is between 4% and 7%. You can see the plan maximum that you can put in from all contribution sources is $70,000, plus whatever catch-up provision you’re allowed based on your age.

Let’s take a look at a specific example of how this might work.

Example Scenario

Let’s assume we have a 55-year-old employee at PNL who makes a $200,000 income, just to make the math easy. They would be allowed a $23,500 base contribution into the 401(k) plan. This can be done either pre-tax or Roth. Because they’re age 55, they fall in the 50 to 59 age band, which allows for a $7,500 catch-up provision. Now the company match at PNL is 50% on the first 7%. So, with a $200,000 income, the company match would be $7,000.

Let’s start to add this up. A $23,500 base contribution plus the $7,000 company match from PNL brings us to $30,500. This leaves us $39,500 of room before reaching the $70,000 plan maximum. This could be used to make a post-86 after-tax contribution of $39,500. Then, using the Mega Backdoor Roth provision to potentially move the money to tax-free growth, gets us to the $70,000 plan maximum. Plus, because they’re age 55, they have that $7,500 catch-up provision, which gets us to a grand total and maximum contribution of $77,500 in the 401(k) plan. This amount can potentially really supersize your retirement savings and put you ahead.

Key Considerations

Let’s talk about a few considerations to think about when deciding whether you should use pre-tax, Roth, or post-86 after-tax contributions. Some things to think about would be your current tax bracket. Are you in a high tax bracket now and anticipate being in a lower tax bracket in the future? Or are you in your earlier earning years and expecting to be in a higher tax bracket in the future, while being in a lower tax bracket today?

Another thing to consider would be your goals or withdrawal needs. Do you have a pension in addition to Social Security? Where else will you be getting income from when you retire? Are you married? Do you have a spouse who also has retirement needs? Those are all things to consider when evaluating your contribution sources.

SECURE Act 2.0 made a few changes to retirement plans that should be considered as well.

Another option to consider is required minimum distributions. Pre-tax contributions are generally subject to required minimum distribution rules, which require that you take out a certain percentage of the account once you reach age 73 or older.

As you move forward through life, it’s important to think about creating a diversified income plan and considering the different income sources you’ll have available to you, along with the tax implications of each.

This can help you build a customized plan specific to your needs.

Final Thoughts

I’ve gone through a lot in a very short period of time here, so I just want to give you a quick look at our team here at Cornerstone. We are more than happy to sit down with you and talk about your specific situation, your goals, your concerns, and how we might be able to help you think through ways to maximize your 401(k) plan or other retirement planning needs. Please feel free to reach out to us. We’d be happy to help. Thanks for watching. Have a great day.

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