For most Americans, employer-sponsored retirement plans like 401(k), 403(b), and 457 plans are the primary, if not the only, method of saving for retirement. These plans are vital for building a retirement on your terms, yet many participants don't fully understand the rules and nuances that could maximize their potential.
In this post, we’ll explore six little-known facts about 401(k) plans that could transform your retirement planning strategy. If you have employer stock in your 401(k), make sure to pay close attention to fact #6!
1. Many 401(k) Plans Don’t Allow Partial Withdrawals After Separation
One of the most surprising discoveries retirees face is that many 401(k) plans don’t permit partial withdrawals after leaving their employer. Instead, some plans only allow for a lump-sum withdrawal.
Why does this matter? Retirees often plan to take monthly withdrawals to cover living expenses. If your plan doesn’t allow this, it can disrupt your income strategy.
What can you do?
Roll over your 401(k) into an IRA, which typically offers more flexibility with withdrawals.
Check if your plan permits installment payments, though these may come with restrictions.
Tip: Review your Summary Plan Description (SPD) before retiring to understand your plan’s rules.
2. You Can Contribute Beyond IRS Limits with After-Tax Contributions
For 2024, the 401(k) contribution limit is $23,000 ($30,500 for those over 50). However, some plans allow additional after-tax contributions, bringing the total plan contribution limit to $69,000 or $76,500 (over 50).
How after-tax contributions work:
Contributions are made without a tax deduction.
Withdrawals of the contributions are tax-free, but the earnings are taxable unless converted.
Why consider this? High-income earners who max out their pre-tax and Roth contributions can use after-tax contributions to grow more tax-advantaged funds.
Bonus Tip: Pair after-tax contributions with a Mega Backdoor Roth IRA conversion to turn taxable growth into tax-free growth.
3. Some 401(k) Plans Offer In-Plan Roth Conversions
Did you know you can convert pre-tax dollars in your 401(k) directly to a Roth 401(k)?
What’s an in-plan Roth conversion? It allows you to move funds from the pre-tax bucket of your 401(k) to the Roth bucket, paying taxes now to avoid potentially higher taxes later.
When to consider this strategy:
During low-income years when your tax rate is lower.
If you prefer to keep all your retirement assets in one account instead of opening a separate Roth IRA.
Important: Taxes aren’t withheld during in-plan Roth conversions, so plan to cover the tax bill with cash savings to avoid penalties.
4. Brokerage Accounts in Your 401(k): More Investment Options
Many employers offer a self-directed brokerage account within their 401(k). This feature lets you invest in a broader range of assets, including:
Individual stocks
Bonds
ETFs
Mutual funds
Advantages:
Access to potentially lower-cost, passive investments.
Greater diversification opportunities.
Risks:
Speculative investments, like leveraged ETFs or individual stocks, can expose you to greater volatility.
Tip: Use this option only if you’re a savvy investor who understands the risks.
5. The Rule of 55: Access Funds Penalty-Free Before Age 59½
Typically, withdrawing from a retirement account before age 59½ results in a 10% penalty, but the Rule of 55 offers an exception:
If you leave your job in the year you turn 55 or older, you can withdraw funds from your 401(k) without the early withdrawal penalty.
Key points to remember:
Withdrawals must come directly from the 401(k); rolling funds to an IRA disqualifies this rule.
This rule doesn’t apply if you leave your job before turning 55.
Example: If you separate from your employer at 54 and wait a year, you won’t qualify for the Rule of 55.
6. Net Unrealized Appreciation (NUA) for Employer Stock
If your 401(k) holds employer stock, you could use the Net Unrealized Appreciation (NUA) strategy to save on taxes.
How it works:
Move employer stock into a taxable brokerage account upon retirement.
Pay ordinary income tax on the cost basis (what you paid for the stock).
Pay long-term capital gains tax on the growth when you sell the stock.
Why use NUA? Long-term capital gains tax rates are generally lower than income tax rates, offering significant tax savings.
Things to consider:
You must withdraw all 401(k) assets in the same calendar year to use NUA.
The first transaction after a qualifying event (e.g., retirement) must involve the NUA stock.
Example: If your employer stock has a low cost basis and significant growth, this strategy can reduce your tax liability compared to rolling the funds into an IRA.
Key Takeaways for Maximizing Your 401(k)
Understand your plan’s rules by reviewing the Summary Plan Description (SPD) or contacting your plan administrator.
Consider rolling over to an IRA for more flexibility, especially regarding withdrawals.
Explore advanced strategies like after-tax contributions, in-plan Roth conversions, and NUA for employer stock.
Next Steps in Your Retirement Planning Journey
Retirement planning requires careful consideration of taxes, contribution strategies, and withdrawal rules. By understanding the nuances of your 401(k), you can maximize your savings and reduce your tax burden in retirement.
For more insights into tax-efficient retirement planning, check out our other guides or consult with a financial professional to create a tailored plan for your unique situation.
Did you find this helpful? Share this post with a friend or colleague who’s planning for retirement and wants to make the most of their 401(k).
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About the author
Jake Skelhorn
Jake is a CFP Professional with a focus on planning for both traditional and early retirement. He’s a Florida native, growing up in Fort Lauderdale and now residing in Jacksonville with his husband Chris and their 120-lb “puppy” Barli. Jake enjoys cooking (favorite cuisine to make is Thai), traveling, and spending time with friends and family as much as possible.
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