What is the Difference Between Designated Roth and Voluntary After-Tax Contributions?

Self-Directed Solo 401(k)s offer two advantageous ways to increase tax-free money in retirement by allowing for designated Roth contributions and Voluntary After-Tax contributions, (if the plan is designed to include these provisions.) There is often some confusion, however, as to what the difference is between these two options.

Designated Roth Contributions

When a contribution, (the account basis,) is made to a designated Roth account, it is done so with income that has already been taxed, so the amount contributed does not provide an income tax deduction. The gain and/or income that grows in the account is on a tax-deferred basis. When the account holder makes a withdrawal from the account, the distribution, (basis, gain, and income,) is completely tax-free as long as the account holder is at least 59 ½ years old and it has been at least five years since he or she contributed the amount to be withdrawn.

Roth contributions can only be made to a Self-Directed Solo 401(k) as an elective salary deferral, so the amount is limited to $19,500 in 2020 for those less than 50 years old, or $26,000 for those 50 years old and older because of the $6,500 catch-up contribution.

Voluntary After-Tax Contributions

Voluntary After-Tax contributions are similar to Roth contributions in that they are also made with income that has already been taxed and they do not provide an income tax deduction. The contribution grows tax-deferred, as well, but the investment gains and income are taxed as ordinary income upon withdrawal. Since the basis was made with after-tax dollars, it is not taxed when withdrawn.

An after-tax contribution is not considered to be a “salary deferral” contribution, so it is not subject to the 2020 limit of $19,500/$26,000. Instead, it is subject to the overall 2020 contribution limit of $57,000 for those less than 50 years old or $63,500 for those 50 years old and older, which means that the account holder can contribute the full amount, ($57,000/$63,5000) with after-tax dollars.