401(k)ology – The Hidden Risks of Uncapped Voluntary After-Tax Contributions

Voluntary After-Tax contributions can supercharge 401(k) retirement savings—but when payroll systems fail to enforce the annual additions limit or cap the After-Tax so that participants receive the full employer match owed them, the results can be costly. This post dives into the hidden compliance risks, real-world consequences, and smart strategies employers can use to prevent excess contributions and protect both their plans and their employees.

In the pursuit of maximizing retirement savings opportunities, many employers in recent years have offered Voluntary After-Tax (”After-Tax”) contributions as a powerful tool for employees to boost their 401(k) balances beyond traditional pre-tax and Roth deferral limits. These contributions, when paired with in-plan Roth conversions—commonly known as the "Mega Backdoor Roth" strategy—can significantly enhance long-term tax-advantaged growth.

However, what begins as offering employees a savvy financial enhancement can quickly spiral into an employer-side compliance nightmare if payroll systems fail to enforce Internal Revenue Code §415(c) annual additions limit. This limit, which caps the total contributions (including employer match, employee deferrals, and After-Tax contributions) to a 401(k) plan, is often overlooked in payroll configurations. The result: Employees inadvertently exceed the legal threshold, triggering a cascade of administrative headaches, tax complications, and potential plan disqualification.

This post explores how the absence of automated safeguards in payroll systems and plan procedures can lead to excess contributions, the consequences for both employees and plan sponsors, and what steps plan sponsors can take to prevent these costly errors.

Understanding the §415(c) Limit: What It Includes

IRC Section 415(c) limit governs the total annual additions (total allocations of contributions and forfeitures from all sources) to a participant’s defined contribution plan, such as a 401(k) or 403(b) plan. For the 2025 plan year, this limit is $70,000. Annual additions include:

• Employee elective deferrals (pre-tax and Roth)

• Employer contributions (matching, non-elective, profit-sharing)

• Voluntary After-Tax contributions

• Allocated forfeitures (forfeitures allocated as an additional employer contribution)

• Qualified non-elective contributions (QNECs)

Importantly, catch-up contributions for employees aged 50 and over ($7,500 in 2025) or those aged 60-63 ($11,250 in 2025) and rollovers from other plans are excluded from this limit.

The IRC §415(c) limit is applied using a “lesser of” test:

• The IRS dollar limit ($70,000 in 2025), or

• 100% of the employee’s compensation for the year.

To clarify, if an employee earns less than $70,000, their total contributions cannot exceed their total compensation for the plan year. Also, a catch-up eligible employee’s annual additions limit is increased by the applicable catch up limit ($70,000 plus either $7,500 or $11,250 in 2025).

It is also critical to understand that the allocations relate to the limitation year applicable to the contributions. For most plans, the limitation year is the same as the plan year. One misconception is that employer contributions are treated as annual additions in the year deposited. However, the applicable limitation year is the plan year for which the employer contributions were allocated (because the allocation was based on compensation for a specific plan/limitation year subject to annual nondiscrimination testing for that specific period). If the allocations were based on 2024 eligible plan compensation but deposited in 2025 (up to the deduction deadline applicable to the employer), then those employer allocations in 2025 count in the 2024 annual additions limit.

Payroll Pitfall #1: When Systems Don’t Enforce the Limit

Despite clear limitations published by the IRS annually, many payroll systems are not configured to monitor or cap After-Tax contributions in conjunction with the 402(g) Deferral Limit and other employer contributions provided. This is especially problematic because:

• After-Tax contributions are often made as a percentage of compensation per payroll date, and the annual compensation limit applicable to retirement plans is not tracked each payroll. Rather, systems often apply the limit only once the plan year ends. This makes After-Tax contributions harder to track in conjunction with an employee’s pre-tax and/or Roth deferrals over the remainder of the year, especially if there is no cap on the After-Tax contributions.

• Employer contributions are typically calculated after the fact, meaning the full picture of annual additions is unknown until after year-end. This is especially true for plans that include a required safe harbor match or a fixed match that is required to make a true-up contribution using full year compensation and deferrals.

• Employees may not be aware of the §415(c) limit, assuming that if the payroll system allows it, it must be compliant.

• Without automated payroll limits, employees can easily exceed the limit—especially high earners aggressively funding their plans through After-Tax contributions.

Payroll Pitfall #2: System Enforces the Limit without Regard to Deferrals and Match

Another common issue is when the employee has a high percentage After-Tax election and therefore reaches the annual additions limit early in the year. In this situation, the participant may not have the ability to make further deferrals or receive the full employer matching contributions.

This is problematic because:

• The participant probably did not understand that the After-Tax contribution percentage elected would cause the inability to maximize benefits.

• The service provider’s plan document may not permit funding of employer matching contributions after reaching the annual limit.

• The participant will often request a sufficient portion of the After-Tax to be returned so they can continue to make deferrals and receive matching contributions, but that is not permitted.

On the last point, HR teams frequently question whether the After-Tax can be reversed in payroll because the employee misunderstood how the plan limits apply. Unfortunately, once the employee has made the After-Tax election and the funds have been deducted from compensation and deposited into the plan, there is no mechanism for a mulligan. There is no distributable event because the employee has not exceeded a plan limit. The After-Tax contributions must count towards the annual additions limit for the year of the contribution.

Consequences of Exceeding the §415(c) Limit

When an employee exceeds the IRC §415(c) limit, the plan sponsor must take corrective action. This often includes:

• Forfeiture of excess employer contributions and associated earnings from the participant’s account, in accordance with the specific terms of the plan document.

• Refunding contributions, which can create tax reporting headaches for the employee and potentially unexpected tax liabilities.

• Potential plan qualification issues if errors are not corrected properly and timely.

If a participant exceeds the annual additions limitation, the plan must distribute a refund to the affected participant no later than the end of the plan year following the plan year for which the allocations were made. Remember this is not based on deposit date, rather it follows the limitation year of the allocations.

Example: The plan and limitation year are both calendar year 2024. The employee is under age 50 in 2024; therefore, the annual additions limitation is the lesser of 100% of compensation or $69,000.

Assume the employee has compensation in excess of $150,000 and the applicable limit is $69,000. The employee has the following allocations to his account for 2024:

• $23,000 in deferrals

• $8,000 in employer match

• $45,000 in After-Tax contributions

• Total equals $76,000

• §415(c) Excess Annual Additions of $7,000 ($76,000 less $69,000)

Pursuant to the Employee Plans Compliance Resolution System (EPCRS), excess annual additions are corrected pursuant to the Correction of Excess Allocations in the following order:

1. Refund unmatched After-Tax contributions (adjusted for earnings)

2. Refund unmatched elective deferrals (adjusted for earnings)

3. Refund matched After-Tax contributions plus earnings (matched After-Tax rarely applies)

4. Refund matched elective deferrals plus earnings (note that any reduction in matched deferrals will require a reduction in the match that will also reduce the annual additions, so math is required)

To correct the excess annual additions in the example, the plan will refund the employee $7,000 in After-Tax contributions (adjusted for earnings) from the 401(k) plan. The correction is not handled in payroll, and the employer does not make any adjustments to the employee’s Form W-2. The employer requests the refund from the plan to maintain the plan’s compliance with the IRC §415(c) regulations.

Employees must forfeit any Excess Allocation attributable to employer matching or nonelective contributions (adjusted for earnings), and the plan holds those funds in an unallocated account to be used to reduce employer contributions in the current or following plan year.

Refunds due to §415(c) failures are taxable in the year distributed. If After-Tax contributions are returned first, only the earnings on the After-Tax are taxable in the year of distribution. The recordkeeper reports these refunds on Form 1099-R, using Code E, and they are not eligible for rollover. If the After-Tax contributions have already been converted to Roth (likely), the plan distributes the refund from the Roth source.

If a plan fails to timely correct excess annual additions (no later than the end of the plan year following the plan year for which the allocations were made), the plan has a qualification issue that the employer must correct using EPCRS. In most cases, the employer can self-correct the plan failure as long as the failure is identified and corrected timely (generally by the end of the third plan year following the year of the failure if it is a significant failure, otherwise there is no time limit prescribed).

Best Practices for Employers and Payroll Providers

To avoid the pitfalls of exceeding the §415(c) limit, employers and payroll providers should consider implementing the following safeguards:

• Automated Contribution Monitoring: Configure payroll systems to track all types of contributions—employee deferrals, employer match, and After-Tax—against the §415(c) limit in effect for the year.

• Cross-System Integration: Ensure that payroll, recordkeeping, and HRIS platforms are integrated or reconciled regularly.

• Employee Education: Provide clear guidance to employees about the §415(c) limit and how After-Tax contributions count toward it.

• Internal Audits and Corrections: Conduct proactive mid-year and year-end reviews to identify and correct excess contributions. Early detection can prevent costly tax consequences and plan compliance issues.

• Limit AFTER-TAX Contributions in Payroll: Establish a cap on After-Tax contributions in payroll (e.g., $25,000–$30,000), especially if the system cannot dynamically calculate the remaining room under the §415(c) limit.

Payroll monitoring, audits, and employee education are great tools; however, the only real solution for most employers is to adopt an administrative policy which caps the After-Tax contributions. The policy can set the cap before each plan year once the IRS publishes the applicable annual limits. If the employer provides a matching contribution, consider determining the maximum match that an employee could be entitled to based on the compensation limit in effect for the year. The appropriate After-Tax cap is the annual additions limit reduced by both the annual deferral limit and the maximum match.

For example, Employer B has a required safe harbor match of 4% of eligible plan compensation. For 2025, the compensation limit is $350,000 so the maximum safe harbor match for 2025 is $14,000 ($350,000 times 4%). The annual additions limitation for 2025 is $70,000. $70,000 less $23,500 (2025 deferral limit) less $14,000 equals $32,500. Employer B determined before 2025 that all participants would have an After-Tax contribution cap of $32,500 for 2025 and implemented that cap in payroll. Employer B notified all eligible employees (and new hires) that After-Tax contributions would be limited to $32,500.

Employer B has taken appropriate and best practice steps to protect the plan from qualification failures, while simultaneously ensuring employees have the opportunity to reap the benefits of After-Tax contributions without the potential downsides. While it is true that employees with compensation under the limit will not be able to fully maximize the total allocations under these limitations, the ability to avoid plan qualification issues, costly corrections, and upset employees clearly weighs in favor of this approach.

BONUS CONTENT ==> Plan Document Provisions - §415 Limit Hard Stops <== BONUS CONTENT

Establishing After-Tax contribution limits within payroll, according to an annual administrative policy, is vitally important to ensure that participants receive the full employer contributions available under the terms of the plan. Without a cap imposed through payroll, the majority of plan documents effectively state that no additional contributions can be made upon reaching the annual additions limit. Hard stop.

Real world example: Company C has no limit on After-Tax contributions and has a required enhanced safe harbor match equal to 4% of compensation (100% of deferrals on deferrals up to 4% of eligible compensation). In 2024 the employee set a high percentage election on After-Tax contributions and by mid-2024 contributed $43,747.64 in After-Tax contributions , deferred $23,000 (maximum for 2024), and received safe harbor match on a per pay period basis of $2,252.36 for a total of $69,000. The problem is that the plan provisions require an annual true-up of the safe harbor match, and the employee is owed $7,279.64 of employer contributions. Yet the basic plan document states that no additional contributions can be made to that employee’s account upon reaching the $69,000 annual additions limit.

Unknowingly, the employee has missed out on $7,279.64 in employer contributions with no ability to undo the mistake.

What about the required safe harbor contributions owed to the plan? This poses a quandary in the retirement services community. Some legal advisors state that the employer must still make the required safe harbor match regardless of the language in the basic plan document, while others argue that the plan terms imposing the hard stop upon reaching the IRC §415 limit must control. There is not a clear or unanimous answer to this predicament. Ultimately, it is the plan sponsor’s responsibility to ensure that participants do not exceed the annual additions limit. Employers in this situation should consult with the plan’s service provider and ERISA counsel to determine the appropriate course of action.

Employer Checklist: Preventing §415(c) Excess Contributions

• Know the annual cap ($70,000 in 2025) and what counts toward it.

• Configure payroll systems to track all contribution types and enforce limits.

• Synchronize payroll, HRIS, and recordkeeping platforms to maintain accurate data.

• Educate employees by providing clear guidance on how After-Tax contributions work and their limits.

• Set caps on After-Tax contributions.

• Conduct year-end reviews to catch and correct issues early.

• Work with plan administrators and ERISA counsel to stay compliant.

A Small Oversight with Big Consequences

Voluntary After-Tax contributions can be a powerful retirement savings strategy, especially when paired with in-plan Roth conversions. But without proper payroll controls, these contributions can push employees over the IRS §415(c) annual additions limit—leading to potential compliance violations, missed benefits, and administrative burdens.

The key takeaway? Good intentions must be matched with good systems. Employers and payroll providers must have an automated or manual process to monitor total contributions to ensure compliance and fulfill the purpose of adding the After-Tax benefit to their retirement plans.

Conclusion

Newfront Retirement Services’ team of advisors and dedicated service team are always available to help plan sponsors understand how the IRS’ rules and regulation impact their specific retirement plan and to assist in plan design strategies that will maintain the plan’s operational compliance while also permitting employees to take advantage of the benefits offered in the plan. Feel free to contact me or just connect to keep up to date on all things ERISA 401(k): Joni_LinkedIn and 401(k)ology

Helpful Links:

• Understanding After-Tax Contributions: Key Insights, Strategies, and Considerations

• 401(k)ology - Catch Up Contributions

• Fixing Common Plan Mistakes – Failure to limit contributions for a participant

• COLA increases for dollar limitations on benefits and contributions

• EPCRS overview

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