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I find myself in a lucky position. I have a stable, high-paying job that allows me to achieve nearly all my financial goals, including:

  • Maxing out the yearly contributions to my 401(k), including the employer match
  • Fully fund a 6 month emergency fund
  • Satisfy all of my monthly expenses, with plenty left over

I would like to invest a portion of my monthly surplus to augment my retirement savings, but I'm unsure about the most efficient way to do it. The two options that I'm considering are contributing over the yearly limit on my 401(k) or opening a taxable brokerage account to invest in a set of index funds.

I know that contributing over the 401(k) limit can have significant tax implications, including being taxed twice. However, all index funds also charge fees. (I'm looking mostly at Vanguard index funds, which charge on the order of 0.05% to 0.2%)

How do I determine which of these investment strategies is the most efficient from the perspective of minimizing fees/taxes?

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    How exactly are you planning to contribute over the limit? Employers usually track how much you contribute and won't let you
    – littleadv
    Feb 4 at 17:58
  • If that's the case with my employer, this question may be moot. I'll need to check with my HR department.
    – Tyrian
    Feb 4 at 18:56
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    @Tyrian your 401k plan administrator won't knowingly let you overcontribute to your 401k, at least if all contributions are made into that plan (it is possible to accidentally overcontribute if you contributed to a different plan at some point in the year and didn't notify the new plan of those contributions). Allowing overcontributions to sit in 401k plans can invalidate the entire plan (not just your account) of its tax-advantaged status.
    – Stan H
    Feb 4 at 19:49
  • You seem to be under the mistaken impression that there's no expense ratio for 401(k) accounts. The opposite is true, they are very often significantly higher than expenses on index funds you select yourself. At best they might be equal.
    – Ben Voigt
    Feb 6 at 21:23
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    A 401k is an account, not an investment like an index fund. You can hold index funds in a 401k account. Any investment inside a 401k will also have fees.
    – Nosjack
    Feb 7 at 20:41

3 Answers 3

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You cannot "over-contribute" into a 401k. As mentioned in the comments, the plan allowing you doing so will lead to the whole plan losing it's retirement qualification status. That would mean that all the participants (not just you) may end up on the hook for taxes for all the deferred balances.

As alluded in the other answer, you can contribute an additional amount on top of the standard 401k contribution limit, after paying taxes on it, as an "after-tax" contribution. There are limits to that as well, so that the total after all the contributions (including regular deferrals or Roth up to the limit, matches, and after tax) doesn't exceed 69K (as of 2023).

Worth noting that these contributions are not Roth contributions (which are also after tax), but rather traditional contributions with basis. Generally you do not want basis in your traditional retirement accounts, so it is only worthwhile if your plan allows immediately converting these contributions into Roth (this is called "mega backdoor Roth").

If you accidentally end up exceeding 401k contribution limits (usually happens when you have multiple plans during the same year), you'll have to withdraw the excess contribution (and its earnings) by the tax due date. Not doing so will lead to a 6% excise tax charge on the excess amount every year. It is unlikely that you can beat your own taxable account by >6% in the 401k account.

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You didn't mention contributing to an IRA in addition to your 401k. Contribution limits for IRAs and 401ks are separate, so you could contribute up to $23,000 to your 401k AND up to $7,000 in an IRA in the same year assuming:

  • 2023 contribution amounts (the specific numbers change annually)
  • your income is below the IRA phaseout threshold (for single filers, the range of the phaseout is $77,000 - $83,000)
  • you aren't eligible for catch-up contributions (starting at age 50)

After both of those contributions are maxed out, you can contribute to a traditional brokerage account with no limits, but you lose the tax advantages of retirement accounts (you still could be eligible for advantageous capital gains rates on distribution, but you are still paying taxes on the income pre-investment AND on the gains when you sell the investment).

A traditional brokerage account will always be more advantageous than over-funding a retirement account above the contribution limits. The consequences of overcontributing to your 401k mean that the income is taxed in the year you contribute and then income is taxed again at normal rates when you withdraw, meaning you lose the benefit of capital gains rates! Similar rules impact an IRA.

Taking into account an investment fund's fees is not relevant to the tax position of the investment vehicle. You would have those same fees if you invested in that fund through your 401k/IRA or a brokerage account. Brokerage fees are relevant to investment performance metrics, but not to tax planning.

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Some companies do allow you to over-contribute to the 401(k) account. They do this because you are allowed to, but the additional money isn't pre-tax, and it isn't Roth. This money is post-tax money. This option has existed for decades.

There is a higher number that covers all the pre-tax, Roth, company match, and post tax money. In 2024 for people under age 50 the higher limit is $69,000.

Why do people do this? In the old days it wasn't unusual to have a little extra contributed when you could only adjust the percentage being contributed to integer numbers of percent and could only adjust it once a quarter.

Some companies allow people to convert the post tax money contribution into Roth money with a mega back door Roth conversion. You do this while still employed with the company.

This gets around the low annual limit of the IRA, and the maximum income limits of the IRA.

Note: before the Roth IRA was created, post-tax 401(k) contributions were not taxed on withdraw, but the growth/gains was taxed. Now with the Roth 401(k) none of that money is taxed on withdraw if it is the Roth section of the 401(k). There never was double taxation.

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    After tax contributions are not "over contributing", you're allowed to contribute to each bucket up to a certain limit. It may be that that's what the OP was referring to, but that's not the right term.
    – littleadv
    Feb 4 at 20:57

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