Are AVCs Tax Free? Contributions, Growth, and Withdrawals

Additional voluntary contributions are not entirely tax-free, but they carry significant tax advantages at one stage or another depending on how you make them. Whether AVCs are tax free going in, growing inside the plan, or coming back out in retirement depends on which of three contribution types your plan offers: pre-tax (traditional), Roth, or after-tax non-Roth. Each treats the tax bill differently, and mixing them is often the smartest play.

Pre-Tax AVCs: Tax-Free Going In

Pre-tax AVCs to a traditional 401(k), 403(b), or similar employer plan come off your taxable income for the year you make them. Contribute $15,000 pre-tax on a $90,000 salary and you pay federal income tax on $75,000. Payroll handles it automatically, so the savings show up in every paycheck.

The tax doesn’t disappear. It’s deferred. Every dollar you eventually withdraw — your original contribution plus all its growth — is taxed as ordinary income in the year you take it out.¹ This works in your favor if you retire into a lower bracket than you’re in now, which is the common case. Pre-tax contributions also drop your adjusted gross income, which can pull you under phase-out thresholds for other tax benefits.

Roth AVCs: Tax-Free Coming Out

If your plan has a designated Roth option, your AVCs go in with after-tax dollars. No deduction, no upfront break. In exchange, qualified distributions later come back to you completely free of federal tax — contributions and all the investment growth.²

Two conditions have to be met for a Roth distribution to qualify. The account must have been open at least five tax years, counting from January 1 of the year you made your first Roth contribution to that specific plan. And you must be at least 59½, disabled, or deceased (with the money going to a beneficiary). Fall short on either and the earnings portion is taxed as ordinary income, usually with a 10% penalty on top.²

One quirk that catches people: each employer plan runs its own five-year clock. Roth IRAs use a single clock across all your accounts, but Roth 401(k)s don’t. Starting a new job resets the timer on the new plan. The simple workaround is to make even a token Roth contribution early at each employer just to start the count.

Growth Inside the Plan Is Not Taxed as It Accumulates

Whichever contribution type you use, dividends, interest, and capital gains inside the plan compound without any annual tax. You can rebalance freely. Compare that to a regular brokerage account, where selling a fund held over a year can trigger 15% or 20% capital gains tax depending on income, and short-term gains face ordinary rates up to 37%.³

For pre-tax and after-tax contributions, the growth is tax-deferred: you pay when you withdraw. For Roth contributions, the growth becomes permanently tax-free once you take a qualified distribution. Over two or three decades of compounding, that distinction is worth serious money.

After-Tax (Non-Roth) AVCs and the Mega Backdoor Roth

Some plans allow a third bucket: after-tax, non-Roth contributions. On their own they look bad — no deduction now, and the earnings will be taxed later. Their real value is what you can do with them.

Under IRS Notice 2014-54, when you take a distribution that mixes pre-tax and after-tax money, you can direct the pre-tax portion to a traditional IRA and the after-tax portion to a Roth IRA in one transaction.⁴ Because you already paid tax on the contributions, only whatever the money has earned is taxable when converted. Rolling over quickly, before earnings pile up, keeps that tax bill small.

This “mega backdoor Roth” strategy uses the space between your elective deferral limit and the overall Section 415(c) cap of $72,000. If you defer $24,500 and your employer adds $10,000, roughly $37,500 of room is left for after-tax contributions that can be converted to Roth. It only works if your plan both accepts after-tax contributions and allows either in-service distributions or in-plan Roth conversions. Check the summary plan description before assuming yours does.

How AVC Withdrawals Are Taxed

The tax treatment at withdrawal follows the contribution type:

Pre-tax withdrawals are taxed in full as ordinary income, every dollar of contribution and growth.¹
Qualified Roth withdrawals are completely tax-free, contributions and earnings alike.²
After-tax withdrawals that were never converted return your original contributions tax-free, but the earnings on them are taxed as ordinary income.⁵

The plan administrator reports distributions on Form 1099-R, breaking out the taxable and non-taxable portions.⁶

A common mistake is assuming all retirement income will fall in a low bracket. Social Security, pensions, and required distributions stack up quickly. Holding both pre-tax and Roth money gives you year-by-year control, letting you pull from whichever bucket keeps total income under the next rate threshold.

Early Withdrawals Carry a 10% Penalty

Taking money out before age 59½ generally triggers an extra 10% tax on the taxable portion, on top of any regular income tax.⁷ On a $50,000 early pre-tax withdrawal, that’s $5,000 in penalty plus your marginal rate on the whole amount.

Several exceptions waive the penalty (though not the underlying income tax):⁸

Separation from service in or after the year you turn 55 (age 50 for public safety employees in government plans), for distributions from that employer’s plan
Death or total and permanent disability
Qualified birth or adoption expenses, up to $5,000 per child
Terminal illness certified by a physician
Federally declared disaster distributions, up to $22,000 per event
Distributions made because the IRS levied the plan
Substantially equal periodic payments based on life expectancy

Required Minimum Distributions

Pre-tax AVCs can’t sit in the plan forever. Under SECURE 2.0, you must begin RMDs at 73 if you were born between 1951 and 1959, or at 75 if you were born in 1960 or later. The first RMD is due by April 1 of the year after you hit the applicable age; every one after that is due by December 31. Deferring the first RMD to April means taking two in the same calendar year, which can push you into a higher bracket.⁹

Miss an RMD and the excise tax is 25% of the shortfall, dropping to 10% if you correct it within a two-year window.¹⁰

An important change for Roth AVCs: as of 2024, designated Roth accounts in employer plans are no longer subject to RMDs.¹¹ If part of your reason for making Roth AVCs is to let the balance grow untouched as long as possible, the money can now stay in the plan for life without a forced payout.

2026 Contribution Limits for AVCs

Federal law caps how much you can voluntarily contribute each year, and going over triggers penalties and double taxation. The 2026 numbers:¹²

Elective deferral limit for 401(k), 403(b), and 457(b) plans: $24,500
Catch-up contribution for age 50 and older: an additional $8,000
Enhanced catch-up for ages 60 through 63: $11,250 instead of $8,000
Total annual additions under Section 415(c): $72,000, covering employee deferrals, employer contributions, and any after-tax contributions, not counting catch-up amounts¹³
IRA contribution limit: $7,500, plus a $1,100 catch-up for age 50 and older

If you’re between 60 and 63 in 2026, your maximum elective deferral is $35,750 ($24,500 plus the enhanced $11,250 catch-up). At 64 the catch-up drops back to $8,000.¹⁴

The elective deferral limit is combined across every plan you participate in during the year. Contributing to both a 401(k) and a 403(b) at different employers, your combined deferrals still cannot exceed $24,500 plus any applicable catch-up. The Section 415(c) cap, by contrast, applies separately to each unrelated employer.¹⁵

1
Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust
2
Office of the Law Revision Counsel. 26 USC 402A – Optional Treatment of Elective Deferrals as Roth Contributions
3
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
4
Internal Revenue Service. Rollovers of After-Tax Contributions in Retirement Plans
5
Internal Revenue Service. Topic No. 410, Pensions and Annuities
6
Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
7
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts
8
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
9
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
10
Office of the Law Revision Counsel. 26 USC 4974 – Excise Tax on Certain Accumulations in Qualified Retirement Plans
11
Congressional Research Service. Required Minimum Distribution (RMD) Rules for Original Owners
12
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500
13
Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs
14
Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
15
Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contributions Under Qualified Plans