Three Lesser-Known But Powerful 401(k) Features
In this episode of Motley Fool Hidden Gems Investing, Motley Fool personal finance expert Robert Brokamp discusses:
- Advocating with your employer for more features and better investment choices.
- How a self-directed brokerage within can help both the stock and non-stock side of your portfolio.
- How to implement the mega-backdoor Roth.
- How the rule of 55 (or 50) can allow some people to make withdrawals a few to several years before age 59 1/2 and avoid the 10% early distribution penalty.
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A full transcript is below.
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This podcast was recorded on Sept. 12, 2026.
Robert Brokamp: A few unique, lesser-known features of 401(k). Today on this Saturday Personal Finance edition of the Motley Fool Hidden Gems Investing podcast. I'm Robert Brokamp.
Before we get into the main topic of today's show, I want to let you know that the last episode of this month will be a financial planning mailbag. If you have any questions about carry planning, tax planning, estate planning, college planning, or just about any aspect of personal finances, email them to podcasts@fool.com, and we'll do our best to answer them. That's podcast with an “s” at fool.com. Now let's move on to 401(k) because after all, this past Thursday was National 401(k) Day, which is usually the Friday after Labor Day. But since this past Friday was September 11th, 401(k) Day was moved to September 10th out of respect to September 11th and its own 25th anniversary memorial events.
Now, in the May 9th episode of this year, I provided 11 suggestions for maximizing the value of your work-based retirement plan, so I encourage you to go back and listen to that episode, if you haven't already. But this episode, I thought I’d focus on a few lesser-known or underutilized 401(k) features, the self-directed brokerage account, the mega backdoor Roth, and the rule of 55. I'll say up front that part of the reason you may not hear much about these is that not every 401(k) offers them. But as I often point out, if your 401(k) is lacking features or a robust menu of investments, bring it up to your employer and see if they'd be open to improving your plan. That's what a few of my colleagues and I did at The Motley Fool many years ago, and fortunately, the company's leadership was open towards our suggestions, and perhaps the folks in charge of your company will be, too.
Let’s start with the self-directed brokerage account, which, as the name suggests, permits you to buy investments beyond that standard slate of 15-25 mutual funds that you’ll find in most 401(k). And this brokerage account could just provide a broader range of mutual funds or even let you buy individual stocks or bonds. About 20% to 30% of 401(k) plans have this feature, but it's only used by about 1% to 3% of eligible participants.
I think one of the reasons for the low utilization rate is that many participants just don't know about it. So check the features of your plan. You may have more investment choices than you think. One reason that more 401(k)s don't offer a self-directed brokerage account may be that plans do have a fiduciary responsibility to provide prudent investments to participants. Some plan providers worry that if they let employees choose any investment they want, they may make irresponsible decisions with their retirement money. As you might expect, we fools believe that investors should have more choices. Plus, the brokerage account doesn't just allow participants to buy individual stocks as well as maybe a wider range of stock funds and ETFs. It also offers more choices for people who want to play it safer with their money. The typical 401(k) has maybe one cash account, maybe two or three bond funds, but there are many other perhaps better ways to invest the non-stock portion of your portfolio. Check to see if your plan offers a self-directed brokerage account. If not, ask to see if that feature could be added. If you start utilizing that account, don't do anything crazy, because after all, this is your retirement money.
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Robert Brokamp: All right, let's move on to the mega-backdoor Roth. As we all know, 401(k)s have contribution limits. For 2026, the annual contribution limit is $24,500 plus another $8,000 catch up limit if you’ll be 50 or older by Dec. 31. Savers ages 60-63 have an even higher catch-up contribution limit, and that is $11,250. You're likely familiar with those figures. But there's another limit that gets far less attention. Specifically, in 2026, it's $72,000 plus the relevant catch-up amounts for the 50 and older crowd. Those are the amounts that can be contributed when you factor in traditional and or Roth contributions, the employer match, and any profit-sharing contributions. If all those added together don't exceed this other annual limit, then you can make up the difference with another type of contribution known as an after-tax contribution if your plan allows it, and that's a big if.
For example, let's say a 40-year-old makes traditional and Roth contributions, totaling $24,500 to their 401(k), the employer makes matching contributions of another $5,500 for a grand total of $30,000. You subtract that from $72,000, and you get $42,000. That's how much more the employee could deposit via after-tax contributions. Now, obviously, you'd have to be making a pretty good income to be able to save that much. But some people are super savers who are trying to retire early, and you might have a situation where someone's maybe in their 50s or 60s, the kids have left home, the college bills have been paid, and they're trying to play a little catch-up with their retirement savings. Now, don’t confuse these after-tax contributions with Roth contributions. After tax contributions are post-tax, and the growth on that money is tax-deferred. The distribution of the contributions will be tax-free, but the gains attributed to the after-tax contributions will be taxed as ordinary income.
If that were the end of the story, after tax contributions would have some appeal, but many investors might justifiably decide that instead, I'm going to deposit my additional retirement savings in a taxable brokerage account where the long term capital gains are taxed at lower capital gains rates than ordinary income, plus, the money isn't locked up until age 59.5 and more on that a little later. However, this isn't the end of the story. When you’re able to transfer the money from your 401(k) to an IRA, perhaps because you switched jobs or you retired, you can roll the after-tax contributions into a Roth IRA and the attributable gains into a traditional IRA. From then on, any growth and distributions from that Roth IRA will be tax-free as long as you follow the rules. Plus, unlike traditional retirement accounts, Roth accounts are not subject to required minimum distributions at age 73 or age 75 if you're born in 1960 or later.
But wait, there's more. Depending on the features of your 401(k), you may not have to wait until you leave your employer to move money from your plan to an IRA. The rules are going to be somewhat different for after-tax contributions and their associated earnings versus all the other money in your account. Check with your plan provider and make it clear that you're asking about all the types of contributions, earnings, and company matches in your account. If you’re able to move the money, transfer your after-tax contributions to a Roth IRA and the taxable growth to a traditional IRA. There’s one more way that you can turn after-tax contributions into Roth assets, known as an in-plan Roth conversion, or also known as an in-plan Roth transfer. This allows you to turn non-Roth assets into Roth assets within your 401(k) while you’re still working for the same employer. Again, this is only possible if your employer makes in-plan Roth conversions available in your plan.
Now, when you convert traditional pretax assets into Roth assets, the amount you convert does get added to your taxable income in the year you did the conversion, resulting in a higher tax bill. But with after-tax contributions, you already paid the taxes. Converting the after-tax basis is generally tax-free. However, converting any earnings on that money is taxable. Once you’ve converted that after-tax money, those assets will grow tax-free, and this conversion of after-tax contributions into Roth assets has come to be known as the mega backdoor Roth. Now, I do have to point out that these in-plan Roth conversions have many moving pieces and, if done incorrectly, can result in a higher tax bill. For example, you'll owe taxes if you convert any of the gains earned on your after-tax contributions. So it's best to convert them as soon as possible. Some plans offer automatic daily or per-payroll conversion of after-tax contributions, which generally reduces the earnings to near zero.
The Motley Fool 401(k), for example, you can just click on a button that automates the conversion of every after-tax contribution. I hope you can see how this can get pretty complicated. Please, please, do additional research and perhaps speak with a financial professional before pursuing the mega-backdoor Roth strategy. Again, unfortunately, most employer plans don't allow for after-tax contributions and in plan roth conversions. See if they're available in your plan. It has not asked to have them added.
Now, you may be told why your plan doesn't allow for after-tax contributions, and it's actually a valid reason. It gets pretty legalistic and technical, so I'm just going to give you the general gist. 401(k) are not allowed to disproportionately benefit highly compensated employees. These plans have to go through annual non-discrimination testing. If not enough of the plans non-highly compensated employees make after-tax contributions, the highly compensated employees can get their after-tax contributions refunded to them at year’s end, sometimes substantially. This is why some plans don’t allow for after-tax contributions, and why some plans that do cap them at a modest percentage of pay. The bottom line here is that the mega backdoor Roth strategy may not work if you're a highly paid employee who works at a place where most of the other employees aren't saving as much as you do. Talk to your plan provider, ask if you’re able to do the mega backdoor Roth, and whether the company regularly passes non-discrimination testing.
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Robert Brokamp: Let's move on to our third lesser-known 401(k) feature, and it's come to be known as the rule of 55. Generally speaking, withdrawals from a tax-advantaged account before age 59.5 are assessed a 10% penalty. However, there are many exceptions. Some of those exceptions apply to both IRAs and employer-sponsored accounts, others apply to just one or the other. The rule of 55 is one of those exceptions, and it only applies to 401(k) and similar plans like 403Bs and the Federal Savings Plan. Any employee who separates from service during or after the calendar year the employee reaches Age 55 will not owe a 10% early distribution penalty on withdrawals.
However, like all things with Uncle Sam and the IRS, conditions apply. First off, the exception only applies to the plan you are participating in during the calendar year in which you turned 55 or older. Doesn't apply to 401(k), as you had with employers you worked for before turning 55. However, there may be a workaround. Roll that old 401(k) into your current employer's plan before you separate service if the plan accepts rollovers. For the rule of 55 to work, the money must remain in the employer's plan. If you roll over your funds to an IRA or a new employer's plan, you lose the ability to use the rule of 55. Any separation from service counts, voluntary or otherwise, and working for another employer or starting your own business doesn't prevent you from utilizing the Age 55 exception with the 401(k) at your former job as long as you didn't transfer those funds to a different account.
News is even better for some, not all, but some qualified public safety employees, such as eligible law enforcement officers, corrections officers, customs and border protection officers, firefighters, EMTs, forensics employees, air traffic controllers. For the folks who are eligible to do this, they can take penalty-free distributions at age 50 or 25 years of service under the plan, whichever is earlier. If you work in any field related to public safety for, generally speaking, a government entity, but not always, check to see if your particular role and particular plan is eligible. Again, make sure to check because not everyone is a qualified use this exception. Finally, keep in mind that the rule of 55 gets you out of paying the 10% early distribution penalty, but not applicable taxes.
Those are three lesser-known and sometimes complicated features of 401(k). I hope you learned a thing or a few. Remember, if you have any personal finance questions for our upcoming mailbag, please email them to podcast@fool.com. Thank you so much for spending part of your weekend with us, and thanks to the incomparable Kristi Waterworth, the engineer for this episode.
As always, people on the program may have an interest in the investments they talk about. The Motley Fool may have formal recommendations for or against, so don’t buy or sell investments based solely on what you hear. All personal finance content follows Motley Fool editorial standards, and it's not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. I'm Robert Brokamp. Fool on, everybody.
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