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|Subject: Re: Poll: Did your 401k recover from the 2008 de||Date: 12/28/2010 7:19 AM|
|Author: madbrain||Number: 67979 of 75811|
I thought these funds were in an after-tax 401-k? Why discuss a capital loss? What happens in the 401-k, generally stays in the 401-k.
No, in this case the funds don't stay in a 401k, I'm only using the 401k after-tax contributions as a short-term conduit to rollover to a Roth IRA.
My employer allows in-service withdrawals of all after-tax contributions every 6 months (or 12 months, I forget) without penalties. And the IRS allows the rollover of those after-tax contributions to a Roth IRA.
My plan is to contribute as much as I can after-tax to the 401k, then zero out the after-tax balance every 6-12 months as allowed by the plan, and roll them over to a Roth IRA. If there are earnings or losses attributable to those after-tax 401k contributions before this rollover, then it complicates tax matters.
a) If there is a gain, I have to find outside money to pay the 38% taxes on those gains. Let's say hypothetically that I made 20,000 of after-tax contributions last year. There was a huge short-term market rally and the balance doubled to 40,000 before I rolled over to the Roth IRA at the end of the year. Then, I need to pay the taxes on the 20,000 gain, and find another 7,600 of outside money to pay the taxes due, in order to rollover the 40,000 of after-tax contributions and their gain from the 401k to the Roth IRA.
Another option is to withdraw 7600 in order to pay the taxes, and rollover 32400 to the Roth IRA.
b) If there is a loss.
I made the same 20,000 of after-tax contributions. But the market tumbled and the funds are now only worth 10,000.
It's the end of the year and I want to rollover the after-tax balance to my Roth IRA. I do the rollover of the 10,000 remaining after-tax balance. No taxes are due on it, and I have a 10,000 capital loss. But I can't deduct the entire loss in the same tax year since it's over 3,000. It has to be spread over 4 years. And I might not be in a 38% tax bracket in each one of those 4 years, depending on my job situation, so the capital loss isn't worth as much due to the time value of money. Of course maybe I will be in a higher tax bracket, or maybe we'll go into deflation and it will not be as bad :) But I won't bet on that.
The after-tax 401k has tax treatment fairly similarly to a non-deductible IRA, but without the $5000 annual contribution limit.
Does my previous post now make some sense to you ?
It is only a paper gain if you do not sell immediately after the roll-over (or immediately before the roll-over, for that matter).
Now I am the one who doesn't follow you.
What capital loss is there to take? Once it is in the Roth, the account does not generate capital losses that can be offset againt capital gains (or ordinary income, up to the $3,000 annual limit and carry forward until death.
What about the (however unlucky) case where the Roth IRA balance has a net decline between contributions and withdrawal in retirement ? I know the IRS allows a capital loss deduction in this case for non-deductible contributions in a traditional IRA. It seems fair enough - in a non-deductible IRA you pay taxes on the gains when you withdraw, so if you are unlucky enough to have a loss when you withdraw, you get the capital loss tax break (with a $3000 max).
What I wonder if in the case of a Roth IRA if you have such a loss. Since you never pay any taxes on the gains on the Roth when you withdraw the funds, it would seem very unlikely that if you lose all your funds through bad investments in a Roth, you would then be able to take a capital loss when you withdraw. But I'm not the IRS. Perhaps somebody else knows. OK, I just googled it. http://www.fairmark.com/rothira/losses.htm . Looks like some deductions are allowed, but it's subject to many limitations.
And gettin back to my original point, unless limited by dollars outside the rollover amount to pay taxes and choosing to avoid the penalty that arises from using a portion of the rollover to pay taxes, I fail to see why $x contributed and rolled over is better than $x contributed and $y earned during the interim both being rolled over. There is more in the Roth in the latter scenario.
Yes, dollars outside the rollover amount to pay taxes are not unlimited ;) I'm neither Bill Gates nor Ben Bernanke ;).
You keep mentioning gains, and not losses. The reason why not to risk the short-term money before rollover really comes down to the risk of capital loss that I already mentioned above.
Remember that I plan to rollover once to twice a year as permitted, so the money would be invested as cash equivalent fairly short term. I'm not a short term trader and I'm not confident about my ability to generate gains in every 6 to 12 months period between rollovers.
As of today my retirement assets are already $320,000 (between IRAs and 401k). I had about $17,000 of after-tax 401k contributions this year. That is 5.3% in cash investment earning basically nothing for 12 months. I don't think it's an excessive portfolio cash allocation overall. If anything, I have been guilty of being 100% in equities before which hurt me a lot in 2008. Yes, the return on those 5% is nothing right now, but it is short-term money.
This year, the after-tax money was invested for a very short-time, actually mostly during the last few months of the year. I set my contribution percentage very high and my net paychecks went down to close to zero. I had to watch it because my employer allows after-tax contribution rates up to 75% of gross income, but the taxes and other benefits actually make up more than 25%. I was careful not to have a negative paycheck. I wonder if payroll would do a direct debit every 2 weeks instead of direct deposit if that happened. I didn't really want to find out that badly ! I got a total of about $40,000 contributions to the 401k including pre-tax, matching and after-tax. Next year I will spread out the pre-tax and after-tax more evenly so that I can hit the maximum $49,000 ceiling in december.
In the later part of this year, I have actually been spending down my e-fund to pay the $6000/month loans and other expenses on my 2 properties, all the while collecting essentially no paycheck while I max out the 401k both pre-tax and after-tax in a mad rush before the end of the year. My older house is for sale and the sale was supposed to close monday, sigh. And my father's estate still to be settled, which also includes the sale of his home in France as well, but some money as well. Now, perhaps you understand why I don't mind having the after-tax contributions not being at risk. If my efund gets too low in the next few months, I can withdraw the after-tax contributions instead of I rolling them over, but only if they are still there. But I shouldn't have to do that unless I lose my job, neither my old home or my father's home sells in the next year, and the euro goes to zero. I think none of them are likely, let alone all.
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