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My original plan was for DH and I to retire in 20 years (when I reach age 55). However, upon realizing we will have the mortgage paid off in 10 years, I'd like to consider retiring earlier. That said, we would need to increase our retirement savings. We currently max out both our 401ks and IRAs (back door Roth). Our 401k plan allows for post-tax contributions (I'm not talking Roth 401k) which, by my understanding, can later be rolled into a Roth IRA. Would it be worthwhile to start making post-tax 401k contributions as opposed to a regular, taxable brokerage account?

-Steph
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Would it be worthwhile to start making post-tax 401k contributions as opposed to a regular, taxable brokerage account?

Almost certainly not.

1st off, the bookkeeping is a nightmare, to keep track of the after-tax amount. And you get screwed by the IRS on the ratios when you take withdrawals.

2nd off,
401K is taxed as ordinary income.

Regular taxable accounts are taxed as capital gains. If you are in 15% tax bracket in retirement, the capital gains tax rate is currently 0% (zero!)
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1st off, the bookkeeping is a nightmare, to keep track of the after-tax amount.

My 401k plan currently does this automatically.

And you get screwed by the IRS on the ratios when you take withdrawals.

What does this mean?

2nd off,
401K is taxed as ordinary income.


The post-tax contributions have already been taxed. Once I leave the company, those post-tax funds could be rolled into a non-deductible traditional IRA then converted to a Roth IRA and I'd only pay taxes on the gains, not the contributions. Therefore, I've managed to use more tax-advantaged Roth IRA space than I could otherwise (due to the annual $5000 cap on contributions).

Regular taxable accounts are taxed as capital gains. If you are in 15% tax bracket in retirement, the capital gains tax rate is currently 0% (zero!)

I doubt I would ever be in the 15% bracket in retirement.

I cross-posted this on LBYM and the way I see it, one pro is that post-tax 401k will allow you to back door into a Roth IRA and take advantage of tax-advantaged space I wouldn't otherwise have. One con is the limited investment choices. Which one of those outweighs the other and what are the other pros and cons? Thanks.

-Steph
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I agree with the conclusion that Rayvt came up with, but, not necessarily the reasons.

1st off, the bookkeeping is a nightmare, to keep track of the after-tax amount.

As far as I know 401k and IRA administrators will take this into account when you withdraw and it is just a matter of reporting the correct amount on tax return.

And you get screwed by the IRS on the ratios when you take withdrawals.

I don’t think you get screwed by the IRS (any more than usual). If you pay taxes before contributions you will not be taxed upon withdrawals.
Generally, I don't think it is a good idea to put taxed money into a tax deferred account unless you need the space for tax inefficient investments.
In your case I suggest you look forward to your withdrawals in the future. You indicate you plan to retire before age 55. At that age you would pay penalties on withdrawals from tax deferred accounts. It would be better to have a taxable account to take expenses from during this period.

Bob
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In your case I suggest you look forward to your withdrawals in the future. You indicate you plan to retire before age 55. At that age you would pay penalties on withdrawals from tax deferred accounts. It would be better to have a taxable account to take expenses from during this period.

Bob


I wouldn't want to take withdrawals from the traditional, pre-tax 401k before age 55. I would want to take withdrawals from my Roth IRA and/or taxable brokerage accounts only. Roth IRA contributions (vs earnings) can be withdrawn at anytime, after 5 years, without penalty. Once I turn 55, I could choose to withdraw from the pre-tax 401k and/or start to collect a pension from my employer.

-Steph
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Once I turn 55, I could choose to withdraw from the pre-tax 401k

Only if you end service the employer in or after the year you turn 55, or you are willing to do SEPP/72(t) withdrawals.

For example, if you leave the service of your employer in the year you turn 50, you may as well roll your 401(k) over to an IRA, because the withdrawal treatment is no different than the IRA: Wait until 59 1/2, take SEPP/72(t) withdrawals or pay a 10% penalty.

AJ
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Only if you end service the employer in or after the year you turn 55, or you are willing to do SEPP/72(t) withdrawals.

For example, if you leave the service of your employer in the year you turn 50, you may as well roll your 401(k) over to an IRA, because the withdrawal treatment is no different than the IRA: Wait until 59 1/2, take SEPP/72(t) withdrawals or pay a 10% penalty.

AJ


Thanks AJ. I have a hard time keeping all the details straight. This may push me to finding a CFP one of these days.

-Steph
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The post-tax contributions have already been taxed. Once I leave the company, those post-tax funds could be rolled into a non-deductible traditional IRA then converted to a Roth IRA and I'd only pay taxes on the gains, not the contributions. Therefore, I've managed to use more tax-advantaged Roth IRA space than I could otherwise (due to the annual $5000 cap on contributions).

Keep in mind that there is no Roth-like benefit here until you retire and actually transfer the money around into a Roth IRA.

The earnings on post-tax contributions to a 401k are still taxable as ordinary income when withdrawn, just like all other earnings in the account and just like the pre-tax contributions. So all you'd be doing is earmarking some money that in the future could be added to your Roth IRA and only then begin generating tax free income.

Personally, I'd prefer an ordinary after-tax investment account.
-Dividends and long-term capital gains get taxed at a lower rate than ordinary income. Well, they do for now - it's anybody's guess what those will be in a decade, although there is a very long history of giving some preferential treatment to long-term capital gains.
-There are no restrictions on withdrawal - you can take what you want when you want. However if you have to sell some investment to get the cash, you'll have some tax consequences. But you can manage that to your benefit. You can choose to sell a winner and pay some tax. You can sell something that's at breakeven and have no tax. Or you can sell something that's at a loss and get a reduction in your taxes. You can sell multiple assets - some winners and some losers - to get the desired tax treatment. That's a lot of flexibility.

--Peter
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And you get screwed by the IRS on the ratios when you take withdrawals.

What does this mean?


In an IRA, if you have both pre- and post-tax money, when you take withdrawals it is prorated between the two based on the ratio. The effect is that the post-tax withdrawals (which you don't have to pay tax on) are very small and stretched out over 25-30 years in tiny dribbles. I don't know if 401k withdrawals work the same way or not.

I doubt I would ever be in the 15% bracket in retirement.
The fact is the reverse. When the bulk of your income is non-W2 income it's extremely easy to have a high income of which only a small amount is taxable income.

Right now, if you file MFJ the 15% bracket tops out at $68K. You can pull down a lot of capital gains and qualified dividends if they fall in the 0%. It's rather complex, but a few hours spent running scenarios in TurboTax will show you.
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And you get screwed by the IRS on the ratios when you take withdrawals.

What does this mean?

In an IRA, if you have both pre- and post-tax money, when you take withdrawals it is prorated between the two based on the ratio. The effect is that the post-tax withdrawals (which you don't have to pay tax on) are very small and stretched out over 25-30 years in tiny dribbles. I don't know if 401k withdrawals work the same way or not.

401(k) post tax contributions do not work the same way. There are provisions to withdraw 401(k) post tax contributions separately.

AJ
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The ability to contribute after-tax contributions to one's 401(k) MAY be of benefit to certain employees, but is NOT an advantage to others.

Those employees who have maxed out their pre-tax 401(k) contributions and Roth IRA contributions, and are in a high Fed + State tax rate, may be well served to contribute after tax to their 401(k) and enjoy tax deferred growth of these contributions. Diligence must be taken to keep track of the after tax amount in the 401(k), as at rollover time, the plan may (or may not) accurately reflect in the 1099-R the after tax portion (aka 'basis') of the rollover. A failure here means withdrawal of the after tax contributions will be taxed twice.

However, the potential 300 lb gorilla here are the fees and expenses the 401(k) assesses employees. For some, these expenses are high enough to take most or even all of the yearly earnings (dividends and interst) of the employee's investments.

For moderate income households with the after-tax-401(k) option, they are generally best served by making their after tax contributions to a taxable brokerage account. As the previous poster points out, these accounts have full flexibility, full investment choices, favorable tax treatment for capital gains and not rules and restrictions on future withdrawals.

BruceM
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SRenaeP,


My original plan was for DH and I to retire in 20 years (when I reach age 55). However, upon realizing we will have the mortgage paid off in 10 years, I'd like to consider retiring earlier. That said, we would need to increase our retirement savings. We currently max out both our 401ks and IRAs (back door Roth). Our 401k plan allows for post-tax contributions (I'm not talking Roth 401k) which, by my understanding, can later be rolled into a Roth IRA. Would it be worthwhile to start making post-tax 401k contributions as opposed to a regular, taxable brokerage account?


I am in the same situation as you as far as retirement age goes.
I won't have my mortgage paid off in 10 years, though. But I am still choosing to make some after-tax 401k contributions because I expect the return to be higher than my mortgage, and I have some money I inherited that I would rather not invest in a taxable account, but would very much like to invest in a tax-deferred account. This way, last year I made $23,000 of after-tax 401k contributions. I plan to make $26,000 this year. I am limited by the $49,000 annual maximum, less pretax and maxing contributions.

My 401k employer plan allows me to withdraw the after-tax contributions every 12 months. This is called an "in-service withdrawal". I did this in january and rolled them over to the Roth. There was no penalty. Check if your plan allows this.

At the time I did this withdrawal in january, JP Morgan also automatically withdrew the earnings associated with those after-tax contributions. These were modest since the contributions were made within the last year. These earnings are taxable for 2011. There is no penalty. Note that I did not have to withdraw any of the pre-tax contributions, or matching contributions, or associated earnings, which are the majority of my 401k account. JP Morgan does all the bookkeeping.

IMO, this is a very nice backdoor which means that I can essentially contribute large amounts to my Roth every year by doing this rollover. I also rollover $5k every year from nondeductible IRA contributions.
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The major advantage that I see to after tax 401K (and IRA contributions) is the ability to manage your investments without worrying about capital gains and holding things long term.

I'll agree that long term buy and hold in a taxable account is better when you manage to hold the investment long term, but in these volatile times many have trouble doing that. Do you let your investment gains go away waiting for them to become long term gains or do you sell and pay ordinary tax rates on the short term gain?

In spite of the theory, as practical matter, many end up paying taxes on short term gains.
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I'll agree that long term buy and hold in a taxable account is better when you manage to hold the investment long term

Well put!

I prefer the regular taxable brokerage account. I am still under the illusion I will be holding some very basic stocks - some with fair dividends (SO, T) and some smaller or none (AMZN, CAT) for a LONG time.

Will even put the occassional ''hidden gem'' in there.
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Personally, I'd prefer an ordinary after-tax investment account.
-Dividends and long-term capital gains get taxed at a lower rate than ordinary income. Well, they do for now - it's anybody's guess what those will be in a decade, although there is a very long history of giving some preferential treatment to long-term capital gains.
-There are no restrictions on withdrawal - you can take what you want when you want. However if you have to sell some investment to get the cash, you'll have some tax consequences. But you can manage that to your benefit. You can choose to sell a winner and pay some tax. You can sell something that's at breakeven and have no tax. Or you can sell something that's at a loss and get a reduction in your taxes. You can sell multiple assets - some winners and some losers - to get the desired tax treatment. That's a lot of flexibility.

--Peter


Very good points. I think you have me convinced. :-) Thanks.

-Steph
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My 401k employer plan allows me to withdraw the after-tax contributions every 12 months. This is called an "in-service withdrawal". I did this in january and rolled them over to the Roth. There was no penalty. Check if your plan allows this.

My plan does allow this but there is a penalty of sorts - they will stop the 401k match for six months after the in-service withdrawal.

IMO, this is a very nice backdoor which means that I can essentially contribute large amounts to my Roth every year by doing this rollover. I also rollover $5k every year from nondeductible IRA contributions.

That was my original thought. However, after reading some of the other responses, I'm thinking that, for the sake of flexibility, I should put a decent 'buffer' amount in a taxable account before contributing to the after-tax 401k. Thanks.

-Steph
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UniversalFG writes,

Consider max fund life. both tax deferred and tax free withdraws. no market risk. Invest in the mkt without downside. if you run the numbers, I have a book i can send you the link to that has the some great calculators, it will show you the best combination

</snip>


That's exciting. It sounds better than cold fusion.

intercst
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it sounds better than cold fusion.


sounds too good to be true
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I use a tool that allows me to grow an acct mirroring the s&p 500 without any downside risk. Also, gains are tax deferred and I have access to the capital prior to age 59 1/2 without the IRA or 401K 10% penalties. If the market goes up 10%, i get 10%. If the market goes down 5%. I do not participate in the loss. Say for example we start with 100,000 and the market goes up 10%. my acct will have 110,000. if the market the next year goes down 10%. My account will have 110,000. If the third yr, the market goes up 10%. My value would then be 121000.

And how much do you pay in fees or commissions for this tool?

Also, you should be aware that TMF has rules against selling your products using their boards.

Tax deferred and tax free withdraws.

Which is it? Tax deferred or tax free? They are two different things - with tax deferred you owe taxes based on withdrawals, which is not 'tax free'.

AJ
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I use a tool that allows me to grow an acct mirroring the s&p 500 without any downside risk.... If the market goes up 10%, i get 10%. If the market goes down 5%. I do not participate in the loss.

So, if you use this tool, and you don't lose to the market, then where do you lose? in annual fees? in upfront costs? And if someone had a tool like this, why wouldn't they just use the tool themselves and make money without ever losing any? Do the people behind this tool want to get MY money involved? If so, why?

Please don't misunderstand the nature of my questions. This tool is just mysterious to me, and I truly want to understand it. But so far, I can't make any financial sense out of it.

culcha
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Please don't feed the troll. I just FA'ed both posts.

-Steph
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Please don't feed the troll. I just FA'ed both posts.



well poot. i would have liked to see his reply to intercst ..

but the first post DID look like Spam
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