Author Topic: Is there a point to after tax 401k contributions?  (Read 463 times)

Stamag

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Is there a point to after tax 401k contributions?
« on: February 06, 2019, 05:24:16 PM »
This year my company is defining me as a "highly compensated employee" which means the max before tax 401k contributions is 10% of income.  There is an option to make after tax 401k contributions up to the normal $19,000 limit.  A situation could be:

Income: $140,000
Pre-tax 401k: $14,000
Optional After-tax 401k: $5,000

That sounds like a bad idea to me though because then money would be taxed on the way into the 401k, then again when withdrawn.  The only benefit being that growth of the funds would not be taxed.  Am I understanding this correctly?

Thank you so much for any advice you can give!

ixtap

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Re: Is there a point to after tax 401k contributions?
« Reply #1 on: February 06, 2019, 05:30:18 PM »
Only the gains would be taxed on the way out.

However, most people use this after tax space to roll over to a Roth IRA. In order to do this without worrying about gains, your plan would have to allow an in service distribution. The process is known as a mega backdoor Roth.

If you are able to do this and choose to, you will likely be able put even more in to the after tax space, bringing the total to the current 401k max, which I believe is $55k for 2019.

sol

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Re: Is there a point to after tax 401k contributions?
« Reply #2 on: February 06, 2019, 06:08:17 PM »
The advantage of after-tax 401k contributions is that they still grow tax free each year.

Remember that investments are normally taxed three different ways: on the way in, as they grow, and on the way you.  You pay income tax when you earn the money in the first place (unless you put it in a pre-tax account like a 401k).  If you were to invest in a taxable account, you would then pay taxes on the earnings and dividends each year.  Then you pay capital gains (or worse yet, regular income tax) when you sell the investment.

So if your alternatives for those dollars are a taxable brokerage account or an after-tax 401k contribution, the 401k contribution still offers you protection from the 2nd of those three taxing possibilities and the taxable account would not.
 
A Roth IRA would offer you no up front tax deduction, but it would also shield you from taxes on growth and on capital gains when you sell.

ice1717

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Re: Is there a point to after tax 401k contributions?
« Reply #3 on: February 08, 2019, 02:15:57 PM »
Not that it totally fits your situation, but I also believe it plays in based on your employee match. 

For instance if your company matched up to 12%, but you could only contribute 10%, or your company matched 6% and you made $250,000, you would miss out on some of the matching dollars.  After tax contributions could help, depending on the rules of your plan.   

Stamag

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Re: Is there a point to after tax 401k contributions?
« Reply #4 on: February 08, 2019, 10:23:05 PM »
Thanks for the great information.  I looked into mega backdoor Roth contributions and that seems like a brilliant way to use After-tax 401k contributions.  It also lead me to learn about Spousal IRA contributions!

Here's a video on mega backdoor Roth for those who learn well through that medium: https://www.youtube.com/watch?v=f64xPe_mLz8

So using this information I think my savings situation will look like this:
Before Tax 401k - 10% of income (Highly Compensated Employee limit)
Roth IRA - $6000
Spousal Roth IRA - $6000
After Tax 401k, (mega backdoor) rolled over to Roth IRA - 8% of income (Employer limit)

Great experience for my first post on MMM, should have expected people would be helpful and nice!