Author Topic: After-Tax 401(k) vs. traditional brokerage  (Read 1060 times)

familyFIguy

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After-Tax 401(k) vs. traditional brokerage
« on: December 19, 2019, 10:30:41 AM »
Hey everyone,

I just got a new job which allows me to contribute after-tax 401(k) contributions. I'm not fully understanding why I would do this as opposed to a traditional brokerage account, if I plan on hitting FI in 10 years.

Details:
  • Married filing jointly
  • 180k annual take home (roughly)
  • I'm maxing out my 2020 401(k) at $19,500
  • Employer is matching my contribution with an additional $9,750
  • Wife and I are maxing our tIRAs annually
  • Maxing our family HSA for early retirement HSA hack
  • The plan is to do a roth ira conversion ladder for our tIRA & 401(k) to avoid taxes

Now, I have the option to then contribute an additional $27,750 in an after-tax 401(k) option. Given my early retirement goals, why would I choose to do this? My understanding is that the cash would be taxed on entering, I could pull contributions tax free, but earnings would be taxable and penalized upon removal in early retirement. Wouldn't it be better just to put the $27,750 into a taxable brokerage with Vanguard?

I'm probably not putting all of this together correctly. Can anyone help??

Thanks!

ixtap

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #1 on: December 19, 2019, 10:36:53 AM »
If your plan allows for it, you move the after tax contributions to Roth, expanding your Roth accounts much faster than annual contributions will allow.

Search for "mega back door Roth"

This is a real boon for early retirees, as well as anyone concerned about RMDs in traditional retirement. Basically, you are giving your Roth conversion ladder a running start.

familyFIguy

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #2 on: December 19, 2019, 10:44:11 AM »
If your plan allows for it, you move the after tax contributions to Roth, expanding your Roth accounts much faster than annual contributions will allow.

Search for "mega back door Roth"

This is a real boon for early retirees, as well as anyone concerned about RMDs in traditional retirement. Basically, you are giving your Roth conversion ladder a running start.
Thanks for the reply. I'm not totally following though. Could you add some more clarity?

Specifically, if I put money into the after-tax portion of my 401(k) and then move it to my Roth IRA account, I have paid taxes when it went into my after-tax 401(k), and will only be able to withdraw the contribution amount without penalty.

If I want to withdraw the earnings, I will have to pay early-withdrawal penalties from the Roth IRA, correct? In this way, I will have paid tax on the contribution when I put it into my after-tax 401(k), and tax on the earnings when I withdrawal them from my Roth IRA. Is that right?

terran

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #3 on: December 19, 2019, 10:49:42 AM »
If your plan allows for it, you move the after tax contributions to Roth, expanding your Roth accounts much faster than annual contributions will allow.

Search for "mega back door Roth"

This is a real boon for early retirees, as well as anyone concerned about RMDs in traditional retirement. Basically, you are giving your Roth conversion ladder a running start.
Thanks for the reply. I'm not totally following though. Could you add some more clarity?

Specifically, if I put money into the after-tax portion of my 401(k) and then move it to my Roth IRA account, I have paid taxes when it went into my after-tax 401(k), and will only be able to withdraw the contribution amount without penalty.

If I want to withdraw the earnings, I will have to pay early-withdrawal penalties from the Roth IRA, correct? In this way, I will have paid tax on the contribution when I put it into my after-tax 401(k), and tax on the earnings when I withdrawal them from my Roth IRA. Is that right?

Right, but that's the same as making direct Roth contributions. The penalty only applies until you're 59.5 years old. The "mega backdoor roth" is basically like having access to a Roth IRA with a giant annual limit, except you have to jump through a few hoops to get it.

This only works if your 401(k) allows you to make after tax contributions (which is does) and either roll over those contributions to an IRA while still working or convert to Roth 401(k) within the plan (you need to check with your 401(k) administrator and/or read the plan documents to find out if you can do that second step with your plan).

Schaefer Light

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #4 on: December 19, 2019, 06:08:06 PM »
If your plan allows for it, you move the after tax contributions to Roth, expanding your Roth accounts much faster than annual contributions will allow.
Is there any reason to put after tax dollars in a 401k if you can't also take in service withdrawals?  I have a hard time understanding the advantage of putting after tax dollars in a 401k if you can't turn around and move them to a Roth IRA.

mtnrider

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #5 on: December 19, 2019, 07:32:47 PM »
If your plan allows for it, you move the after tax contributions to Roth, expanding your Roth accounts much faster than annual contributions will allow.

Search for "mega back door Roth"

This is a real boon for early retirees, as well as anyone concerned about RMDs in traditional retirement. Basically, you are giving your Roth conversion ladder a running start.
Thanks for the reply. I'm not totally following though. Could you add some more clarity?

Specifically, if I put money into the after-tax portion of my 401(k) and then move it to my Roth IRA account, I have paid taxes when it went into my after-tax 401(k), and will only be able to withdraw the contribution amount without penalty.

If I want to withdraw the earnings, I will have to pay early-withdrawal penalties from the Roth IRA, correct? In this way, I will have paid tax on the contribution when I put it into my after-tax 401(k), and tax on the earnings when I withdrawal them from my Roth IRA. Is that right?


There's a tax drag on your taxable brokerage earnings, assuming you're in a tax bracket where they are taxed at 15%.  If you could avoid touching those earnings until 59.5 you'll probably come out ahead with a mega backdoor Roth.

If you are near to early retirement now and you're sure you'll be in the 0% capital gains bracket, you have no state taxes on dividends and you're pretty sure that taxable account tax law won't change, you might come out ahead with a taxable account.  You'll get more flexibility here too, since you can tax gain and tax loss harvest.

I'd think about doing some of both, perhaps depending on when you actually need to use the money.






ixtap

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #6 on: December 19, 2019, 07:38:02 PM »
If your plan allows for it, you move the after tax contributions to Roth, expanding your Roth accounts much faster than annual contributions will allow.
Is there any reason to put after tax dollars in a 401k if you can't also take in service withdrawals?  I have a hard time understanding the advantage of putting after tax dollars in a 401k if you can't turn around and move them to a Roth IRA.

Some people can do an in plan rollover to Roth 401k.

If you expect to be in a low tax bracket in retirement, it could be worthwhile to have dividends/distributions sheltered, then do a conversion after you leave that job.

If you plan to leave your job in the next year, you could also sock away the money and do the conversion at that time.
 

mtnrider

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #7 on: December 19, 2019, 07:59:20 PM »
If your plan allows for it, you move the after tax contributions to Roth, expanding your Roth accounts much faster than annual contributions will allow.
Is there any reason to put after tax dollars in a 401k if you can't also take in service withdrawals?  I have a hard time understanding the advantage of putting after tax dollars in a 401k if you can't turn around and move them to a Roth IRA.


If you're going to leave your employer in the next few years, you may still come out ahead.  There's an analysis here: https://thefinancebuff.com/after-tax-401k-to-roth-no-in-service-distribution.html


mtnrider

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #8 on: December 19, 2019, 08:06:00 PM »
Some people can do an in plan rollover to Roth 401k.

I think an in-plan rollover from after-tax 401k to Roth 401k still requires the in-service language in the plan, I could be wrong though, consult your tax accountant, etc...  (:


terran

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #9 on: December 19, 2019, 09:05:16 PM »
Some people can do an in plan rollover to Roth 401k.

I think an in-plan rollover from after-tax 401k to Roth 401k still requires the in-service language in the plan, I could be wrong though, consult your tax accountant, etc...  (:

It does require certain language, but a plan may allow one and not the other (or both).

familyFIguy

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #10 on: December 20, 2019, 11:59:20 AM »
Hey all,

Thanks for the tips. It sounds like a Mega Backdoor Roth is really only beneficial if you plan on waiting to access that money until you are 59.5 years or older. As I'm guessing I will need the money when I am closer to 40, it probably isn't the best option for me, and a taxable brokerage account is the way to go, especially because i believe that I will be in the 0% capital gains bracket.


shuffler

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #11 on: December 20, 2019, 12:07:38 PM »
It sounds like a Mega Backdoor Roth is really only beneficial if you plan on waiting to access that money until you are 59.5 years or older.
Nope.
https://forum.mrmoneymustache.com/investor-alley/how-to-withdraw-funds-from-your-ira-and-401k-without-penalty-before-age-59-5/

It probably isn't the best option for me, and a taxable brokerage account is the way to go, especially because i believe that I will be in the 0% capital gains bracket.
In the future when realizing capital gains from a taxable account, you may indeed be in the 0% tax bracket for those gains.
However, the full value of the capital gains are still considered income and contribute to your MAGI for the purposes of ACA benefits determination, which can reduce the benefits for which you are eligible.
Whereas Roth withdrawals are not income, and don't contribute to MAGI.

MDM

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Re: After-Tax 401(k) vs. traditional brokerage
« Reply #12 on: December 20, 2019, 04:52:22 PM »
As I'm guessing I will need the money when I am closer to 40....
Presumably you will need money when you are age 60+ also.  For most, Roth will be better than taxable, but your situation might differ.