After tax (non-Roth) 401k or taxable account?

[35andFI]

I am maxing all of my retirement accounts and have some money in a taxable account through Vanguard (VTSAX).

In addition to this, I have been contributing to an after tax (non-Roth) 401k to set myself up for a Mega Backdoor Roth when I leave my company (since they do not allow for in-service withdrawals). I currently have no plans on leaving but I am only 28 so there's a lot of time for something to happen.

In my 401k (both pre-tax and non-Roth after tax) am investing in WFSPX (iShares S&P 500 index fund) which has an Expense Ratio of 0.04%. Just today, I found that I am paying a 0.15% annual "consulting services" charge from the brokerage that my 401k is through.

It's still not clear if I am paying this or if my company is covering it but assuming I am paying this 0.15% fee (in addition to the WFSPX ER), would I be better off continuing to contribute into this non-Roth after tax 401k or should I switch those contributions to my taxable account where all that I pay is the 0.04% ER from VTSAX?

Also, would it be correct to think of it as WFSPX for 0.19% (plus future tax advantages for MBDR) vs VTSAX for 0.04% (with no tax advantages)?

Thanks!

[Boofinator]

If you don't already contribute enough to a taxable account to allow you to pretty consistently max out the $3k TLH limit every year, I would recommend taxable.

If on the other hand you do consistently max TLH losses, than I would go with the after-tax 401k, seeing that VTSAX in a taxable account is going to have a dividend drag of about 0.15% (~1% dividends times 15% tax) every year anyways (versus a one-time earned income tax when you perform the backdoor and then no taxes ever again).

[Aggie1999]

One thing you need to think about is when you do the conversion from the after tax 401k to IRA's all your gains over the years will go into a tIRA. That means when you withdraw the money from the tIRA you will be paying the ordinary income tax rate. If you put money in the a normal taxable account then your earnings would be taxed at the capital gains rate if you withdraw after a year.

You have to decide if this will matter to you (i.e. what tax bracket you will be in when withdrawing from the tIRA, etc), but in general people normally only contribute after-tax to a 401k if they have the option of in-service withdraws.

[Boofinator]

One thing you need to think about is when you do the conversion from the after tax 401k to IRA's all your gains over the years will go into a tIRA. That means when you withdraw the money from the tIRA you will be paying the ordinary income tax rate. If you put money in the a normal taxable account then your earnings would be taxed at the capital gains rate if you withdraw after a year.

You have to decide if this will matter to you (i.e. what tax bracket you will be in when withdrawing from the tIRA, etc), but in general people normally only contribute after-tax to a 401k if they have the option of in-service withdraws.

True. There is a timeframe that represents a breakeven point between the two investments. Perform the Roth conversion immediately and you have a great deal; wait 40 years until after you retire and you probably have a really crappy deal (depending on future tax rates).

[35andFI]

If you don't already contribute enough to a taxable account to allow you to pretty consistently max out the $3k TLH limit every year, I would recommend taxable.

If on the other hand you do consistently max TLH losses, than I would go with the after-tax 401k, seeing that VTSAX in a taxable account is going to have a dividend drag of about 0.15% (~1% dividends times 15% tax) every year anyways (versus a one-time earned income tax when you perform the backdoor and then no taxes ever again).

I haven’t tax loss harvested my taxable account yet (probably because I’m unsure of exactly what to do) but I have ~$55k in there and contribute an additional ~$400/mo to it

One thing you need to think about is when you do the conversion from the after tax 401k to IRA's all your gains over the years will go into a tIRA. That means when you withdraw the money from the tIRA you will be paying the ordinary income tax rate. If you put money in the a normal taxable account then your earnings would be taxed at the capital gains rate if you withdraw after a year.

You have to decide if this will matter to you (i.e. what tax bracket you will be in when withdrawing from the tIRA, etc), but in general people normally only contribute after-tax to a 401k if they have the option of in-service withdraws.

A very good point. I honestly have no idea how long it will be before I will be able to roll the funds into IRAs. Are you aware of any “rule of thumbs” as far as timelines are concerned? Would 5-10 years be too long?

[Boofinator]

TLH is easy. Check your funds for any losses in specific lots. If you see any losses, exchange these lots (including all purchased within the last 30 days*) for a similar but not identical fund (for VTSAX I use VFIAX).

To use an example, say you have three lots of VTSAX, with cost basis $60, $65, and $70. Stock price drops $68. Exchange the third lot for VFIAX and capture $2 per share of losses. At this point, you just can't buy any VTSAX for 30 days after the sale.

This is an easy process that just requires occasional glances at your cost basis. Stocks are down a bit over the last few weeks, so you likely have a good opportunity to TLH at the moment. This could save you annually up to $3000 x your marginal tax bracket (for me it is over $700 per year).

*To avoid a wash sale, you cannot buy replacement shares within 30 days prior to or 30 days after a capital loss sale.

[35andFI]

I'll look into TLH more. What I have to wrap my head around is avoiding a wash sale while investing in the following:

t401k: WFSPX (S&P 500 index fund)
tIRA: VTSAX (Total US market index fund)
HSA: SPTM (Total US market ETF)
After-tax non Roth 401k: WFSPX (S&P 500 index fund)
Taxable: VTSAX (Total US market index fund)

If I sell VTSAX in my taxable account at a loss and purchase VFIAX, I have to check to see if I can sell that in the future (to TLH again) while purchasing WFSPX in my 401k.

That being said, I don't want to derail this thread.
I would like to keep the focus on the after-tax non Roth 401k vs a taxable account.

Does anyone have an opinion on continuing to contribute to the after-tax 401k vs switching back to taxable based on an expected distribution (when I can roll the after tax 401k funds into Roth and traditional IRAs) date in say 5-10 years?

[Boofinator]

A brief discussion on TLH is relevant to this thread, since it is one of the main advantages for having a taxable account.

The IRS has explicitly applied wash sale rules to IRAs, but is essentially silent regarding whether the wash sale rule applies to 401(k)s or HSAs, as far as I can tell. See https://www.irs.gov/pub/irs-pdf/p550.pdf page 56 and https://www.irs.gov/irb/2008-03_IRB#RR-2008-5. I've taken this to assume that wash sale rules do not apply to 401(k)s and HSAs, because if they did the IRS would explicitly note it.

That being said, it should be pretty easy to avoid investing in the same investments between your taxable and tax-deferred accounts. For example, you could use your tax-deferred accounts to invest in International or World markets and your taxable to invest in Domestic (or vice versa). You could also invest in a target date fund.

[35andFI]

Thanks for the links.

Contributing to a taxable account and TLHing would not outweigh the benefits of contributing to an after-tax 401k if I were able to do in service withdrawals immediately. So the question becomes at what point does a taxable account (even w/ TLHing) become preferable?

I am content with my asset allocation being 100% low cost broad based US index funds at this time so I would not consider changing the funds in my tax advantaged accounts to something else just to be able to TLH in my taxable account.

After doing some research on wash sales, I think that I would be okay chancing that buying WFSPX in my 401k within 30 days of selling something like VFIAX in my taxable account would not trigger it.

I would consider TLHing from VTSAX to VFIAX (because I wouldn't mind holding VFIAX indefinitely) but I would only be able to do that if I moved ≥ $3,000 since the minimum investment for VFIAX is 3k, right?

[Boofinator]

Contributing to a taxable account and TLHing would not outweigh the benefits of contributing to an after-tax 401k if I were able to do in service withdrawals immediately. So the question becomes at what point does a taxable account (even w/ TLHing) become preferable?

Don't be so fast to discount taxable relative to Roth, especially for a potential early retiree (or, if you don't plan to retire early, from a risk-mitigation perspective).

Let's say you are currently at a combined 25% income tax bracket, and have the choice of whether to invest $30k per year in taxable or Roth ($30k is probably a good number that would allow for consistent maxing out of TLH). The key thing to realize is that if you retire early (or if you lose your job and need an income stream), then your capital gains will be in the 0% tax bracket, therefore acting just like a Roth. So the difference between taxable and Roth is that you're receiving an extra $750 per year and then paying an extra ~0.15% dividend tax. If we assume 7% growth and no other changes, than taxable will be winning over the first 25 years (and be a better absolute investment over the first 15 years, when Roth starts catching up).

TL;DR: Under current tax law and given the assumptions above, Taxable would beat Roth out to about 25 years of accumulations.

[35andFI]

I am single, 28, and in the 22% tax bracket (AGI brings me down to the 12% tax bracket).

I have about $12k/yr to invest in taxable or after-tax 401k.

When I first decided to stop taxable contributions and move them over to after-tax 401k contributions, I didn't realize that LTCG can be as low as 0% (for single income up to $39,375).

I'm close to making the switch back from after-tax 401k to taxable. Do you think this is the most optimal thing to do for someone in my situation?

I appreciate the help in getting my head around this.

[Boofinator]

I'm close to making the switch back from after-tax 401k to taxable. Do you think this is the most optimal thing to do for someone in my situation?

Yours is one of those situations without a clear-cut right or wrong answer, so in my opinion I'd just pick a strategy and run with it. But if I was in your position, I'd probably invest in taxable, using the logic provided in my last post. (This of course assumes you are maxing out every other tax-advantaged space available.)

[35andFI]

I hate grey areas!! I’ll have to do some more research to make an informed decision.

I’m pretty sure I’m maxing out every tax advantaged space available.
$19,000 to t401k
$6,000 to tIRA
$2,750 to HSA (my employer contributes the other $750)

Then I have about $1200/mo (maxed the % allowed by employer) going into that after-tax 401k and the rest ~$250-$500/mo going into my taxable brokerage account.

Going back to the TLHing, I looked at my cost basis and found that I have less than $1,300 in total losses (have been in for a few days shy of 1 year) so I wouldn’t be able to buy a new fund (that I would want) with that since the minimums are $3k.

Is the general idea to purchase another fund in my taxable account and have it ready for TLHing when markets are down?

[35andFI]

I hate grey areas!! I’ll have to do some more research to make an informed decision.

I’m pretty sure I’m maxing out every tax advantaged space available.
$19,000 to t401k
$6,000 to tIRA
$2,750 to HSA (my employer contributes the other $750)

Then I have about $1200/mo (maxed the % allowed by employer) going into that after-tax 401k and the rest ~$250-$500/mo going into my taxable brokerage account.

Going back to the TLHing, I looked at my cost basis and found that I have less than $1,300 in the lots that have losses (have been in for a few days shy of 1 year) so I wouldn’t be able to buy a new fund (that I would want) with that since the minimums are $3k. Total losses are only $23 as of yesterday.

Is the common strategy to purchase another fund in my taxable account and have it ready for TLHing when markets are down?

[Boofinator]

Looks like you're doing a good job maxing out the tax-advantaged space.

For TLH, yes, you might serve yourself by putting the minimum into your TLH partner (such as $3k into VFIAX). Then, you could tax-loss harvest the next day if desired. That being said, I wouldn't TLH over $23, which would be saving you about $6 in taxes. Try to be patient, and when there's a significant drop (I would say at least a couple hundred dollars or 5% of basis, whichever is less), that's when you want to strike.

[35andFI]

Gotcha. Thanks!