$10K after tax into 401k or brokerage account?

[ZiziPB]

Any members here putting money into their 401k on after-tax basis?  I am having a hard time figuring out how much of my stache should be in tax advantaged accounts v. after-tax accounts.

I max out my pre-tax 401k (and now also HSA) contributions every year and started investing another $50-60K on after tax basis a year (actual amount dependent on bonus but last year I started $4K per month automatic investment program that will result in a minimum of $48K invested).  I am not eligible for a Roth 401k and I figured that instead opening another traditional IRA, I can put money on after tax basis into my 401k.  Last year I contributed about $10K over the IRS max.

So the question I have, should I be doing that or should I just invest it through my brokerage account?

I am planning to retire in 4 and half years at the age of 50 1/2. 

[Chiron]

How did you Plan Administrator permit you to contribute 10k over the IRS max?  You are only permitted (as an employee) to contribute $17.5k into your 401k.  Whether doing this on a pre-tax v. Roth basis is more advantageous to you will depend on your circumstances.  In general, there are very few circumstances where putting money in a non-tax advantaged account will be better for you than putting it into a tax-advantaged one.  Although you won't be retirement age when you retire, you can roll part or all of your 401k into a Roth IRA and have access to those funds in 5 years. 

You can also contribute to a Roth IRA for 2013 and for each year before you retire and have access to those contributions should you need them before you retire. 

[ZiziPB]

Our plan permits after tax contributions up to $51K IRS total limit (pre and post tax employee contributions plus employer match).  A lot of plans allow that.  The $17.5K limit is only as to what you can contribute pre-tax.

I have never been able to do a Roth, always made too much for it ;-)

[Bruised_Pepper]

I wouldn't stick any more money in a 401k than I could put in pre-tax.  If you're not getting any tax benefits, you might as well put it in a taxable account: you won't have restrictions on when you can withdraw, plus you can do neat things like capital loss harvesting. 

Putting the first $5,500 of that $10k into a traditional IRA would be a good idea if you qualify for the tax deduction (not sure if the income limit is higher or lower than the Roth phase-out limit?) 

[ZiziPB]

Thanks Bruised Pepper, I do not qualify for a tax deduction for an IRA.  I figured that the one advantage of putting more money into a 401k is that it is growing tax free.  I am hoping to be in much lower tax bracket in retirement than I am in now so that in my mind is a good way of taking advantage of it.

[Bruised_Pepper]

Thanks Bruised Pepper, I do not qualify for a tax deduction for an IRA.  I figured that the one advantage of putting more money into a 401k is that it is growing tax free.

Color me confused on this one.  Does paying taxes on a 401k contribution mean you don't have to pay taxes on that portion upon withdrawal?  Or are you simply referring to interest/dividend income is sheltered from taxes in the meantime?

Unless you just found a brilliant workaround to essentially funding a Roth, I would think a taxable account comes out ahead.  If you contribute post-tax to a 401k, then pay tax upon withdrawal, you're being taxed twice at your marginal tax rate.  However, if you contribute to a taxable account, you would pay tax now, but the tax you pay for cashing out would be at the lower capital gains rate. 

Maybe I'm just completely missing something obvious here.

[ZiziPB]

I'm afraid I have no brilliant workaround ;-)  But the post tax contributions do come out tax free (so I get taxed once, not twice on the money I contribute), you only get taxed on the earnings (so different from Roth, where both the contribution and the earnings are tax free).  So yes, I was just referring to interest/dividend income that I can shelter for now v. investing in a brokerage account.

[Bruised_Pepper]

[...](so different from Roth, where both the contribution and the earnings are tax free).

Here's the problem.  Roth contributions are actually taxed initially, then grow tax-free. 

I'm not sure if a post-tax traditional 401k contribution gets tax-free withdrawals; I'd have to check that out for myself.  But if that is the case, then yes: you're basically funding a Roth.

[ZiziPB]

Should have said Roth is "tax free upon withdrawal".

So here is my understanding how this would work:

Contribution of $10K (after tax) to Roth, grows to $15K over time, you withdraw $15K tax free
Contribution of $10K (after tax) to 401k, grows to $15K over time, you withdraw $10K tax free, and $5K is subject to tax at the time of withdrawal.

[seattlecyclone]

Should have said Roth is "tax free upon withdrawal".

So here is my understanding how this would work:

Contribution of $10K (after tax) to Roth, grows to $15K over time, you withdraw $15K tax free
Contribution of $10K (after tax) to 401k, grows to $15K over time, you withdraw $10K tax free, and $5K is subject to tax at the time of withdrawal.

Your understanding is correct. Compare after-tax 401(k) contributions to investments in a taxable brokerage account. If your $10k grows to $15k in a taxable account, you'll pay capital gains rates on the $5k gain when you sell. In the 401(k), you'll pay the higher regular income tax rate on the $5k earnings when you withdraw. If you're planning to let the money grow for a couple of decades in one account or the other, the brokerage account is probably your better bet because of the lower tax rate on investment gains.

The one good reason to make after-tax 401(k) contributions is that this money can be rolled over to a Roth IRA when you leave your current employer. You'll have to pay tax (at your regular marginal rate) at that time on any earnings between now and when you roll the money over, but that money will grow completely tax free after that since it's in a Roth IRA. This can be a very attractive option if you're planning to leave your current employer in the next few years, because the gains (and thus taxes) on the amount rolled over will be relatively low at that point. It's a good way to build up a really big balance in your Roth IRA when you've already maxed out your pre-tax contributions.

[Undecided]

Should have said Roth is "tax free upon withdrawal".

So here is my understanding how this would work:

Contribution of $10K (after tax) to Roth, grows to $15K over time, you withdraw $15K tax free
Contribution of $10K (after tax) to 401k, grows to $15K over time, you withdraw $10K tax free, and $5K is subject to tax at the time of withdrawal.

Your understanding is correct. Compare after-tax 401(k) contributions to investments in a taxable brokerage account. If your $10k grows to $15k in a taxable account, you'll pay capital gains rates on the $5k gain when you sell. In the 401(k), you'll pay the higher regular income tax rate on the $5k earnings when you withdraw. If you're planning to let the money grow for a couple of decades in one account or the other, the brokerage account is probably your better bet because of the lower tax rate on investment gains.

The one good reason to make after-tax 401(k) contributions is that this money can be rolled over to a Roth IRA when you leave your current employer. You'll have to pay tax (at your regular marginal rate) at that time on any earnings between now and when you roll the money over, but that money will grow completely tax free after that since it's in a Roth IRA. This can be a very attractive option if you're planning to leave your current employer in the next few years, because the gains (and thus taxes) on the amount rolled over will be relatively low at that point. It's a good way to build up a really big balance in your Roth IRA when you've already maxed out your pre-tax contributions.

My plan permits in-service withdrawls twice a year, so I contribute the maximum possible after-tax amount---in my case, this year, that's $26,400 ($52,000-($17,500 [employee contribution] + $8,100 [employer contribution])=$26,400). I roll that amount to my traditional IRA and then convert it to a Roth IRA. So with my regular $5,500 backdoor Roth contribution, that's nearly $32,000 of money that I had to pay taxes on anyway getting sent into a Roth IRA. My plan also takes inbound rollovers, so to the extent there are earnings on the amount rolled out of the plan (which have to be rolled out with the related contributions), I don't convert them to the Roth IRA, instead sending them back from the traditional IRA to the 401(k).

[Chiron]

I earn too much money to contribute to a Roth IRA too, but I still do it!  You can still do this for 2013 as well.  See:

http://en.wikipedia.org/wiki/Backdoor_Roth_IRA#Traditional_IRA_conversion_as_a_workaround_to_Roth_IRA_income_limits

I think I understand your plan a little better now.  You want to make after-tax contributions above your employee contribution limit to essentially pre-fund a Roth IRA right before retirement.  To me the tradeoff here is between (a) tax-free growth post-rollover with the 401k option and (b) capital gains treatment on pre-rollover growth and more liquidity with the taxable account option.  This would come down to what investments you want to make.  The tax consequences is just a math problem you could figure out.  The liquidity issue will depend on what you want to invest in and whether you anticipate needing liquidity in the near-medium term. 

[Chiron]

Should have said Roth is "tax free upon withdrawal".

So here is my understanding how this would work:

Contribution of $10K (after tax) to Roth, grows to $15K over time, you withdraw $15K tax free
Contribution of $10K (after tax) to 401k, grows to $15K over time, you withdraw $10K tax free, and $5K is subject to tax at the time of withdrawal.

Your understanding is correct. Compare after-tax 401(k) contributions to investments in a taxable brokerage account. If your $10k grows to $15k in a taxable account, you'll pay capital gains rates on the $5k gain when you sell. In the 401(k), you'll pay the higher regular income tax rate on the $5k earnings when you withdraw. If you're planning to let the money grow for a couple of decades in one account or the other, the brokerage account is probably your better bet because of the lower tax rate on investment gains.

The one good reason to make after-tax 401(k) contributions is that this money can be rolled over to a Roth IRA when you leave your current employer. You'll have to pay tax (at your regular marginal rate) at that time on any earnings between now and when you roll the money over, but that money will grow completely tax free after that since it's in a Roth IRA. This can be a very attractive option if you're planning to leave your current employer in the next few years, because the gains (and thus taxes) on the amount rolled over will be relatively low at that point. It's a good way to build up a really big balance in your Roth IRA when you've already maxed out your pre-tax contributions.

My plan permits in-service withdrawls twice a year, so I contribute the maximum possible after-tax amount---in my case, this year, that's $26,400 ($52,000-($17,500 [employee contribution] + $8,100 [employer contribution])=$26,400). I roll that amount to my traditional IRA and then convert it to a Roth IRA. So with my regular $5,500 backdoor Roth contribution, that's nearly $32,000 of money that I had to pay taxes on anyway getting sent into a Roth IRA. My plan also takes inbound rollovers, so to the extent there are earnings on the amount rolled out of the plan (which have to be rolled out with the related contributions), I don't convert them to the Roth IRA, instead sending them back from the traditional IRA to the 401(k).

This is a genius scheme to fund a Roth IRA.  My plan's in-service withdrawals are limited to hardship.  I will have to explore this option since we will be considering a new plan this year.

[Undecided]

I earn too much money to contribute to a Roth IRA too, but I still do it!  You can still do this for 2013 as well.  See:

http://en.wikipedia.org/wiki/Backdoor_Roth_IRA#Traditional_IRA_conversion_as_a_workaround_to_Roth_IRA_income_limits

I think I understand your plan a little better now.  You want to make after-tax contributions above your employee contribution limit to essentially pre-fund a Roth IRA right before retirement.  To me the tradeoff here is between (a) tax-free growth post-rollover with the 401k option and (b) capital gains treatment on pre-rollover growth and more liquidity with the taxable account option.  This would come down to what investments you want to make.  The tax consequences is just a math problem you could figure out.  The liquidity issue will depend on what you want to invest in and whether you anticipate needing liquidity in the near-medium term.

The OP should definitely find out if s/he can take inservice rollover distributions, which would allow for avoiding the tradeoff as described in my prior post.

[seattlecyclone]

...to the extent there are earnings on the amount rolled out of the plan (which have to be rolled out with the related contributions), I don't convert them to the Roth IRA, instead sending them back from the traditional IRA to the 401(k).

Can you do that? I thought that partial Roth conversions from a traditional IRA are always considered to be apportioned proportionally between pre-tax and post-tax amounts. So if you have $10,000 of post-tax contributions in the account, and $2,500 of untaxed earnings in the account, and you roll over $10,000 to your Roth, you'll have to pay tax on $2,000 of the conversion because your traditional IRA was split 80/20 between post-tax contributions (which aren't taxed on a conversion) and IRA earnings (which are taxed on a conversion). This is why the "backdoor Roth" doesn't work well for people who already have substantial pre-tax assets in a traditional IRA, because they have to pay tax on the majority of the conversion. I could be wrong though.

[Undecided]

...to the extent there are earnings on the amount rolled out of the plan (which have to be rolled out with the related contributions), I don't convert them to the Roth IRA, instead sending them back from the traditional IRA to the 401(k).

Can you do that? I thought that partial Roth conversions from a traditional IRA are always considered to be apportioned proportionally between pre-tax and post-tax amounts. So if you have $10,000 of post-tax contributions in the account, and $2,500 of untaxed earnings in the account, and you roll over $10,000 to your Roth, you'll have to pay tax on $2,000 of the conversion because your traditional IRA was split 80/20 between post-tax contributions (which aren't taxed on a conversion) and IRA earnings (which are taxed on a conversion). This is why the "backdoor Roth" doesn't work well for people who already have substantial pre-tax assets in a traditional IRA, because they have to pay tax on the majority of the conversion. I could be wrong though.

Yes, but in reviewing how I did it last year I see that I did the "return" of the earnings to the 401(k) before I did the conversion to the Roth IRS, so there was no taxable money in the IRA at the time of the conversion. The earnings were minimal anyway, as I made the contributions in a very short amount of time (two months), so I suppose even if the IRS disagrees, I'd be ok with it.

I first saw this method discussed here: http://www.bogleheads.org/forum/viewtopic.php?t=82767

[seattlecyclone]

Huh, that's interesting. It looks like it works because 401(k) plans can't accept after-tax rollovers, so any money you roll back into the plan is deemed to be coming from the pre-tax portion. This is in contrast to if you rolled over into another IRA where the rollover amount would be prorated pre-tax/after-tax based on the composition of the entire account.

[ZiziPB]

Thanks for all the responses.  My ability to do in-service distributions is unfortunately limited.  Under our plan, the after-tax money has to be in the account for at least 2 years before I am able to do that. 

So unfortunately, I can't do backdoor Roth (due to significant IRAs that I have besides the 401k), and I have to wait 2 years before I can convert the after tax 401k contributions. 

But I still like that option, so I think I will continue to put some extra money into the 401k.  Eventually, I will probably do a Roth pipeline.

[catccc]

mind blown.  I can contribute more to my Roth, this is awesome.  We are a one income family, so income limits aren't stopping us, but the $5.5K max (x2, hurrah for the spousal IRA) does.  I so wish I had known this last year. 

The only thing I think I need some clarification on the pro-rata rule and whether it applies to rollovers from the 401K the way it does to rollovers from a traditional IRA.  I'm finding varying information on ye old internet here...

out of luck, IRS says 401K rollover must follow the pro-rata rule:
http://www.kiplinger.com/article/retirement/T046-C000-S002-a-sweet-deal-on-roth-ira-conversions.html

go for it, you can rollover just the after tax amount:
http://cdn.ameriprisecontent.com/cds/alwp/advisor/james.a.barlow/cuserstempdesktopjumpstart-roth-401k-after-tax634554166110589130.pdf

The IRS says:
Rollovers to Roth IRAs.   You can roll over distributions directly from a qualified retirement plan (other than a designated Roth account) to a Roth IRA. You must include in your gross income distributions from a qualified retirement plan (other than a designated Roth account) that you would have had to include in income if you had not rolled them over into a Roth IRA. You do not include in gross income any part of a distribution from a qualified retirement plan that is a return of contributions to the plan that were taxable to you when paid. In addition, the 10% tax on early distributions does not apply.
  Any amount rolled over into a Roth IRA is subject to the same rules for converting a traditional IRA into a Roth IRA. For more information, see Converting From Any Traditional IRA Into a Roth IRA in chapter 1 of Publication 590.

But... my employer doesn't allow withdrawal of any pre-tax contributions/earnings while you are with the company, unless you are 59.5+.  It does allow in service withdrawals of after-tax contributions/earnings, so it sounds like since they won't let me take any of the pre-tax monies out for rollover, than my rollover funds (with the exception of earnings) are solidly after-tax, and will not trigger additional taxes.  Does that sound right?

Still, even if rolling over w/o taxes (or much taxes) isn't an option, I think that tax deferred earnings are a nice bonus.

[Undecided]

cartccc, it's hard to know what to make of the first article, since it doesn't provide any cites. Could be it's talking about distributions after 59.5 or after separation. Also, at least what I've done is not a direct rollover to a Roth. It's first a rollover to a traditional IRA, then a rollover of the taxable amount back to my 401(k) (separating the taxable and non-taxable portions) and then a conversion of the non-taxable amount left in the traditional IRA to my Roth IRA.

[catccc]

Thanks, Undecided.  I just got off of the phone with both VG (hooray for a low cost 401K) and our HR department, I think what I'm trying to do (max out pre-tax and also contribute after-tax, then roll after tax to a roth ira) is a-ok.  Awesome.  I want to shout it from the rooftops, but I don't want to annoy people with the knowledge that I am maxing out my 401K and have money left over to save.

[ZiziPB]

catccc, the way I understood it, any rollover to a Roth IRA is subject to the pro-rata or proportionality limitations (so it doesn't work well if you have other traditional IRAs), but a rollover from regular 401k to Roth 401k is not subject to that.  Does your 401k plan have a Roth component so that you could rollover inside the plan?

[engineerjourney]

I have been doing a lot of reading of the after tax 401K to Roth IRA deal. 
Its pretty sweet if the following:
- You are able to do after tax contributions to your 401K plan (mine does)
- Your provider/employer allows for in service withdrawls/rollovers without penalty (waiting for the answer on this one).

I found the following link to be very insightful:
http://cdn.ameriprisecontent.com/cds/alwp/advisor/jay.d.jacobs/cusersjjacob3desktopjump-start-your-roth-ira-with-a-401k-after-tax-conversion-4-11634680185434967153.pdf

For 2014 the limit is $52K overall, not $49K, otherwise the info in the pdf is good. 

If you are able to meet the conditions its a great way to get more into Roth before contributing to a taxable account.  Good luck!

[Redfive20]

engineerjourney, would being in multiple 401K plans (not from the same employer) provide more than $52K limit?

[shuffler]

engineerjourney, would being in multiple 401K plans (not from the same employer) provide more than $52K limit?

I was going to say "nope", but then I tried to look it up and began to doubt that answer.

See what you think of this, particularly "Example 1":
http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---401(k)-and-Profit-Sharing-Plan-Contribution-Limits

[ZiziPB]

I have not looked into the $52K limit question, but I checked on the $17,500 limit when I changed jobs a few years ago.  That does not double when you have multiple employers and multiple 401k plans.

[4alpacas]

I have been doing a lot of reading of the after tax 401K to Roth IRA deal. 
Its pretty sweet if the following:
- You are able to do after tax contributions to your 401K plan (mine does)
- Your provider/employer allows for in service withdrawls/rollovers without penalty (waiting for the answer on this one).

I found the following link to be very insightful:
http://cdn.ameriprisecontent.com/cds/alwp/advisor/jay.d.jacobs/cusersjjacob3desktopjump-start-your-roth-ira-with-a-401k-after-tax-conversion-4-11634680185434967153.pdf

For 2014 the limit is $52K overall, not $49K, otherwise the info in the pdf is good. 

If you are able to meet the conditions its a great way to get more into Roth before contributing to a taxable account.  Good luck!

Thanks!  I have this option at work right now, so I might have to pursue it further.