Exploring After-Tax 401k Contributions

Exploring After-Tax 401k Contributions

July 20, 2021
Share |

For many individuals who are in the high-income tax brackets, exploring all your retirement saving options is crucial. Individuals who are single making over $140,000, or a married couple who earns over $208,000 combined, are phased out from contributing to a Roth IRA. Furthermore, these individuals will typically max out their 401k contributions at $19,500 each year, or $26,000 per year if you are aged 50 and over.

However, there is a new strategy that is being offered by some large employers that individuals should be aware of. This new strategy allows individuals to contribute an additional $38,500 of after-tax money into a 401k account and then convert some or all of that money into a Roth 401k account.

The IRS allows a total of up to $58,000 to be contributed into a 401k for fiscal year 2021. If you are over the age of 50, the IRS allows $64,500, which includes catch up contributions. Once you have maxed out your pre-tax contributions of $19,500 or $26,000, you should explore after tax contributions and see if an automated Roth 401k conversion is available.

 Once those after-tax contributions are converted into a Roth 401k account, the earnings grow tax-free. One thing to note, you will have to pay taxes on any earnings that accrued between when your original after-tax contributions were made and when you convert the contribution to a Roth 401k.

 

Fidelity listed the benefits on the Roth in-plan conversions:

  • Roth provides you with additional savings flexibility within your plan. It allows you to diversify your retirement assets between pretax and after-tax accounts.


  • You can grow tax-free earnings on your retirement savings, provided you meet appropriate qualification rules (a distribution from a Roth 401(k) plan is tax-free and penalty- free, provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, disability, or death). Ŧ

 

  • Roth can also potentially reduce future income taxes and keep more of what you earn on your investments in your workplace savings plan.

 

According to Vanguard group, of the 4.7 million individuals who participate in their 401k plans, about 40% of them have access to this strategy. Of those who do have access to this type of plan, only 10% of those individuals are taking advantage of these additional after-tax contributions.

Make sure, if this option is available to you, that you explore the possibility of making additional After-Tax contributions!

  • Greg Munroe – Private Wealth Manager, Founder and CEO

Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual.

Ŧ A distribution from a qualified retirement plan (other than an IRA) made to you after you separate from service with your employer may be penalty-free if the separation occurred in or after the year you reached age 55. Note that while penalty-free, earnings on Roth contributions are taxable if you are under 59 ½ at the time of distribution.