contribute after tax money to my 401K plan

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contribute after tax money to my 401K plan

Postby liuruyu » Sat Jan 26, 2013 1:36 pm

I read in another thread here regarding contributing after-tax money to 401K plan. I wonder if anyone can help explain the reasoning behind it.

I currently max out my 401K, and do a backdoor roth. I also save extra (after tax $) to my vanguard account for retirement planning. So should I also divert some of my after tax $ to my 401K (assume plan allows it)? The only benefit I can see so far is there are options/funds available in my 401K is not available for individual investors in Vanguard (due to minimum investment requirement). And seems like fee structure is better for most of the funds in my 401K as well.

Any downside of doing it? (any catch?) I guess I won't be able to take the after-tax contribution in my 401K (at least not as easy as I could have from the vanguard personal account). We have cash liquidity on hand and I don't see ourselves need to pulling cash out of my 401K plan.

Also how does it work when I roll my 401K plan in the future, as there will be after tax and before tax amount, will the roll-over become a tax trigger event if I have gain in the after tax portion of the 401k??


thx!
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Re: contribute after tax money to my 401K plan

Postby Alan S. » Sat Jan 26, 2013 2:03 pm

The main caveat is that even if your plan allows you to make after tax contributions, you are allowed to make periodic distributions of these contributions (and their earnings). This allows your money to end up in your Roth IRA through a Roth rollover, where you have access to it if needed. Otherwise, it is trapped in your 401k plan until you separate from service or qualify for some other distributable event.

Funds in your Roth can be tapped for any purpose, and the 5 year holding period to avoid the 10% penalty only applies to the taxable portion of your conversion. If you contribute 20k and do the Roth rollover after a gain of $500 for example, the $500 will be taxed. If you need some of that money before 5 years, the $500 will incur the 10% tax, but the rest of the rollover was not taxable and will not be subject to the tax.

So before contributing, check what your distribution options are for this money. Finally, your total annual additions (Code 415(c)) are limited to 51k for 2013. That includes your pre tax deferrals, company match, forfeitures, and your after tax contribution amounts.

The principal benefit of course is that Roth IRA funds generate potentially tax free earnings, while saving in taxable accounts does not. But you also need the plan to allow periodic distributions to get those contributions into your Roth before they generate earnings in the plan to realize the main benefit. SInce you would distribute out your after tax contributions while still working, they would not be in the plan after you separate. If you separated while there was an after tax balance in the plan, then your entire plan balance is available for rollover and pro rate rules would apply to any distributions you took.
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Re: contribute after tax money to my 401K plan

Postby liuruyu » Sat Jan 26, 2013 2:39 pm

Thanks Alan!

Unfortunately (or fortunately), my company has very good match (max out the combined 401K room). I guess I won't be able to contribute after tax money after all.
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Re: contribute after tax money to my 401K plan

Postby WHL » Sun Jan 27, 2013 1:42 am

I would like to ask a question pertaining to this topic! My 401k administrator has told me that they allow in-service rollovers, but do not allow contributions over 17.5k annually. Does this sound right?? I'm going to ask for some clarification (something on paper) because I would love to be able to contribute more to roll into my Roth.

Also, I know that doing backdoor Roth IRA contributions get messed up if there is a large tIRA balance to work around. Is this the same when rolling after-tax 401k money into a Roth IRA?
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Re: contribute after tax money to my 401K plan

Postby Default User BR » Sun Jan 27, 2013 12:58 pm

liuruyu wrote:Unfortunately (or fortunately), my company has very good match (max out the combined 401K room). I guess I won't be able to contribute after tax money after all.

Just to clarify, your contributions plus the company contribution will exceed $51,000 for 2013?


Brian
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Re: contribute after tax money to my 401K plan

Postby Default User BR » Sun Jan 27, 2013 1:02 pm

WHL wrote:I would like to ask a question pertaining to this topic! My 401k administrator has told me that they allow in-service rollovers, but do not allow contributions over 17.5k annually. Does this sound right?

They can do that if they want.

WHL wrote:Also, I know that doing backdoor Roth IRA contributions get messed up if there is a large tIRA balance to work around. Is this the same when rolling after-tax 401k money into a Roth IRA?

You can roll the contributions directly to a Roth and avoid pro-rata. You would owe taxes on any earnings that came with the after-tax contributions. There's a technique that's supposed to end up with the non-taxable in Roth and the taxable in a TIRA, but I'm a little leery of it myself.


Brian
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Re: contribute after tax money to my 401K plan

Postby WHL » Sun Jan 27, 2013 2:43 pm

Default User BR wrote:
WHL wrote:I would like to ask a question pertaining to this topic! My 401k administrator has told me that they allow in-service rollovers, but do not allow contributions over 17.5k annually. Does this sound right?

They can do that if they want.

WHL wrote:Also, I know that doing backdoor Roth IRA contributions get messed up if there is a large tIRA balance to work around. Is this the same when rolling after-tax 401k money into a Roth IRA?

You can roll the contributions directly to a Roth and avoid pro-rata. You would owe taxes on any earnings that came with the after-tax contributions. There's a technique that's supposed to end up with the non-taxable in Roth and the taxable in a TIRA, but I'm a little leery of it myself.


Brian


I had assumed all of this to be correct, thank you for confirming / clarifying. I wish the company would let me add after-tax money! :(
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