Additional post-tax 401(k) contribution

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PolarBearMarket
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Additional post-tax 401(k) contribution

Post by PolarBearMarket » Tue Oct 09, 2018 12:00 pm

Fairly straightforward question to ensure I'm thinking about things correctly: Currently I am maxing out my 401(k) and IRA contributions. My employer offers a additional after-tax savings plan of up to 10% of total income (up to the contribution maximum). Here's what this looks like in Vanguard.

My understanding is that disbursements from the after-tax 401(k) savings plan are taxed as if they are traditional 401(k) contributions, e.g. as regular income in retirement. Additionally, my understanding is that the cash that I put in the additional after-tax 401(k) savings plan can be rolled over to a Roth IRA once I leave employment, since it's already been taxed. Thus, my options are:
  1. Contribute to the additional post-tax plan, then pay additional income taxes on the withdrawals at retirement
  2. Contribute to the additional post-tax plan, but rollover to a Roth IRA and withdraw tax-free in retirement
  3. Do not contribute to the additional post-tax plan; put the money in a brokerage account and pay capital gains tax at withdrawal
Two questions:
  • Is this an accurate representation of my options?
  • Option 2 seems clearly superior - are there risks to this approach I am not seeing?

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David Jay
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Re: Additional post-tax 401(k) contribution

Post by David Jay » Tue Oct 09, 2018 12:06 pm

A lot of good information on the WIKI, link: https://www.bogleheads.org/wiki/After-tax_401(k)

As I read the WIKI, only the GAINS in the account are taxed (as regular income, in the year of the gain). The contributions do not appear to be taxed. Check it out.
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PolarBearMarket
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Re: Additional post-tax 401(k) contribution

Post by PolarBearMarket » Tue Oct 09, 2018 2:36 pm

David Jay wrote:
Tue Oct 09, 2018 12:06 pm
A lot of good information on the WIKI, link: https://www.bogleheads.org/wiki/After-tax_401(k)

As I read the WIKI, only the GAINS in the account are taxed (as regular income, in the year of the gain). The contributions do not appear to be taxed. Check it out.
Thanks David! Missed that page on the wiki. Sounds like my backdoor plan makes sense.

pingpong
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Re: Additional post-tax 401(k) contribution

Post by pingpong » Tue Oct 09, 2018 8:23 pm

I think you have to rollover the entire contribution and earnings. To avoid any taxes you should contribute the contribution to Roth and the earnings to traditional IRA.

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Earl Lemongrab
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Re: Additional post-tax 401(k) contribution

Post by Earl Lemongrab » Wed Oct 10, 2018 1:14 pm

Make sure that the plan allows in-service rollovers of the after-tax contributions. If so, get the details: frequency allowed, any fees for the rollover, any restrictions.

The law requires distributing a proportional share of earnings with the distribution. If done fairly frequently, this shouldn't be a big deal. The IRS clarified that the plan is allowed to split the distribution into the pretax earnings and after-tax contribution. If your plan does that, you could put the pretax in TIRA and the other in Roth. Many find it just as easy to roll it all to the Roth and pay a bit of taxes.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

PolarBearMarket
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Re: Additional post-tax 401(k) contribution

Post by PolarBearMarket » Wed Oct 10, 2018 3:25 pm

Earl Lemongrab wrote:
Wed Oct 10, 2018 1:14 pm
Make sure that the plan allows in-service rollovers of the after-tax contributions. If so, get the details: frequency allowed, any fees for the rollover, any restrictions.

The law requires distributing a proportional share of earnings with the distribution. If done fairly frequently, this shouldn't be a big deal. The IRS clarified that the plan is allowed to split the distribution into the pretax earnings and after-tax contribution. If your plan does that, you could put the pretax in TIRA and the other in Roth. Many find it just as easy to roll it all to the Roth and pay a bit of taxes.
The plan does allow in-service rollovers, but there's a catch. My company routinely fails the non-discrimination test and generally refunds a portion of the plan to employees after the end of the year. Thus, if I convert the after-tax savings plan to a Roth through a mega-backdoor during the course of the year, I run a significant risk of having to pay early withdrawal penalties when the plan is reconciled. Thus, I plan to wait until the dust settles before converting anything.

pingpong wrote:
Tue Oct 09, 2018 8:23 pm
I think you have to rollover the entire contribution and earnings. To avoid any taxes you should contribute the contribution to Roth and the earnings to traditional IRA.
Is there a difference between keeping the earnings in a Traditional account or converting it to Roth besides the time that I pay taxes on it? It seems simpler to move it all into Roth where I can purchase admiral shares rather than leave a lowly $100-200 in a traditional account by itself. I have never been in a position where it made sense to contribute directly to a Traditional IRA, so mine is empty except for the time between when I fund it and conduct the backdoor Roth conversion.

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Earl Lemongrab
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Re: Additional post-tax 401(k) contribution

Post by Earl Lemongrab » Wed Oct 10, 2018 6:51 pm

PolarBearMarket wrote:
Wed Oct 10, 2018 3:25 pm
The plan does allow in-service rollovers, but there's a catch. My company routinely fails the non-discrimination test and generally refunds a portion of the plan to employees after the end of the year. Thus, if I convert the after-tax savings plan to a Roth through a mega-backdoor during the course of the year, I run a significant risk of having to pay early withdrawal penalties when the plan is reconciled. Thus, I plan to wait until the dust settles before converting anything.
That is a sound plan.
PolarBearMarket wrote:
Wed Oct 10, 2018 3:25 pm
Is there a difference between keeping the earnings in a Traditional account or converting it to Roth besides the time that I pay taxes on it? It seems simpler to move it all into Roth where I can purchase admiral shares rather than leave a lowly $100-200 in a traditional account by itself. I have never been in a position where it made sense to contribute directly to a Traditional IRA, so mine is empty except for the time between when I fund it and conduct the backdoor Roth conversion.
Some plans would allow you to roll the small TIRA back into the plan. If you are using the regular backdoor Roth, then that would of course be a pro rata situation. In that case you'd either want to convert it or roll it into the 401(k).
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

Alan S.
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Re: Additional post-tax 401(k) contribution

Post by Alan S. » Wed Oct 10, 2018 7:07 pm

If a plan fails the ACP test almost every year, it is odd that they would not cap the after tax contributions enough to avoid testing failures. Testing failures cost the employer (processing, 1099R etc) and the employee if excess contributions are returned, but only cost the employer if they make QNEC contributions to the non HCEs rather than returning excess amounts to the HCEs.

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