What are 401k after-tax contributions?

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radnor
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What are 401k after-tax contributions?

Post by radnor » Fri Feb 17, 2017 12:18 pm

My 401k plan allows for pre-tax, after-tax, and Roth contributions (I plan to do a mega-backdoor Roth by contributing after-tax and then converting it to Roth). But I don't actually understand what exactly "after-tax" means, as opposed to Roth. Could someone please explain this?

DSInvestor
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Re: What are 401k after-tax contributions?

Post by DSInvestor » Fri Feb 17, 2017 12:23 pm

These are 401k contributions that do not offer tax deduction or Roth treatment. They are essentially non-deductible contributions to Traditional 401k. I believe these after-tax non-Roth 401k contributions are made after you reach your 18K employee salary deferral limit. When you do the rollover of after-tax Traditional 401k assets out to Roth IRA, you're essentially doing a Roth conversion of money that has already been taxed (basis) resulting in a tax free conversion. The amount converted in excess of basis is taxable.
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radnor
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Re: What are 401k after-tax contributions?

Post by radnor » Fri Feb 17, 2017 12:28 pm

DSInvestor wrote:These are 401k contributions that do not offer tax deduction or Roth treatment. They are essentially non-deductible contributions to Traditional 401k. When you do the rollover of after-tax Traditional 401k assets out to Roth IRA, you're essentially doing a Roth conversion of money that has already been taxed (basis) resulting in a tax free conversion. The amount converted in excess of basis is taxable.
So with after-tax, if I just left it there and did not do the Roth conversion, I would effectively pay taxes on the basis when I deposit it and AGAIN on the basis and interest when I go to withdraw in retirement (not that I would do this...)? Why would anyone choose to do that?

DSInvestor
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Re: What are 401k after-tax contributions?

Post by DSInvestor » Fri Feb 17, 2017 12:33 pm

radnor wrote:So with after-tax, if I just left it there and did not do the Roth conversion, I would effectively pay taxes on the basis when I deposit it and AGAIN on the basis and interest when I go to withdraw in retirement (not that I would do this...)? Why would anyone choose to do that?
No, you're not taxed on the basis on withdrawal or conversion. If you contributed 20K after-tax, you'd have 20K basis. If this grows to 30K, you still have 20K basis. If you withdraw 30K, 20K is non-taxable and 10K is taxable.

I would not make any after-tax non-Roth 401k contributions unless there was a way to transfer to Roth IRA soon after the contribution. If the in-service rollover feature is not available, I think it would be better to contribute to taxable rather than after-tax non-Roth 401k.
Last edited by DSInvestor on Fri Feb 17, 2017 12:37 pm, edited 1 time in total.
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aaronb
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Re: What are 401k after-tax contributions?

Post by aaronb » Fri Feb 17, 2017 12:35 pm

I just read an article at Morningstar about after-tax 401(k) contributions. It includes this explanation (and more), which appears to be consistent with DSInvestor's statements:
Q: Is making an aftertax 401(k) contribution the same as making a Roth 401(k) contribution? Both involve aftertax dollars.

A: No. The two differ in a few key ways. First, Roth 401(k) contributions are subject to the usual 401(k) contribution limits--in 2017, that's $18,000 and $24,000. Aftertax 401(k) contributions can be higher, as long as the total 401(k) contribution doesn't exceed $54,000.
More importantly, the tax treatment of Roth 401(k) contributions and aftertax contributions is different. The earnings on Roth 401(k) contributions begin compounding tax-free from the get-go. Meanwhile, to the extent that the aftertax contributions generate investment earnings inside the 401(k), those earnings compound on a tax-deferred--not tax-free--basis.

JW-Retired
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Re: What are 401k after-tax contributions?

Post by JW-Retired » Fri Feb 17, 2017 12:48 pm

radnor wrote:
So with after-tax, if I just left it there and did not do the Roth conversion, I would effectively pay taxes on the basis when I deposit it and AGAIN on the basis and interest when I go to withdraw in retirement (not that I would do this...)? Why would anyone choose to do that?
No, the earnings get taxed on withdrawal but you don't pay tax again on the contributions. The 401k admin keeps track of how much the after-tax contribution basis amounts to. I think you can now split that off to a Roth if you do a rollover of the 401k.

Why did people do it? Back before Roths the after-tax 401k contribution was better than nothing if you wanted more savings.

I don't wish to rollover my 401k so we are just getting the basis back now as a non-taxable portion of my RMD.
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ved
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Re: What are 401k after-tax contributions?

Post by ved » Fri Feb 17, 2017 12:51 pm

DSInvestor wrote:These are 401k contributions that do not offer tax deduction or Roth treatment. They are essentially non-deductible contributions to Traditional 401k. I believe these after-tax non-Roth 401k contributions are made after you reach your 18K employee salary deferral limit. When you do the rollover of after-tax Traditional 401k assets out to Roth IRA, you're essentially doing a Roth conversion of money that has already been taxed (basis) resulting in a tax free conversion. The amount converted in excess of basis is taxable.
Not necessarily. It depends on your plan. Some plans allow for simultaneous contributions into pre-tax, Roth and after-tax, along with employer's match.
The key is that:
max(pre-tax + Roth ) = $18 k per year
max(pre-tax + Roth + after-tax+match ) = $54 per year

Also, even if your plan doesn't allow the rollover of after-tax to Roth IRA/Roth401k, it may be beneficial for you to still contribute to the after-tax. Usually (again depends on your plan), when the employment is terminated, you may be able to rollover the after-tax contribution into Roth IRA, and any earnings into a traditional IRA. So, if you plan to leave your employer in a few years, you may want to consider after-tax (even if the in-service rollover option is not available).

But, do remember that if you don't rollover your after-tax, and wait until retirement, then the earnings are treated as ordinary income. Whereas if you had contributed to a taxable account (outside of your 401k), the earnings are treated as long term cap gains, which is generally a lower tax rate than ordinary income.

WhiteMaxima
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Re: What are 401k after-tax contributions?

Post by WhiteMaxima » Fri Feb 17, 2017 12:54 pm

That is called mega Roth. You can do after tax and rollover to Roth.

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radnor
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Re: What are 401k after-tax contributions?

Post by radnor » Fri Feb 17, 2017 12:55 pm

DSInvestor wrote:I would not make any after-tax non-Roth 401k contributions unless there was a way to transfer to Roth IRA soon after the contribution.
I called the 401k provider and they said that you can do an in-service conversation from after-tax to Roth within the 401k (I didn't ask them about transferring after-tax 401k funds to my personal Roth IRA, nor did I even know that this was even possible).
DsInvestor wrote:If the in-service rollover feature is not available, I think it would be better to contribute to taxable rather than after-tax non-Roth 401k.
Why do you say that? From your previous explanation, it sounds that growth on after-tax 401k funds is taxed upon withdrawal. I believe that is similar to how taxable funds work, except they also have "mandatory" periodic withdrawals in the form of stock dividends/bond interest. So wouldn't the after-tax 401k still marginally win out?

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radnor
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Re: What are 401k after-tax contributions?

Post by radnor » Fri Feb 17, 2017 12:56 pm

ved wrote:But, do remember that if you don't rollover your after-tax, and wait until retirement, then the earnings are treated as ordinary income. Whereas if you had contributed to a taxable account (outside of your 401k), the earnings are treated as long term cap gains, which is generally a lower tax rate than ordinary income.
And I suppose that that answers my second question from the reply that I just wrote. :happy

Also, ved, I assume that you are implying here that even the earnings on after-tax 401k funds won't be taxed as long as I convert the after-tax balance (including both basis and earnings) to Roth sometime before I retire (but will be taxed if I fail to do this)?

ved
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Re: What are 401k after-tax contributions?

Post by ved » Fri Feb 17, 2017 1:17 pm

radnor wrote:
Also, ved, I assume that you are implying here that even the earnings on after-tax 401k funds won't be taxed as long as I convert the after-tax balance (including both basis and earnings) to Roth sometime before I retire (but will be taxed if I fail to do this)?
No.
You will still be taxed on the earnings (if you rollover the earnings also into the Roth along with the after-tax contributions) in the year you do the rollover. However, these earnings are likely to be minimal if you regularly do teh rollover from after-tax to Roth.

Another option (if your plan allows) is to have the earnings rolled over to a traditional IRA / 401k, and the contributions to Roth. In that case, you are delaying the tax on the earnings (and their growth) to when you withdraw from your traditional IRA/401k at retirement.

I recommend the best option is to rollover the AT contributions and earnings regularly to Roth (and pay the small tax on the earnings).

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Re: What are 401k after-tax contributions?

Post by Ron » Fri Feb 17, 2017 1:27 pm

My 401(k) was with FIDO during my working years, and I contributed quite a bit "above the line" over the years which was returned to me upon my retirement. The earnings of the excess contributions were included with the Rollover IRA I executed at the time of retirement, with the tax-free funds going into my taxable MM account cash bucket, which was used to help fund my retirement in the early years.

It was easier to just contribute above the line and keep my investments within the funds I had already selected from FIDO rather than to take the excess and perform taxable investing, IMHO.

- Ron

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Re: What are 401k after-tax contributions?

Post by avalpert » Fri Feb 17, 2017 2:11 pm

radnor wrote:
DsInvestor wrote:If the in-service rollover feature is not available, I think it would be better to contribute to taxable rather than after-tax non-Roth 401k.
Why do you say that? From your previous explanation, it sounds that growth on after-tax 401k funds is taxed upon withdrawal. I believe that is similar to how taxable funds work, except they also have "mandatory" periodic withdrawals in the form of stock dividends/bond interest. So wouldn't the after-tax 401k still marginally win out?
No, the 401k earnings are taxed at your marginal income tax rates whereas capital gains in taxable are at the more favorable capital gains rates.

stilllurking
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Re: What are 401k after-tax contributions?

Post by stilllurking » Tue Sep 11, 2018 2:04 pm

I know this is an old thread but looking for clarity in my situation.

I have a rollover IRA from a number of old employers with Vanguard. This is invested in VTSAX and VBILX to get to my overall asset allocation. My current 401(k) is also with Vanguard. In my current 401(k), I have the S&P 500, mid-cap and small-cap index funds to choose from in order to equate to total market but since my 401(k) is small compared to the total portfolio, I leave it all in the S&P 500 for simplicity.

I have a true-up at my company so I can get the employer's match even if I contribute the max $18.5K before year's end. I already have a taxable account that I've been investing in for the past 5 or so years.

I learned that my 401(k) allows for after-tax contributions to the plan and also in-service withdrawals as well. Knowing that I want simplicity and that VTSAX is better than the S&P 500 fund I have in my 401(k), I'd like to keep the rollover IRA as is and just start making after-tax 401(k) contributions.

I had helped a friend with transferring their 401(k) to Vanguard last year. He had made, pre-tax, Roth and after-tax contributions to the account and the old provider provided the ability to cut multiple checks in order to allow him to move the appropriate money to the appropriate accounts. So all the pre-tax went to his rollover IRA and the Roth/after-tax money went to his Roth IRA.

What am I missing if I decide not to do the extra work in managing the in-service withdrawals? Wouldn't the 401(k) provider keep track of the amounts and basis for each account and then cut checks or each amount and I would just deposit to the appropriate account upon leaving the company?

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Re: What are 401k after-tax contributions?

Post by bradpevans » Tue Sep 11, 2018 2:58 pm

stilllurking wrote:
Tue Sep 11, 2018 2:04 pm
I know this is an old thread but looking for clarity in my situation.

I have a rollover IRA from a number of old employers with Vanguard. This is invested in VTSAX and VBILX to get to my overall asset allocation. My current 401(k) is also with Vanguard. In my current 401(k), I have the S&P 500, mid-cap and small-cap index funds to choose from in order to equate to total market but since my 401(k) is small compared to the total portfolio, I leave it all in the S&P 500 for simplicity.

I have a true-up at my company so I can get the employer's match even if I contribute the max $18.5K before year's end. I already have a taxable account that I've been investing in for the past 5 or so years.

I learned that my 401(k) allows for after-tax contributions to the plan and also in-service withdrawals as well. Knowing that I want simplicity and that VTSAX is better than the S&P 500 fund I have in my 401(k), I'd like to keep the rollover IRA as is and just start making after-tax 401(k) contributions.

I had helped a friend with transferring their 401(k) to Vanguard last year. He had made, pre-tax, Roth and after-tax contributions to the account and the old provider provided the ability to cut multiple checks in order to allow him to move the appropriate money to the appropriate accounts. So all the pre-tax went to his rollover IRA and the Roth/after-tax money went to his Roth IRA.

What am I missing if I decide not to do the extra work in managing the in-service withdrawals? Wouldn't the 401(k) provider keep track of the amounts and basis for each account and then cut checks or each amount and I would just deposit to the appropriate account upon leaving the company?
You are describing what most here call "Mega Backdoor Roth"
a) After tax 401k Contributions (plan must allow, you need to have the $)
b) in service withdraw / in service rollover (plan must allow, not all plans do)
c) call your plan holder and let them know you wish to do in-service rollover, from after tax 401K to Roth IRA
d) they will let you know:
1) you have x in basis --> goes directly to Roth IRA
2) you have y in gains (i.e. gains since the time of money in to time of rollover)
with these y dollars you can send to 401k (but then pay income tax at the time you withdraw)
send to Roth IRA (and pay the taxes come next April)

So, you want to convert sooner than later - the whole point of Roth is tax free growth.
The plan will track this for you, but it is in your best interest (tax wise) to convert immediately,
so that the gains occurs inside Roth IRA, not inside after tax 401K.

My plan charges $20 each time I do this. You can dampen this impact by contributing a high % for a short time,
then transferring over. If you get a once a year bonus, you can bump your % contribution for that check to fund it quickly.

stilllurking
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Re: What are 401k after-tax contributions?

Post by stilllurking » Tue Sep 11, 2018 3:22 pm

bradpevans wrote:
Tue Sep 11, 2018 2:58 pm
You are describing what most here call "Mega Backdoor Roth"
a) After tax 401k Contributions (plan must allow, you need to have the $)
b) in service withdraw / in service rollover (plan must allow, not all plans do)
c) call your plan holder and let them know you wish to do in-service rollover, from after tax 401K to Roth IRA
d) they will let you know:
1) you have x in basis --> goes directly to Roth IRA
2) you have y in gains (i.e. gains since the time of money in to time of rollover)
with these y dollars you can send to 401k (but then pay income tax at the time you withdraw)
send to Roth IRA (and pay the taxes come next April)

So, you want to convert sooner than later - the whole point of Roth is tax free growth.
The plan will track this for you, but it is in your best interest (tax wise) to convert immediately,
so that the gains occurs inside Roth IRA, not inside after tax 401K.

My plan charges $20 each time I do this. You can dampen this impact by contributing a high % for a short time,
then transferring over. If you get a once a year bonus, you can bump your % contribution for that check to fund it quickly.
Thanks bradpevans.

For d) above, can the y gains can be left in the 401(k) or do I need to withdraw them as I am withdrawing the Roth component of the capital?

Will the maximum, $55K - $18.5K (pre-tax) = $36.5K be the amount that can be transferred to the Roth IRA in any given year? Or does it limit to the $5.5K?

Do I need to worry about my existing rollover IRA when completing the in-service transfers?

bradpevans
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Re: What are 401k after-tax contributions?

Post by bradpevans » Tue Sep 11, 2018 4:03 pm

stilllurking wrote:
Tue Sep 11, 2018 3:22 pm
bradpevans wrote:
Tue Sep 11, 2018 2:58 pm
You are describing what most here call "Mega Backdoor Roth"
a) After tax 401k Contributions (plan must allow, you need to have the $)
b) in service withdraw / in service rollover (plan must allow, not all plans do)
c) call your plan holder and let them know you wish to do in-service rollover, from after tax 401K to Roth IRA
d) they will let you know:
1) you have x in basis --> goes directly to Roth IRA
2) you have y in gains (i.e. gains since the time of money in to time of rollover)
with these y dollars you can send to 401k (but then pay income tax at the time you withdraw)
send to Roth IRA (and pay the taxes come next April)

So, you want to convert sooner than later - the whole point of Roth is tax free growth.
The plan will track this for you, but it is in your best interest (tax wise) to convert immediately,
so that the gains occurs inside Roth IRA, not inside after tax 401K.

My plan charges $20 each time I do this. You can dampen this impact by contributing a high % for a short time,
then transferring over. If you get a once a year bonus, you can bump your % contribution for that check to fund it quickly.
Thanks bradpevans.

For d) above, can the y gains can be left in the 401(k) or do I need to withdraw them as I am withdrawing the Roth component of the capital?

Will the maximum, $55K - $18.5K (pre-tax) = $36.5K be the amount that can be transferred to the Roth IRA in any given year? Or does it limit to the $5.5K?

Do I need to worry about my existing rollover IRA when completing the in-service transfers?
the y gains will also be transferred (i had to open a Roth IRA at the same time). Note you have *already* paid the taxes on the funds that generated the y gains. So you want them into Roth IRA as soon as possible.

If you have the means you can drop 36.5K into the after tax 401K, then subsequently into the Roth IRA
Note1: if over 50 you can get 6K additional into your regular 401K (and then max 30.5K after tax)
Note2: employER contributions also count toward the 55K, so factor that in

I try to fund my (traditional) 401K in regular amounts all year (my matching is "per paycheck", no "true-up")
I try to fund the after tax 401K in fewer larger amounts, then transfer soon thereafter

stilllurking
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Re: What are 401k after-tax contributions?

Post by stilllurking » Tue Sep 11, 2018 8:07 pm

Thanks.

I have a call into HR to find out what fees are charged for in service withdrawals.

If none, I'll probably contribute for the remainder of this year and then transfer in early January. Not sure how involved it is to do a transfer.

Is it possible to move the after tax contribution to my Roth and then the gains into my existing rollover IRA since I can't leave it in the 401(k)? I saw that you mentioned that they can be sent to 401(k) but I'm not sure if you meant leave it there. I rather not pay taxes on the gains unless I have to.

stilllurking
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Re: What are 401k after-tax contributions?

Post by stilllurking » Wed Sep 12, 2018 6:58 pm

Following up here. I called Vanguard, my 401(k) provider and they said there are no fees for in service after tax withdrawals and they can be done as many times as desired. I'm thinking biweekly is too often. What is the consensus here for those that do this?

A question about strategy on this. In order to minimize the amount of gains on the after tax contributions, I was thinking of switching the 401(k) fund from the S&P 500 find to total bond or stable value. That way even if I transfer the money once a month or once a quarter, it wouldn't have a lot of gains to move?

I will need to check again but I don't think I can choose a specific fund for each source.

Vanguard did say I can move the gains to a rollover IRA and the after tax to my Roth. Is that really a bad idea? In other words, I would keep the 401(k) in the S&P instead of trying to keep gains to a minimum.

Or am I overthinking this and it doesn't matter in the end?

stilllurking
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Re: What are 401k after-tax contributions?

Post by stilllurking » Thu Sep 13, 2018 8:21 pm

Can anyone shed some light on my questions please?

Dottie57
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Re: What are 401k after-tax contributions?

Post by Dottie57 » Thu Sep 13, 2018 8:23 pm

DSInvestor wrote:
Fri Feb 17, 2017 12:33 pm
radnor wrote:So with after-tax, if I just left it there and did not do the Roth conversion, I would effectively pay taxes on the basis when I deposit it and AGAIN on the basis and interest when I go to withdraw in retirement (not that I would do this...)? Why would anyone choose to do that?
No, you're not taxed on the basis on withdrawal or conversion. If you contributed 20K after-tax, you'd have 20K basis. If this grows to 30K, you still have 20K basis. If you withdraw 30K, 20K is non-taxable and 10K is taxable.

I would not make any after-tax non-Roth 401k contributions unless there was a way to transfer to Roth IRA soon after the contribution. If the in-service rollover feature is not available, I think it would be better to contribute to taxable rather than after-tax non-Roth 401k.
+1

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FiveK
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Re: What are 401k after-tax contributions?

Post by FiveK » Thu Sep 13, 2018 9:18 pm

stilllurking wrote:
Wed Sep 12, 2018 6:58 pm
Following up here. I called Vanguard, my 401(k) provider and they said there are no fees for in service after tax withdrawals and they can be done as many times as desired. I'm thinking biweekly is too often. What is the consensus here for those that do this?

A question about strategy on this. In order to minimize the amount of gains on the after tax contributions, I was thinking of switching the 401(k) fund from the S&P 500 find to total bond or stable value. That way even if I transfer the money once a month or once a quarter, it wouldn't have a lot of gains to move?

I will need to check again but I don't think I can choose a specific fund for each source.

Vanguard did say I can move the gains to a rollover IRA and the after tax to my Roth. Is that really a bad idea? In other words, I would keep the 401(k) in the S&P instead of trying to keep gains to a minimum.

Or am I overthinking this and it doesn't matter in the end?
Paying tax on a small gain is better than not paying tax on no gain.

What Vanguard told you is not a bad idea - it is likely a good idea.

Pigeye Brewster
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Re: What are 401k after-tax contributions?

Post by Pigeye Brewster » Thu Sep 13, 2018 9:27 pm

stilllurking wrote:
Wed Sep 12, 2018 6:58 pm
Following up here. I called Vanguard, my 401(k) provider and they said there are no fees for in service after tax withdrawals and they can be done as many times as desired. I'm thinking biweekly is too often. What is the consensus here for those that do this?

A question about strategy on this. In order to minimize the amount of gains on the after tax contributions, I was thinking of switching the 401(k) fund from the S&P 500 find to total bond or stable value. That way even if I transfer the money once a month or once a quarter, it wouldn't have a lot of gains to move?

I will need to check again but I don't think I can choose a specific fund for each source.

Vanguard did say I can move the gains to a rollover IRA and the after tax to my Roth. Is that really a bad idea? In other words, I would keep the 401(k) in the S&P instead of trying to keep gains to a minimum.

Or am I overthinking this and it doesn't matter in the end?
My employer has bi-weekly payroll and the plan allows for in plan Roth rollovers with every payroll. I utilize it.

Otherwise, don't let the tax tail wag the investing dog. Having gains and paying tax on them > not paying tax on no gains.

2pedals
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Re: What are 401k after-tax contributions?

Post by 2pedals » Thu Sep 13, 2018 9:34 pm

stilllurking wrote:
Wed Sep 12, 2018 6:58 pm
Following up here. I called Vanguard, my 401(k) provider and they said there are no fees for in service after tax withdrawals and they can be done as many times as desired. I'm thinking biweekly is too often. What is the consensus here for those that do this?

A question about strategy on this. In order to minimize the amount of gains on the after tax contributions, I was thinking of switching the 401(k) fund from the S&P 500 find to total bond or stable value. That way even if I transfer the money once a month or once a quarter, it wouldn't have a lot of gains to move?

I will need to check again but I don't think I can choose a specific fund for each source.

Vanguard did say I can move the gains to a rollover IRA and the after tax to my Roth. Is that really a bad idea? In other words, I would keep the 401(k) in the S&P instead of trying to keep gains to a minimum.

Or am I overthinking this and it doesn't matter in the end?
My 401k plan administrator allows me to write two rollover checks
Check #1, written to my Roth IRA account FBO of me for the after tax portion that was deposited
Check #2, written to my Traditional IRA account FBO of me for the gains on the after tax portion

The after tax portion and the gains on the after tax that must be distributed and the plan administrator knows the amounts. I do this once a year so that the after tax gets re-characterized to nontaxable (Roth) and the gains are no longer taxable. You can do this as many times you want for free in my 401k plan but the after tax comes after my pretax space has been filled up and I find it convenient to do this once a year in January. Since the gains of the after tax portion (Check #2) is rolled into the Traditional IRA no taxes are due for that rollover. The after tax portion has already been taxed and no taxes are due for Check #1.

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