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After-tax 401k? How to evaluate usefulness?
09-25-2013, 08:46 PM
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#1
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Recycles dryer sheets
Join Date: Apr 2007
Posts: 126
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After-tax 401k? How to evaluate usefulness?
My almost-megacorp has recently added the capability to add funds to an non-ROTH after-tax 401k (>20k in addition to the 17.5k present limit on the tax-deductible portion). I have not yet ascertained whether in-service distributions go along with this (although the e-mail stating this new benefit did seem to suggest such).
My understanding is that that the primary benefit of an after-tax 401k is to take frequent in-service distributions and convert after-tax money to a ROTH IRA.
I am presently maxing out contributions to the tax-deductible portion of the 401k, accessing a non-deductible IRA to ROTH conversion each year, and adding considerable money to after-tax accounts. I would additionally have the capability to fully utilize this new after-tax 401k space.
Income is reasonable relative to expenses, age is mid-30s, and I am aiming for the possibility of quite early retirement (or rather, financial independence).
I'm presently undecided on whether this benefit offers real advantages in my circumstances. If I were to only access money at standard retirement age, the long-term tax-free compounding would be quite useful. On the other hand, even in a much shorter timeframe (+5yrs), I could always access the initial converted capital with no penalties. Yet doing this does add potential complexity to finances, which I try to keep simple.
I've read a bit on the topic and there doesn't seem to be any driving reason to either partake or not partake in this benefit.
Have others used after-tax non-ROTH 401k options? If so, what drove that decision?
And am I missing anything major that could help refine my decision process?
Thanks in advance -
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09-26-2013, 06:48 AM
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#2
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Thinks s/he gets paid by the post
Join Date: Apr 2007
Location: west bloomfield MI
Posts: 2,223
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I researched the after tax option because I was less familiar with it. Here is what I read, if you can share additional details, might help those not familiar with it to brainstorm...
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earnings are tax-free after age 59 1/2 as long as the account has been open for at least 5 years.
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earnings on after-tax contributions are still taxable when you withdraw them. That makes Roth contributions clearly superior
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As for pre-tax contributions, the only way that after-tax contributions can come out ahead is for your tax rate to be significantly higher when you make withdrawals
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There is one really good tax reason to contribute to an after-tax account though. That’s the ability to contribute additional dollars into your retirement plan that can later be rolled into a Roth account.
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You already covered that last one...
I would focus on a few things
1) If you think you will leave job in 5 years and could roll the money into a Roth, I would strongly consider this option if the Roth could be left untouched for 15 years (that timeframe is a gut feel, no numbers to back it up)
2) How robust is your taxable account? Roth? 401k?
If you retired on 25X expenses, and had a choice between 17X in 401k and 8X in taxable, or 14X in 401k, 5X in taxable and 6X in a Roth, which is better option? The question I am asking is would you contribute enough to this account to make one scenario clearly better than the other? Tax diversification of investments is a good planning tool, but there needs to be enough mass in the Roth to make it worth paying the taxes now.
The quotes I pulled were from this article
http://www.forbes.com/sites/financia...ever-heard-of/
I also found this link which might help
http://benefits.northropgrumman.com/...CC3D56EF1&i=34
__________________
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09-26-2013, 09:51 PM
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#3
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Recycles dryer sheets
Join Date: Apr 2007
Posts: 126
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Quote:
Originally Posted by jIMOh
I researched the after tax option because I was less familiar with it. Here is what I read, if you can share additional details, might help those not familiar with it to brainstorm...
You already covered that last one...
I would focus on a few things
1) If you think you will leave job in 5 years and could roll the money into a Roth, I would strongly consider this option if the Roth could be left untouched for 15 years (that timeframe is a gut feel, no numbers to back it up)
2) How robust is your taxable account? Roth? 401k?
If you retired on 25X expenses, and had a choice between 17X in 401k and 8X in taxable, or 14X in 401k, 5X in taxable and 6X in a Roth, which is better option? The question I am asking is would you contribute enough to this account to make one scenario clearly better than the other? Tax diversification of investments is a good planning tool, but there needs to be enough mass in the Roth to make it worth paying the taxes now.
The quotes I pulled were from this article
The 401(k) Option That You've Probably Never Heard Of - Forbes
I also found this link which might help
http://benefits.northropgrumman.com/...CC3D56EF1&i=34
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Thanks for the links - after reading a bit more and thinking a bit, it really comes down to the following:
1) are in service distributions available
2) is money needed within the 5 year post-conversion time period
If the answer to 1 is yes and 2 is no, this makes complete financial sense.
If 2 is yes, then limited money might make sense.
If 1 is no, the scenario is linked far more closely to expected tax rates and length of time before a separation event that would allow conversion of the money to a ROTH.
I'll have to work out the muddy details before making a decision, but I do think I have a better grasp on at least some of the pitfalls.
I'd still appreciate the insight of anyone who has actually tried to utilize this option. Even over at Bogleheads it seems that it's not a common investment avenue.
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09-27-2013, 05:22 PM
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#4
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Mar 2007
Posts: 14,328
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Quote:
Originally Posted by cho oyu
.........
I'd still appreciate the insight of anyone who has actually tried to utilize this option. Even over at Bogleheads it seems that it's not a common investment avenue.
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I contributed both pre and after tax money to my 401(k) then rolled it all over to a TIRA and a Roth, with the after tax part going to the Roth. This was done a few years back when the whole legality of this move was in a gray area.
Alan S over at Fairmark seems to be the expert on this. You might have more luck over there.
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10-02-2013, 03:33 PM
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#5
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Recycles dryer sheets
Join Date: Jul 2012
Posts: 60
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Quote:
Originally Posted by travelover
I contributed both pre and after tax money to my 401(k) then rolled it all over to a TIRA and a Roth, with the after tax part going to the Roth. This was done a few years back when the whole legality of this move was in a gray area.
Alan S over at Fairmark seems to be the expert on this. You might have more luck over there.
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what is a tira
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10-02-2013, 03:43 PM
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#6
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Thinks s/he gets paid by the post
Join Date: Apr 2006
Posts: 1,684
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Quote:
Originally Posted by wrichards58
what is a tira
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Acronym for Traditional IRA.
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