How to invest after-tax money. 401k after-tax?

[lindalou]

I need some help deciding how to invest our 'extra' money. First some background:
I am 51, DH is 54. We have tentative plans to retire when he turns 60. We both contribute to our 401k before-tax up to the IRS limits plus the over 50 catch up contributions. We have another $5000/month to invest and I am unsure where to invest it. We have $110k in liquid assets (mostly in a money market at Vanguard, some in savings and CDs at Penfed CU, and about $20k is in old EE savings bonds). I figure that this liquid money is about 1.25 years of emergency funds.

My questions:
1. How should we invest the $5000/month after-tax money? Since we make too much to invest in roth IRAs, I was thinking of maybe investing in our 401k after-tax, thinking that we could roll this over to a roth IRA at retirement. However, maybe we should increase our liquid assets first? Or maybe there is a better option? I am unsure of the pros and cons of after-tax money in 401ks.
2. We probably have too much in money market ($80k). Any ideas on how to invest our current $110k liquid assets?

Edited to add, we paid off our mortgage earlier this year and have no debts. We have saved for our children's college costs in a 529 plan and we think those costs are pretty much covered (one is in college, the other will be entering soon).

Thanks for your help. I am always impressed with the willingness of everyone to help and the depth of knowledge on these forums!

 

[Senator]

I put a bunch in a non-deductible IRA. You can put 6500 in it in 2016.

Otherwise, it's just an after tax account. All index ETFs I can buy and hold forever. IVV, IVW and DVY mostly.

I am also paying off a 5.375% mortgage. That gets another $5K a month. A 5.375% guaranteed return is pretty decent too.

 

[bingybear]

you many be able to do a backdoor roth if you don't have traditional IRAs and assuming the feds have not locked that door.
I'm a little surprised the apprehension of investing with after tax and not in some kind of retirement account. Having some after tax $ is a great benefit when RE. You need somewhere to draw spending $ from.
Senator made a few suggestions for investing after tax $. You typically use tax efficient investments in taxable accounts. Bonds for the most part aren't. (Qualified) Dividend generation and capital gains have better tax treatments in the taxable account than bonds.

Look at your entire assets as one portfolio and identify your asset allocation. They determine which investments should be in which accounts.

If you have too much in TIRAs at RMD time, you may have a real tax issue.

Good luck

 

[travelover]

I'd definitely go for the 401(k) after tax (to the maximum) and roll it to a Roth later. The rest I'd do a back door Roth with.

 

[pb4uski]

After-tax 401k would be fine if your 401k plan offers decent investment options at reasonable ERs. Otherwise there is nothing wrong with taxable accounts... especially if you plan to retire before you turn 59 1/2.

 

[thefinancebuff]

I was thinking of maybe investing in our 401k after-tax, thinking that we could roll this over to a roth IRA at retirement.

Chances are you can roll it over to a Roth IRA before retirement, like once a year, right after you contribute to the 401k as after-tax. Ask your plan administrator about it.

 

[growerVon]

I'd suggest prioritizing the 401k after-tax contributions intended to rollover to a Roth account (aka a "mega backdoor Roth IRA" or Roth 401k, depending on what your plan allows) because that route can usually only be done via payroll withholding.

Next the after-tax non-deductible Traditional IRA contributions rolled over to a Roth IRA (aka "backdoor Roth IRA"); note there is tax risk here on the conversion to Roth if you have other Traditional IRA holdings.

Finally once those have been maxed I'd do plain old after-tax brokerage account contributions. The 5k/mo amount may be enough to get both the Roth moves done for you and DH, and still leave some for the brokerage account.

The optimal funds you hold in each account are different based in the tax properties of the accounts. Here is a good article in where best to keep what type of funds: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

Note, your investments across all your and DH's accounts should reconcile against your planned asset allocation.

 

[DrRoy]

When you have filled all the retirement accounts, then invest the rest in a regular taxable account. If you retire early, you need access to funds until you are permitted to tap the sheltered accounts anyway. Decide on what AA you are comfortable with and invest in index ETF's.

 

[scrabbler1]

Back in my working days, I added some after-tax money to my 401k for about 18 months during the 1990s. This was not part of any ER plan, as I had not begun doing a lot of diversified investing at the time.


But when I was putting together my ER plan in the mid-2000s, I had to decide what to do with this relatively small blob of money (about $30k) once I had to liquidate my 401k (I was cashing out my company stock, so I had to empty out the entire 401k per plan rules). I knew I could take the principal portion of the after-tax portion of the 401k without any tax liability and used it to pay some of the income taxes on the cashed-out company stock. I did a rollover of the earnings from the principal into an IRA long with the rest of my (pretax) 401k.

 

[Greencheese]

With $5,000/month you can do the IRA, after tax 401k and put a little extra on the mortgage each month easily.

 

[NgineER]

An after tax 401k contribution is liquid, you can withdraw the contribution without penalty. Check with your plan for details. I roll over contributions monthly.

 

[sengsational]

Although it would only consume $7750/year of your intended savings, if your health plan is HSA qualified, you could put that amount away for distant future medical bills. HSA accounts are 'super Roth accounts' because they let you spend the growth tax-free, as does a Roth, but also let you write-off your contribution.

 

[pjigar]

I thank OP for starting this thread. I was not aware of after-tax contributions to 401K plan which can be later rolled over to Roth IRA. I guess you learn something new every day! Just bumped up 401K contributions to 100% for whatever time is left for current plan year.

 

[travelover]

I thank OP for starting this thread. I was not aware of after-tax contributions to 401K plan which can be later rolled over to Roth IRA. I guess you learn something new every day! Just bumped up 401K contributions to 100% for whatever time is left for current plan year.

Although allowed by law, not every 401(k) plan has this provision.

 

[walkinwood]

We used a non-deductible IRA too, but you should think about it carefully.

All your gains in a non-deductible ira will be treated as Income. Cap gains generally have a better tax rate than income. So, consider investing some of the excess in after tax accounts too.

In an after tax account, be very deliberate in selecting investments. Changing investments will lead to taxable events. If I were to start again, I would use very low cost index funds exclusively. They typically have lower annual distributions (dividends and cap gains), so your tax bill is low.

 

[pjigar]

My plan does not allow in-service withdrawals BEFORE 59 1/2 year but I should be able to rollover after-tax contribution to Roth IRA regardless of what rules my 401K plan has once I leave my company. Isn't that true? I will rollover pre-tax contributions and growth into regular IRA.

 

[pjigar]

We do leverage non-deductible IRA for backdoor IRA contribution. FYI: We do not have any "regular" IRA balance (pre-tax) since we "rolled back" the pre-tax IRA balance to 401k! (In order take advantage of "backdoor" Roth IRA rollover). I still want to contribute more to Roth IRA but I can't so I can take after-tax 401K contribution route to eventually rollover that money to Roth IRA. Correct me if my strategy is flawed.

 

[travelover]

We do leverage non-deductible IRA for backdoor IRA contribution. FYI: We do not have any "regular" IRA balance (pre-tax) since we "rolled back" the pre-tax IRA balance to 401k! I still want to contribute more to Roth IRA but I can't so I can take after-tax 401K contribution route to eventually rollover that money to Roth IRA. Correct me if my strategy is flawed.

As I said above, it depends on what your individual plan allows. Some plans don't allow after tax contributions.

 

[pjigar]

As I said above, it depends on what your individual plan allows. Some plans don't allow after tax contributions.

Yes, my 401K plan allows after-tax payroll contributions.

 

[lindalou]

Thanks, everyone, for your excellent ideas! It is going to take me a while to sift through them and understand all of the consequences, but I really appreciate your taking the time to help us out.

 

[Trooper]

Although it would only consume $7750/year of your intended savings, if your health plan is HSA qualified, you could put that amount away for distant future medical bills. HSA accounts are 'super Roth accounts' because they let you spend the growth tax-free, as does a Roth, but also let you write-off your contribution.

+1. HSAs are triple tax-free: tax-free in, tax-free during, and tax-free out. Because of this extra level of tax freedom, I would actually max out your HSA before the 401k. Two caveats: 1) your health plan is qualified to offer them as said above, and 2) you can't use HSAs to pay for medical premiums until you are Medicare eligible. All other qualified medical expenses are eligible to be paid out of the HSA. We just learned that today

If you're looking for a tax-free growth option, annuities will provide that but they are generally poor investments. I would stick with funding your taxable accounts with low-cost, tax efficient funds. You'll be glad you did when you ER.

Best of luck.