401(k) After-Tax Contributions

Presented by Marc Aarons

I have noticed increasing interest in the benefits of after-tax 401(k) contributions among my general client base.

To get ahead of any questions you might have, I put together a succinct overview of after-tax 401K contributions. I encourage you to review the information below. As always, I am happy to answer any follow-up questions you may have.

How do after-tax 401(k) contributions work?

After-tax contributions allow you to save beyond the standard 401(k) limits by contributing money for which you have already paid taxes. As with a Roth IRA or Roth 401(k), withdrawals on contributions are tax and penalty-free.

However, unlike Roth IRAs, there are no income limits for making after-tax 401(k) contributions, making this a great option for anyone who has maxed out a Roth IRA.

Do they work with my 401(k) plan?

Unfortunately, only about one in five 401(k) plans allows for after-tax contributions, but it’s certainly worth contacting your 401(k) provider to determine eligibility if you are interested.

Just 10% of Americans with the option of making after-tax contributions did so in 2022, so it’s possible some of the other 90% were simply not aware it was an option.

What are the other key limits and conditions?

In 2024, the regular 401(k) contribution limit is $23,000, with an additional $7,500 catch-up for those 50 and older. You can put an additional $46,000 of after-tax dollars and employer match contributions (if applicable) into your 401(k) account. The maximum total contribution (employee plus employer) is $69,000, or $76,500 for those 50+. This is significantly higher than the Roth IRA contribution, which, this year, is $7,000 or $8,000 if you are 50+.

Why to Move After-Tax Contributions

As mentioned earlier, 401(k) after-tax contributions can be withdrawn tax and penalty-free. However, earnings on those contributions are tax-deferred, meaning taxes are due upon withdrawal, and early withdrawals (before age 59½) may incur a 10% penalty. By rolling those contributions into a Roth IRA, you can avoid paying taxes upon withdrawal in retirement.

Other reasons you may consider rolling your after-tax contributions into a Roth IRA include:

• Unlike traditional IRAs and 401(k)s, Roth IRAs do not require minimum distributions during the account holder’s lifetime, offering more flexibility in retirement planning.
• Since Roth IRAs do not have RMDs for the original owner, they can be a strategic tool for passing wealth to heirs more efficiently, potentially tax-free.

Rolling into a Roth

There are two primary methods for transferring after-tax 401(k) contribution dollars into a Roth account:

• In-Plan Conversion: This option allows you to convert all or a portion of your 401k into a Roth within the same plan. When you opt for an in-plan conversion, you need to pay taxes on the converted amount. However, like a Roth IRA, your future withdrawals from the Roth will be tax-free. Some plans even include an auto-convert feature that automatically transitions your after-tax contributions into your Roth account.
• In-Service Withdrawal: If your employer offers in-service distributions or withdrawals, you have the opportunity to perform a mega backdoor Roth. This involves rolling your after-tax contributions into a Roth IRA that is outside of your current retirement plan.

If you have any questions or would like to discuss how this strategy might fit into your financial plan, please don’t hesitate to reach out. I am here to help you navigate these options and make the best decisions for your financial future.

Marc Aarons may be reached at 714-887-8000 or marc@ocmoneymanagers.com

www.ocmoneymanagers.com

This communication is from Money Managers, Inc.; a Securities and Exchange Commission registered investment advisor.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities, and past performance is not indicative of future results.  Investments involve risk and are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here.

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Thanks to a couple of factors, some investors are thinking about this move before 2020 ends. 

Provided by Marc Aarons

Roth IRAs have attracted retirement savers since their introduction in 1998. They offer the potential for tax-free retirement income, provided Internal Revenue Service rules are followed.

Do Roth IRAs seem even more attractive these days? Perhaps. You can cite two factors: current tax rates and the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act.

Roth IRAs differ from traditional IRAs. Typically, distributions from traditional IRAs must start once you reach age 72, and the money distributed is taxed as ordinary income. When distributions are taken before age 59½, they may be subject to a 10% federal income tax penalty (although, the CARES Act does allow for some exceptions to those penalties for the 2020 tax year).¹

On the other hand, if you are the original owner of a Roth IRA, you do not have to start taking distributions at age 72. And if you are least 59½ years old and have owned the Roth IRA for at least five years, any distributions you take may be exempt from federal taxes.²

Remember, this article is for informational purposes only. It does not replace real-life financial or tax advice. Be sure to consult a tax or financial professional before making any decisions regarding your traditional IRA or Roth IRA.

Converting a Traditional IRA to a Roth IRA is a taxable event. You pay ordinary income tax on the converted amount. And federal tax rates are now near historic lows, thanks to the Tax Cuts and Jobs Act, and they are scheduled to stay there through 2025.³

The SECURE Act ruled that a non-spouse beneficiary of an IRA must completely withdraw that inherited IRA balance within 10 years rather than over the beneficiary’s lifetime (the previous guideline). The distribution can be taken as a lump sum or in payments over the 10 years. There is no set guideline other than it must be empty in 10 years.

The rules are similar for a non-spousal beneficiary of a Roth IRA. The new owner must deplete the inherited IRA in 10 years. However, there may not be any federal income taxes on the withdrawn amounts, assuming I.R.S. rules have been respected.³

A Roth conversion may be appealing purely from an income tax perspective. Taxable incomes have declined for many households due to recent economic slowdown, resulting from the COVID-19 pandemic in 2020, and it might put some traditional IRA owners in lower tax brackets this year. Add in the fact that federal income tax rates are low, to begin with, and 2020 could be a good time to go Roth.³

Remember that any Roth IRA conversion is a taxable event, and these conversions can no longer be undone.  Also, keep in mind that tax rules change from year to year, and future tax changes may affect IRAs.

Marc Aarons may be reached at (714) 887-8000 or marc@ocmoneymanagers.com

_{MMI Disclosure This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.}

_{This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.}

_Citations.

1. 1. _{TheStreet, May 13, 2020}
   2. _{NerdWallet, July 31, 2020}
   3. _{Bankrate, July 21, 2020}

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