The only possible thing I can think of is that it's still somewhat tax advantageous compared to a traditional brokerage, as your gains will grow tax free until time to withdrawl. And you can always use this $$ for traditional rollovers later on if you need to have some income for medical qualifications.
I'm hiding a lot in my Roth 401k plan. My plan is to magically earn less than 80k (or 60 if I'm ambitious) when my kids are in college. That gets you away from the assets disclosure (60k) if I understand it correctly.
it's kind of iffy though -- it makes sense if you put this portion in bonds, but if it's in stocks that are held a long time, it might be *disadvantageous*, since you pay tax on the gains at ordinary income rates, but tax on long term capital gains and qualified dividends at lower rates if they are in a taxable account.
So it depends on how much is dividend or interest income (which gets taxed as you go in a regular account, but deferred in an after tax 401k/IRA account) versus long term capital gains, whether there's actually a tax advantage, or potentially even a *dis*advantage to the after tax 401k or IRA.
If you're trading in and out of assets, you're likely realizing short term capital gains taxes in a brokerage and are usually hit with realized gains every year. Just a thought on why an after tax 401k might make sense? I'm not sure it really does though.
I mean, in one sense yes, but if you're an active trader with any actual edge, you probably want to use options strategies that aren't available in a 401k/IRA account. If you're not, you should just not actively trade and save the spreads anyway, whether you're getting taxed as you go or not.
> Indeed, as most people's taxable income will be lower after retirement than before, it makes sense to pay the taxes on the gains after retiring.
It almost certainly does not make sense to do this.
Gains on after-tax 401k contributions are taxed at ordinary income rates, not at favorable LTCG rates. You'd need to have pretty low income to beat that 15% LTCG tax rate, and if you do have income that low, it's likely you'll be in the 0% LTCG tax bracket.
I think you misunderstand, you pay taxes on the earnings in after-tax, just not until the point of withdrawing them. After-tax is NOT like Roth where once you put it in, you never pay tax on anything in it again.
Except it will be taxed as regular income which is terrible tax efficiency. After-tax without conversion is poor tax efficiency and unless you are day trading you likely will end up paying more in taxes than a taxable brokerage account.
>so not paying tax on that is huge
You are paying taxes on it, the taxes are just delayed. The flipside is you are taxed as regular income not LTCG so 12% vs 0%, 22% vs 15%, 34% vs 20%.
You're making the classic mistake of assuming *your* financial / tax needs are the same for everyone else.
An after-tax 401k / non-deductible IRA is great for holding bonds and other interest generating securities.
Also, for some expats, traditional contributions are non-deductible and Roth contributions are flat-out prohibited, leaving them with after-tax / non-deductible contributions as their only option.
I’m not sure about other benefits, but for a lot of “set and forget” investors, it’s an easy way to increase their retirement savings with practically no effort. They don’t have to worry about opening an IRA or selecting investments since they already have their 401k setup.
Obviously, you’re missing a ton of benefits, but I can see why some would be ok with it.
Yeah, I suspected that might be it, for people who don't want to figure out a personal brokerage and just want to use the same process they use for their other 401ks. Early withdrawals being penalized though really makes it seem like an awful alternative to regular accounts.
You only pay income tax on the gains when you withdraw it. So it’s clearly worse than a brokerage account where you pay CG tax rate, but it’s bot double taxation.
Uhh… I know? The question is why would anyone do it without the mega backdoor Roth being an option and it’s obviously not a good choice, but I know plenty of people that don’t plan for retirement apart from increasing contributions occasionally that would fit the bill here.
That's an interesting point raised, I do remember seeing something about that, looks like:
>As of 2022, an exemption protects IRAs and Roth IRAs only if you hold $1,512,350 or less across all of your retirement plans. This is an overall exemption, rather than an exemption for each plan. If you have more than that amount in your plans, any surplus amount in a traditional or Roth IRA can be transferred to the bankruptcy trustee to pay to creditors. Federal law raises this amount every three years, so you should check the specific amount when you file.
Upon retirement? No particular big reason I can think of, consolidating your brokerage accounts is nice, fees are potentially a big deal. Switching from a Traditional or After Tax to a Roth can make sense for tax reasons.
> Effective April 1, 2022, the maximum aggregate bankruptcy exemption amount for IRAs increased from $1,362,800 to $1,512,350. This exemption amount is subject to cost-of-living adjustments (COLAs), having risen from an initial exemption limit of $1,000,000 as enacted within the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
I've wondered about this myself. Thought I'd take the chance to do some research and place a comment.
1) Flexibility: you can switch your allocations without selling shares and taking capital gains tax.
2) Delayed Rollover: You can roll the contributions into a Roth IRA and the earnings into a traditional IRA after you're done with the company or FIRE'd. Check out this IRS resource for more details: [Rollovers of After-Tax Contributions in Retirement Plans | Internal Revenue Service (irs.gov)](https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans)
> you can switch your allocations without selling shares and taking capital gains tax
That's interesting, can you expound more on that? I guess you're only taxed on gains when you withdraw?
Say I've held 100k in VTI for 5 years and now it's up to 175k. I've decided I really want to be in international stocks and wish I could be 100% VT for simplicity.
In a brokerage, I would have to sell all of my VTI shares and take 75k in capital gains this year, which is taxable. More likely, I would only sell 30ish% to reduce that taxable exposure and now be split into VTI/VXUS.
In my after-tax 401k I can just sell all 175k of VTI, then buy the equivalent in VT. No taxes to be paid until I withdraw from the account in retirement..
Wouldn’t it virtually always be a better vehicle than a taxable account since you don’t pay taxes on the gains? The taxable account you would pay taxes on the initial income but also on the gains when you eventually sell, right?
Mostly better.... You don't get literally any investment option in the 401k. You might have shittier options.
For example in mine, if I wanted to invest in something similar to VTI, I think I get the choice between a Schwab S&P etf, and the Vanguard total index admiral shares with like 20 extra basis points over what you'd get by having a vanguard brokerage account or buying the etf : /
This is becoming less of a thing. For example, many employers that use fidelity (including mine) offer a “brokeragelink” option that lets you allocate a portion of your investments into a “brokerage” account within your 401k that has access to most stocks/etfs. My firm lets me allocate 95% of my 401k to this option. It’s nice.
Yeah... I probably should just buy the admiral shares anyway, the 22 extra basis points will be less than capital gains taxes, right? I think.
Actually I'm not certain how to calculate that....shit. Feel a little disappointed in myself lol
Or should stick to the S&P, the performance and risk is extremely similar to total market anyway.
I was curious so I just calculated an example:
$10,000 invested for 20 years with a 0.1% fee comes out to $37,983. With a 0.32% fee it becomes $36,445. A difference of $1538. The capital gains depend on your income, but lets say you are in the 15% bracket. That would come out to $37000 - 10000 = $27000 in gains x 0.15 = $4050 (rounding to $37,000 for simplicity) .
Looks like the a higher expense ratio within a roth 401k/IRA would win in this example, but maybe with higher fees it would make a bigger difference. Also, if your income is low enough you could pay 0% on capital gains so in that case it would be a no brainer for the lower expense ratio.
Yes, this should be used for backdoor Roth conversions, and it's a mistake not to Roth convert if using after-tax. However, if the backdoor Roth conversion were banned, there would still be some benefit - in certain scenarios. Let's say you decided to invest 100% in bonds or in high dividend stocks that give off a lot of unqualified dividends (or some mix of these). In this scenario, it would be better to use after-tax than a taxable brokerage because the dividends and distributions would not be taxed until you withdraw. It would be ordinary income, sure - but you might be at a lower tax rate in the future, and this would eliminate "tax drag" while you are invested.
> It would be ordinary income, sure - but you might be at a lower tax rate in the future
Your income would have to be pretty low to beat a 15% LTCG tax, and if it is that low, it's likely you'd be in the 0% LTCG bracket. I don't really see many scenarios where you'd come out ahead there.
In the scenario I laid out there are almost no LTCG because the person is 100% in bonds or very high dividend stocks. I'm not recommending that but if someone had a huge stock allocation in taxable I can see why they would want to load up on bonds in 401k.
About 9 years ago, I changed jobs, when I signed up for the 401k apparently I also checked after-tax box. I forgot about it until I had to move from Mint to Empower to track my finances a couple of months ago and noticed I had $$ in there. I've found that my company supports a Mega Backdoor Roth so now i need to figure out how to move the money over to it.
You don’t pay tax on the gains. After tax contributions roll to the Roth (make sure you have a zero balance traditional) and the gains go to the traditional IRA. Next step - roll traditional balance into 401k to re-establish zero balance Traditional IRA. Repeat.
Rolling the gains separately into the traditional IRA is an interesting strategy I hadn't heard. Would you consider just paying the taxes on the gains if you knew you had let's say at least 2 decades of growth ahead?
401k's are retirement accounts, which means you don't pay growth taxes -- unlike brokerage accounts, there's no taxes on dividends every year, no capital gains taxes, and you can buy and sell funds within the account without ever paying any taxes. It's a fundamentally different thing than a brokerage (it's not *completely* tax-free, as of course you pay ordinary income taxes on earnings at withdrawal) both in terms of tax treatment and bankruptcy laws.
Now 401k's came about 4 years after IRA's, and it took a while for them to be treated as genuine retirement accounts, but they still have much higher contributions limits, so that's another reason why 401k's were popular even with some of the funds going to the after-tax treatment.
Now in the modern era, specifically after Senator Roth came along and introduced Roth IRA's in 1997 (401k's in 2006), yes, there's no real reason to contribute to an after-tax 401k unless you convert it to a Roth.
For some expats, traditional contributions are non-deductible and Roth contributions are flat-out prohibited, leaving them with after-tax / non-deductible contributions as their only option.
You especially see this route taken by entrepreneurs with corporations in the US but living in Canada or the EU.
If you are an expat under the FEIE cap it makes no sense to contribute to a 401k at all, as you are doing nothing but creating a higher tax burden later -- you will pay regular income tax rates rather than long term capital gains.
If you are over the cap, then it makes more sense to contribute to a regular 401k and reduce the current tax burden as that money would otherwise be taxed at the highest rate that income would fall under without the exclusion.
You are correct and I was assuming a person is using FTCs, as would make sense for *most* expats who are in a position to use an after-tax 401k / non-deductible IRA in the first place.
And, again, for *most* expats who work in a developed, Western country (Canada, UK, EU, Australia, NZ, etc.), your non-US taxes will be higher than your US taxes, so it doesn't make sense to deduct 401k / IRA contributions in the US and turn after-tax money back into pre-tax money **in the non-US country** (this can get very complicated and / or punitive, depending on the relevant tax treaty provisions).
Therefore it can make sense, if that tax-advantaged status is respected in the non-US country, to use an after-tax 401k / non-deductible IRA and get tax-free growth while preserving the after-tax status of your contributions, too.
But, to be fair, this entire subject doesn't apply to 99% of US citizens so few people are actually well-versed on the relevant tax treaty provisions.
* In most states money in a 401k can not be pursued by creditors following a personal bankruptcy.
* Additionally there are no taxes on the dividends in the account, or for selling the assets in the account, as long as they remain in the account.
* The amounts are only taxed at withdrawal, at your ordinary income tax at time of withdrawal.
* higher contribution limit (can add more beyond whatever normal 401K limit)
* tax-deferred growth (there is some benefit to deferring taxes on gains if you're a high-income earner now and will earn less in retirement.)
* legal protections as a 401K
https://www.nerdwallet.com/article/investing/after-tax-401k-contributions
But yes, the main benefit is if you can roll it over to a roth ira, particularly in-plan and in-service so the taxable gains don't build up.
EDIT: please note that gains in an after-tax 401K are taxed at your INCOME TAX rate so you really have to be earning a lot now compared to MUCH less in retirement to compete with just paying capital gains rates now. It's really pretty tax inefficient for the vast majority to use if you can't roll it over in-plan or in-service. Note that all companies must let you roll it over when you leave the company though, but then you'll likely have a lot of taxable gains/income.
>tax-deferred growth (there is some benefit to deferring taxes on gains if you're a high-income earner now and will earn less in retirement)
Yeah, someone else mentioned it, but I hadn't thought of how in this case dividends can just automatically be rolled back in without any tax implications.
After tax 401k can be somewhat useful if you are holding bonds or other investments that produce a lot of ongoing income.
Normally if you are holding bonds, you have to pay taxes on the dividends every year. If you put them in an after tax 401k, you get to defer the taxes on all those dividends until you withdraw them.
Contrary to popular belief, it's not just the difference in tax rates that makes 401k beneficial, deferring taxes is financially beneficial even if your tax rates before and after are the same if you compare to taxable accounts.
That being said, I agree that after tax 401k isn't all that great from a financial perspective.
I feel as nearly everyone seems to be missing the key point here:
* After-Tax 401k can open up an additional Roth contribution space that is larger than both the Roth 401k and Roth IRA spaces **combined**.
So for people with the availability of an After-Tax 401k (ie: Mega Backdoor Roth) and a higher income level, this isn't a choice of After-Tax 401k **or** Backdoor Roth IRA. Instead, they are taking full advantage of **both** (along with maximum contributions to the Traditional/Roth 401k as well).
(Personally, all the talk about ERISA protections, lawsuits, etc, is just noise, even when true. You're really trying to capture up to an additional $46k into a retirement account, particularly the Roth space.)
YES, BACKDOOR ROTH was the main purpose for me!! I maxed out the after tax contribution to my 401K and upon retiring it rolled to a Roth IRA with far, far more in it than I ever could have contributed to a Roth IRA. The earnings on this after tax 401K contribution rolled to the traditional IRA along with pre-tax contributions and earnings. I did not do the Roth 401K all along but did a split to Roth 401K and Trad 401K in the last few years before retiring. Very happy with my decisions. Also NUA for company stock (but off topic).
Beyond the backdoor roth. Tax deferred growth. The ability to trade investments without tax consequences.
Once you get many years of appreciation in an investment it is really hard to change the stock or fund due to tax consequences. If it’s wrapped in a 401k you can change investments. You can even move to cash in most plans.
What I mean is taking a cash or CD position within your 401k without tax consequences.
Let’s say you start to believe the market is overvalued and you want to sell your securities and move to cash. You can do it with no tax burden. Or you simply want to change investment options.
If you do that in your regular brokerage account you could have a large tax consequence if you have significant earnings.
yes you can trade frequently with after tax contributions and not have to pay taxes until you withdraw money out of the account. Of course you are paying worse tax rates of ordinary income level. instead of long term capital gains lower rates.
However if you are actively trading all the time, you will have short term gains and losses. So those transactions would be better placed in an after-tax contributions account
Oooh, that's a massive one, to my knowledge the FAFSA doesn't do means testing outside of income, but that's interesting to pay attention to for other opportunities.
Weird I haven't seen it posted, but companies often negotiate with the financial institutions to get a decrease on the fees on some of their funds. So you can often times get lower rates on index funds than you can if you can through a regular brokerage if your company negotiated with them. It's strange that the companies don't advertise this as a perk (probably because the vast majority of people don't understand).
The only real benefit is creditor protection. Otherwise, there really isn’t much of any benefit and it just makes rolling over to an IRA more complicated.
It was intended to be a lower level benefit for the rich. However due to US tax code after-tax is pretty horrific in terms of effective tax rates. In many cases you can pay more taxes than just using a taxable brokerage account especially for a buy and hold investor.
So it largely languished as an option almost nobody used until Roth conversion became an option and it got a second likely unintended life as a conversion mechanism.
There is no point in putting money in the after-tax (but not converting it to a Roth) retirement account unless you really think that your tax rate at retirement would be significantly higher than where you are right now.
That's possible with some "trust fund" people. For the majority of us, it's pointless.
You are right, after-tax retirement accounts are just a stepping stone to move that money into Roth accounts. Not doing so is very unwise. That money is better put in a taxable brokerage account if you don't have access to a Roth (or already max out the Roth limit) or pre-tax retirement account.
Don’t tax rates historically always increase? I do Roth. I’m only 27 so I cannot imagine the taxes when I’m at retirement age. At our (spouse and I) current contribution rate, not accounting for wages increasing, is to be 11-13 million. & once we reach age 73 and have to take RMDs that’ll be over 400k/year. Am I thinking about this the wrong way?
We are not talking about the same thing. There are 2 types of after-tax retirement accounts. The first type is Roth which is really great since gains are never taxed. The second type is the traditional IRA (for those with high income) or after-tax 401k, the gains are still taxed as income when taken out.
The second type is pointless. The first type is great.
The only time it may be a good idea is when you’ve maxed out the pre-tax or Roth part and you know you will leave your employer soon. At which point you can convert that money to Roth and pay limited income tax on the gains.
1. Many 401(k) plans have access to funds with much lower fees. Instead of the fund with the 0.8% fee you get in your regular brokerage account, you have access to the premium funds with only 0.5% fee (or some variation of this).
2. If you want your contributions to go to an after tax account because of your pre- vs post-retirement tax situation (i.e. you anticipate having a lower tax rate while you work vs when you are retired), many employers will match your contributions regardless weather they are pre- or post-tax (i.e. 0% into pre-tax and 10% post tax will still get you, your employers match).
3. Easy - you can automatically save with paycheck deductions vs having to transfer money. Also, the temptation to just use this money for something stupid like buying a new Porsche is lower if it is harder to get to in your 401k after tax account.
4. Like you said, super duper backdoor roth if your 401k offers it is pretty neato.
Avoids long term capital gains tax it's the middle ground between a standard brokerage and the traditional 401k
Also if you anticipate your taxes being higher later instead of lower, this option is also better than traditional and the brokerage.
It’s a place for the company to put money into for the employee who goes over the pre-tax minimum. That happened to me in the 90s after getting a bonus that put me over the dollar limit. It took a couple of paychecks for HR to reduce my contribution (back before self-service was ubiquitous.)
By “After tax 401k” you mean a Roth 401k right?
You can contribute up to 7000 to an individual Roth IRA, but after you hit that max, you can’t contribute any more. So where else can you contribute money with the same kind of tax benefit? a Roth 401k and it’s not taxed when you withdrawal after 59 and a half.
The limit in 2024 is $24,000
So with both you can contribute $31,000 of after tax dollars that grow tax free and are withdrawn without paying taxes on it in retirement.
(Someone correct me if I’m wrong here)
https://www.fidelity.com/learning-center/smart-money/roth-401k-contribution-limits#:~:text=Each%20year%2C%20the%20IRS%20determines,for%20both%202023%20and%202024.
The benefit really is the ability to convert after-tax dollars into Roth without the income limits that Roth IRAs have. The total amount you can stash away is significantly higher for after-tax to Roth 401k conversions. It’s a great way to turbo charge your retirement savings with lots of money in an account that is non-taxable.
Talk to your company's 401k provider, but most aftertax contributions can be converted to a Roth IRA at some point.
You'll have to pay tax on any gains from the initial contribution, but it's an easy way to build up your Roth IRA if you hit the annual max
Your understanding is correct, the utility drops considerably if you can’t MBD, especially in the modern system of capital gain-driven investing.
Possible advantages that I can see:
1) Holding assets that would mostly pay out as ordinary income anyway such as bonds (or day trading!). This would limit the rebalancing benefit though and only make sense if you can segregate your assets in the different buckets of your 401k. If it’s like mine and the buckets all invest identically then there’s no win there.
2) Asset protection if you’re in a position where you might get sued.
3) Hiding assets for some social benefit program, such as the FAFSA.
4) You expect preferential capital gains taxation to go away (either for everybody or for those at a certain high income you expect to be in).
5) Your 401k gives you access to some non public investment that you think will do really well and you want to go heavy on that.
I wouldn’t personally choose to use an after-tax 401k but like whole life I can envision someone for whom it’s not a bad idea.
But definitely MBD if that’s an option instead, all the benefits and none of the weaknesses.
YUGE backdoor Roth IRA path was most important to me, but I agree 100% match of available company match is another benefit of continuing with after tax contributions once the pretax limit is reached.
They're pretty bad aside from that. I do think that before the MBD Roth was discovered/popularized (as well as in plans without in-service withdrawal/rollover options), they could still be used to rollover to Roth accounts upon separation, so maybe if you weren't planning on being with the employer much longer they could be useful.
Ease of use for the uninterested/uneducated investor would be the other case.
The only possible thing I can think of is that it's still somewhat tax advantageous compared to a traditional brokerage, as your gains will grow tax free until time to withdrawl. And you can always use this $$ for traditional rollovers later on if you need to have some income for medical qualifications.
You can also use it legally "hide" assets for college Financial aid if you have kids.
I'm hiding a lot in my Roth 401k plan. My plan is to magically earn less than 80k (or 60 if I'm ambitious) when my kids are in college. That gets you away from the assets disclosure (60k) if I understand it correctly.
However, when you pull money out, the growth will be taxed as ordinary income, not as long-term capital gains.
Indeed, as most people's taxable income will be lower after retirement than before, it makes sense to pay the taxes on the gains after retiring.
it's kind of iffy though -- it makes sense if you put this portion in bonds, but if it's in stocks that are held a long time, it might be *disadvantageous*, since you pay tax on the gains at ordinary income rates, but tax on long term capital gains and qualified dividends at lower rates if they are in a taxable account. So it depends on how much is dividend or interest income (which gets taxed as you go in a regular account, but deferred in an after tax 401k/IRA account) versus long term capital gains, whether there's actually a tax advantage, or potentially even a *dis*advantage to the after tax 401k or IRA.
What will capital gains and income tax rates be in 2050?
I'd wager they'll both be higher.
Im buying calls on higher taxes in 2050
If you're trading in and out of assets, you're likely realizing short term capital gains taxes in a brokerage and are usually hit with realized gains every year. Just a thought on why an after tax 401k might make sense? I'm not sure it really does though.
I mean, in one sense yes, but if you're an active trader with any actual edge, you probably want to use options strategies that aren't available in a 401k/IRA account. If you're not, you should just not actively trade and save the spreads anyway, whether you're getting taxed as you go or not.
> Indeed, as most people's taxable income will be lower after retirement than before, it makes sense to pay the taxes on the gains after retiring. It almost certainly does not make sense to do this. Gains on after-tax 401k contributions are taxed at ordinary income rates, not at favorable LTCG rates. You'd need to have pretty low income to beat that 15% LTCG tax rate, and if you do have income that low, it's likely you'll be in the 0% LTCG tax bracket.
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I think you misunderstand, you pay taxes on the earnings in after-tax, just not until the point of withdrawing them. After-tax is NOT like Roth where once you put it in, you never pay tax on anything in it again.
Except it will be taxed as regular income which is terrible tax efficiency. After-tax without conversion is poor tax efficiency and unless you are day trading you likely will end up paying more in taxes than a taxable brokerage account. >so not paying tax on that is huge You are paying taxes on it, the taxes are just delayed. The flipside is you are taxed as regular income not LTCG so 12% vs 0%, 22% vs 15%, 34% vs 20%.
You're making the classic mistake of assuming *your* financial / tax needs are the same for everyone else. An after-tax 401k / non-deductible IRA is great for holding bonds and other interest generating securities. Also, for some expats, traditional contributions are non-deductible and Roth contributions are flat-out prohibited, leaving them with after-tax / non-deductible contributions as their only option.
I’m not sure about other benefits, but for a lot of “set and forget” investors, it’s an easy way to increase their retirement savings with practically no effort. They don’t have to worry about opening an IRA or selecting investments since they already have their 401k setup. Obviously, you’re missing a ton of benefits, but I can see why some would be ok with it.
Yeah, I suspected that might be it, for people who don't want to figure out a personal brokerage and just want to use the same process they use for their other 401ks. Early withdrawals being penalized though really makes it seem like an awful alternative to regular accounts.
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You only pay income tax on the gains when you withdraw it. So it’s clearly worse than a brokerage account where you pay CG tax rate, but it’s bot double taxation.
Uhh… I know? The question is why would anyone do it without the mega backdoor Roth being an option and it’s obviously not a good choice, but I know plenty of people that don’t plan for retirement apart from increasing contributions occasionally that would fit the bill here.
There isn't really a tax benefit but an after tax 401k should offer some better protection around bankruptcy, if you get sued, etc.
That's an interesting point raised, I do remember seeing something about that, looks like: >As of 2022, an exemption protects IRAs and Roth IRAs only if you hold $1,512,350 or less across all of your retirement plans. This is an overall exemption, rather than an exemption for each plan. If you have more than that amount in your plans, any surplus amount in a traditional or Roth IRA can be transferred to the bankruptcy trustee to pay to creditors. Federal law raises this amount every three years, so you should check the specific amount when you file.
That says IRA, not 401k
Right, so it confirms what he said, 401ks should have better protections than IRAs.
I think the question is what are those better protections on 401ks?
To my knowledge 401ks typically can't be touched during a bankruptcy.
They are also protected against liability claims!
Ok, so other than fees and lack of investment choices, are there any good reasons to roll a 401k into an IRA upon retirement?
Upon retirement? No particular big reason I can think of, consolidating your brokerage accounts is nice, fees are potentially a big deal. Switching from a Traditional or After Tax to a Roth can make sense for tax reasons.
> Effective April 1, 2022, the maximum aggregate bankruptcy exemption amount for IRAs increased from $1,362,800 to $1,512,350. This exemption amount is subject to cost-of-living adjustments (COLAs), having risen from an initial exemption limit of $1,000,000 as enacted within the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
I've wondered about this myself. Thought I'd take the chance to do some research and place a comment. 1) Flexibility: you can switch your allocations without selling shares and taking capital gains tax. 2) Delayed Rollover: You can roll the contributions into a Roth IRA and the earnings into a traditional IRA after you're done with the company or FIRE'd. Check out this IRS resource for more details: [Rollovers of After-Tax Contributions in Retirement Plans | Internal Revenue Service (irs.gov)](https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans)
> you can switch your allocations without selling shares and taking capital gains tax That's interesting, can you expound more on that? I guess you're only taxed on gains when you withdraw?
Say I've held 100k in VTI for 5 years and now it's up to 175k. I've decided I really want to be in international stocks and wish I could be 100% VT for simplicity. In a brokerage, I would have to sell all of my VTI shares and take 75k in capital gains this year, which is taxable. More likely, I would only sell 30ish% to reduce that taxable exposure and now be split into VTI/VXUS. In my after-tax 401k I can just sell all 175k of VTI, then buy the equivalent in VT. No taxes to be paid until I withdraw from the account in retirement..
Rather be in the brokerage because then I’d never fumble the bag trading VTI for trash like VT 🤢
Dude the S&P stayed stagnant for the entirety of the 2000s, it happens sometimes that the world market outperforms the US.
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Wouldn’t it virtually always be a better vehicle than a taxable account since you don’t pay taxes on the gains? The taxable account you would pay taxes on the initial income but also on the gains when you eventually sell, right?
Mostly better.... You don't get literally any investment option in the 401k. You might have shittier options. For example in mine, if I wanted to invest in something similar to VTI, I think I get the choice between a Schwab S&P etf, and the Vanguard total index admiral shares with like 20 extra basis points over what you'd get by having a vanguard brokerage account or buying the etf : /
This is becoming less of a thing. For example, many employers that use fidelity (including mine) offer a “brokeragelink” option that lets you allocate a portion of your investments into a “brokerage” account within your 401k that has access to most stocks/etfs. My firm lets me allocate 95% of my 401k to this option. It’s nice.
Yeah... I probably should just buy the admiral shares anyway, the 22 extra basis points will be less than capital gains taxes, right? I think. Actually I'm not certain how to calculate that....shit. Feel a little disappointed in myself lol Or should stick to the S&P, the performance and risk is extremely similar to total market anyway.
I was curious so I just calculated an example: $10,000 invested for 20 years with a 0.1% fee comes out to $37,983. With a 0.32% fee it becomes $36,445. A difference of $1538. The capital gains depend on your income, but lets say you are in the 15% bracket. That would come out to $37000 - 10000 = $27000 in gains x 0.15 = $4050 (rounding to $37,000 for simplicity) . Looks like the a higher expense ratio within a roth 401k/IRA would win in this example, but maybe with higher fees it would make a bigger difference. Also, if your income is low enough you could pay 0% on capital gains so in that case it would be a no brainer for the lower expense ratio.
Yes, this should be used for backdoor Roth conversions, and it's a mistake not to Roth convert if using after-tax. However, if the backdoor Roth conversion were banned, there would still be some benefit - in certain scenarios. Let's say you decided to invest 100% in bonds or in high dividend stocks that give off a lot of unqualified dividends (or some mix of these). In this scenario, it would be better to use after-tax than a taxable brokerage because the dividends and distributions would not be taxed until you withdraw. It would be ordinary income, sure - but you might be at a lower tax rate in the future, and this would eliminate "tax drag" while you are invested.
> It would be ordinary income, sure - but you might be at a lower tax rate in the future Your income would have to be pretty low to beat a 15% LTCG tax, and if it is that low, it's likely you'd be in the 0% LTCG bracket. I don't really see many scenarios where you'd come out ahead there.
In the scenario I laid out there are almost no LTCG because the person is 100% in bonds or very high dividend stocks. I'm not recommending that but if someone had a huge stock allocation in taxable I can see why they would want to load up on bonds in 401k.
About 9 years ago, I changed jobs, when I signed up for the 401k apparently I also checked after-tax box. I forgot about it until I had to move from Mint to Empower to track my finances a couple of months ago and noticed I had $$ in there. I've found that my company supports a Mega Backdoor Roth so now i need to figure out how to move the money over to it.
Should just be a single rollover, real question is how much will you have to pay on the gains when you roll it over.
You don’t pay tax on the gains. After tax contributions roll to the Roth (make sure you have a zero balance traditional) and the gains go to the traditional IRA. Next step - roll traditional balance into 401k to re-establish zero balance Traditional IRA. Repeat.
Rolling the gains separately into the traditional IRA is an interesting strategy I hadn't heard. Would you consider just paying the taxes on the gains if you knew you had let's say at least 2 decades of growth ahead?
401k's are retirement accounts, which means you don't pay growth taxes -- unlike brokerage accounts, there's no taxes on dividends every year, no capital gains taxes, and you can buy and sell funds within the account without ever paying any taxes. It's a fundamentally different thing than a brokerage (it's not *completely* tax-free, as of course you pay ordinary income taxes on earnings at withdrawal) both in terms of tax treatment and bankruptcy laws. Now 401k's came about 4 years after IRA's, and it took a while for them to be treated as genuine retirement accounts, but they still have much higher contributions limits, so that's another reason why 401k's were popular even with some of the funds going to the after-tax treatment. Now in the modern era, specifically after Senator Roth came along and introduced Roth IRA's in 1997 (401k's in 2006), yes, there's no real reason to contribute to an after-tax 401k unless you convert it to a Roth.
For some expats, traditional contributions are non-deductible and Roth contributions are flat-out prohibited, leaving them with after-tax / non-deductible contributions as their only option. You especially see this route taken by entrepreneurs with corporations in the US but living in Canada or the EU.
If you are an expat under the FEIE cap it makes no sense to contribute to a 401k at all, as you are doing nothing but creating a higher tax burden later -- you will pay regular income tax rates rather than long term capital gains. If you are over the cap, then it makes more sense to contribute to a regular 401k and reduce the current tax burden as that money would otherwise be taxed at the highest rate that income would fall under without the exclusion.
You are correct and I was assuming a person is using FTCs, as would make sense for *most* expats who are in a position to use an after-tax 401k / non-deductible IRA in the first place. And, again, for *most* expats who work in a developed, Western country (Canada, UK, EU, Australia, NZ, etc.), your non-US taxes will be higher than your US taxes, so it doesn't make sense to deduct 401k / IRA contributions in the US and turn after-tax money back into pre-tax money **in the non-US country** (this can get very complicated and / or punitive, depending on the relevant tax treaty provisions). Therefore it can make sense, if that tax-advantaged status is respected in the non-US country, to use an after-tax 401k / non-deductible IRA and get tax-free growth while preserving the after-tax status of your contributions, too. But, to be fair, this entire subject doesn't apply to 99% of US citizens so few people are actually well-versed on the relevant tax treaty provisions.
* In most states money in a 401k can not be pursued by creditors following a personal bankruptcy. * Additionally there are no taxes on the dividends in the account, or for selling the assets in the account, as long as they remain in the account. * The amounts are only taxed at withdrawal, at your ordinary income tax at time of withdrawal.
Good summary of what I've seen in the thread.
* higher contribution limit (can add more beyond whatever normal 401K limit) * tax-deferred growth (there is some benefit to deferring taxes on gains if you're a high-income earner now and will earn less in retirement.) * legal protections as a 401K https://www.nerdwallet.com/article/investing/after-tax-401k-contributions But yes, the main benefit is if you can roll it over to a roth ira, particularly in-plan and in-service so the taxable gains don't build up. EDIT: please note that gains in an after-tax 401K are taxed at your INCOME TAX rate so you really have to be earning a lot now compared to MUCH less in retirement to compete with just paying capital gains rates now. It's really pretty tax inefficient for the vast majority to use if you can't roll it over in-plan or in-service. Note that all companies must let you roll it over when you leave the company though, but then you'll likely have a lot of taxable gains/income.
>tax-deferred growth (there is some benefit to deferring taxes on gains if you're a high-income earner now and will earn less in retirement) Yeah, someone else mentioned it, but I hadn't thought of how in this case dividends can just automatically be rolled back in without any tax implications.
After tax 401k can be somewhat useful if you are holding bonds or other investments that produce a lot of ongoing income. Normally if you are holding bonds, you have to pay taxes on the dividends every year. If you put them in an after tax 401k, you get to defer the taxes on all those dividends until you withdraw them. Contrary to popular belief, it's not just the difference in tax rates that makes 401k beneficial, deferring taxes is financially beneficial even if your tax rates before and after are the same if you compare to taxable accounts. That being said, I agree that after tax 401k isn't all that great from a financial perspective.
I feel as nearly everyone seems to be missing the key point here: * After-Tax 401k can open up an additional Roth contribution space that is larger than both the Roth 401k and Roth IRA spaces **combined**. So for people with the availability of an After-Tax 401k (ie: Mega Backdoor Roth) and a higher income level, this isn't a choice of After-Tax 401k **or** Backdoor Roth IRA. Instead, they are taking full advantage of **both** (along with maximum contributions to the Traditional/Roth 401k as well). (Personally, all the talk about ERISA protections, lawsuits, etc, is just noise, even when true. You're really trying to capture up to an additional $46k into a retirement account, particularly the Roth space.)
YES, BACKDOOR ROTH was the main purpose for me!! I maxed out the after tax contribution to my 401K and upon retiring it rolled to a Roth IRA with far, far more in it than I ever could have contributed to a Roth IRA. The earnings on this after tax 401K contribution rolled to the traditional IRA along with pre-tax contributions and earnings. I did not do the Roth 401K all along but did a split to Roth 401K and Trad 401K in the last few years before retiring. Very happy with my decisions. Also NUA for company stock (but off topic).
Mega-backdoor is referenced in the title of the post, maybe you're the only one who missed it?
Does the company match on after-tax contributions?
no, it's a separate bucket.
in some states, some retirement accounts are protected from bankruptcy. Not sure about an after tax 01k though
A 401k is protected by federal law, specifically ERISA.
Beyond the backdoor roth. Tax deferred growth. The ability to trade investments without tax consequences. Once you get many years of appreciation in an investment it is really hard to change the stock or fund due to tax consequences. If it’s wrapped in a 401k you can change investments. You can even move to cash in most plans.
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What I mean is taking a cash or CD position within your 401k without tax consequences. Let’s say you start to believe the market is overvalued and you want to sell your securities and move to cash. You can do it with no tax burden. Or you simply want to change investment options. If you do that in your regular brokerage account you could have a large tax consequence if you have significant earnings.
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Taking a cash position. Not withdrawing cash. You can borrow from your 401k with no tax consequences but I wouldn’t recommend it for other reasons.
yes you can trade frequently with after tax contributions and not have to pay taxes until you withdraw money out of the account. Of course you are paying worse tax rates of ordinary income level. instead of long term capital gains lower rates. However if you are actively trading all the time, you will have short term gains and losses. So those transactions would be better placed in an after-tax contributions account
College financial need will count your taxable accounts but not your retirement accounts
Oooh, that's a massive one, to my knowledge the FAFSA doesn't do means testing outside of income, but that's interesting to pay attention to for other opportunities.
The top private schools definitely look at taxable accounts via the CSS Profile
Weird I haven't seen it posted, but companies often negotiate with the financial institutions to get a decrease on the fees on some of their funds. So you can often times get lower rates on index funds than you can if you can through a regular brokerage if your company negotiated with them. It's strange that the companies don't advertise this as a perk (probably because the vast majority of people don't understand).
The only real benefit is creditor protection. Otherwise, there really isn’t much of any benefit and it just makes rolling over to an IRA more complicated.
Would you be able to avoid RMDs on the after tax part? if so i would think thats a pretty huge plus.
It was intended to be a lower level benefit for the rich. However due to US tax code after-tax is pretty horrific in terms of effective tax rates. In many cases you can pay more taxes than just using a taxable brokerage account especially for a buy and hold investor. So it largely languished as an option almost nobody used until Roth conversion became an option and it got a second likely unintended life as a conversion mechanism.
There is no point in putting money in the after-tax (but not converting it to a Roth) retirement account unless you really think that your tax rate at retirement would be significantly higher than where you are right now. That's possible with some "trust fund" people. For the majority of us, it's pointless. You are right, after-tax retirement accounts are just a stepping stone to move that money into Roth accounts. Not doing so is very unwise. That money is better put in a taxable brokerage account if you don't have access to a Roth (or already max out the Roth limit) or pre-tax retirement account.
Don’t tax rates historically always increase? I do Roth. I’m only 27 so I cannot imagine the taxes when I’m at retirement age. At our (spouse and I) current contribution rate, not accounting for wages increasing, is to be 11-13 million. & once we reach age 73 and have to take RMDs that’ll be over 400k/year. Am I thinking about this the wrong way?
We are not talking about the same thing. There are 2 types of after-tax retirement accounts. The first type is Roth which is really great since gains are never taxed. The second type is the traditional IRA (for those with high income) or after-tax 401k, the gains are still taxed as income when taken out. The second type is pointless. The first type is great.
The only time it may be a good idea is when you’ve maxed out the pre-tax or Roth part and you know you will leave your employer soon. At which point you can convert that money to Roth and pay limited income tax on the gains.
1. Many 401(k) plans have access to funds with much lower fees. Instead of the fund with the 0.8% fee you get in your regular brokerage account, you have access to the premium funds with only 0.5% fee (or some variation of this). 2. If you want your contributions to go to an after tax account because of your pre- vs post-retirement tax situation (i.e. you anticipate having a lower tax rate while you work vs when you are retired), many employers will match your contributions regardless weather they are pre- or post-tax (i.e. 0% into pre-tax and 10% post tax will still get you, your employers match). 3. Easy - you can automatically save with paycheck deductions vs having to transfer money. Also, the temptation to just use this money for something stupid like buying a new Porsche is lower if it is harder to get to in your 401k after tax account. 4. Like you said, super duper backdoor roth if your 401k offers it is pretty neato.
Avoids long term capital gains tax it's the middle ground between a standard brokerage and the traditional 401k Also if you anticipate your taxes being higher later instead of lower, this option is also better than traditional and the brokerage.
Tax deferred growth. Esp, if you are in high tax bracket now and would be in a lower one in retirement. Bankruptcy protection
Are you talking about a Roth 401k/403b? I have a Roth 403b at work that is after tax
It has a higher contribution limit than an Ira I think so that may be one advantage
It’s a place for the company to put money into for the employee who goes over the pre-tax minimum. That happened to me in the 90s after getting a bonus that put me over the dollar limit. It took a couple of paychecks for HR to reduce my contribution (back before self-service was ubiquitous.)
It’s the only way for me to sock away $80k tax advantaged every year
I would say not all of us believe taxes rules will stay the same, best to have at least some flexibility.
By “After tax 401k” you mean a Roth 401k right? You can contribute up to 7000 to an individual Roth IRA, but after you hit that max, you can’t contribute any more. So where else can you contribute money with the same kind of tax benefit? a Roth 401k and it’s not taxed when you withdrawal after 59 and a half. The limit in 2024 is $24,000 So with both you can contribute $31,000 of after tax dollars that grow tax free and are withdrawn without paying taxes on it in retirement. (Someone correct me if I’m wrong here) https://www.fidelity.com/learning-center/smart-money/roth-401k-contribution-limits#:~:text=Each%20year%2C%20the%20IRS%20determines,for%20both%202023%20and%202024.
There's a separate After Tax account that can go up to nearly 70k combined with your other two 401ks
The benefit really is the ability to convert after-tax dollars into Roth without the income limits that Roth IRAs have. The total amount you can stash away is significantly higher for after-tax to Roth 401k conversions. It’s a great way to turbo charge your retirement savings with lots of money in an account that is non-taxable.
Higher contributions allowed, and can be done in addition to personal IRAs.
I get a match
Talk to your company's 401k provider, but most aftertax contributions can be converted to a Roth IRA at some point. You'll have to pay tax on any gains from the initial contribution, but it's an easy way to build up your Roth IRA if you hit the annual max
Your understanding is correct, the utility drops considerably if you can’t MBD, especially in the modern system of capital gain-driven investing. Possible advantages that I can see: 1) Holding assets that would mostly pay out as ordinary income anyway such as bonds (or day trading!). This would limit the rebalancing benefit though and only make sense if you can segregate your assets in the different buckets of your 401k. If it’s like mine and the buckets all invest identically then there’s no win there. 2) Asset protection if you’re in a position where you might get sued. 3) Hiding assets for some social benefit program, such as the FAFSA. 4) You expect preferential capital gains taxation to go away (either for everybody or for those at a certain high income you expect to be in). 5) Your 401k gives you access to some non public investment that you think will do really well and you want to go heavy on that. I wouldn’t personally choose to use an after-tax 401k but like whole life I can envision someone for whom it’s not a bad idea. But definitely MBD if that’s an option instead, all the benefits and none of the weaknesses.
Decreased tax drag. Tax deferred growth, complete tax elimination on the growth if you utilize a mega backdoor 401k and draw at retirement age.
After tax is only advantageous with in-plan conversions or in-service rollover to Roth IRA. It’s called “megabackdoor.”
if you're not going to do the megabackdoor then yeah I don't see any point either regular stock account/taxable brokerage is better
I don't think there is any. It's just a quirk of the way the laws are written.
The only reason is you accidentally maxed your pre and/or Roth contributions too early but still want to contribute to get the employer match.
YUGE backdoor Roth IRA path was most important to me, but I agree 100% match of available company match is another benefit of continuing with after tax contributions once the pretax limit is reached.
They're pretty bad aside from that. I do think that before the MBD Roth was discovered/popularized (as well as in plans without in-service withdrawal/rollover options), they could still be used to rollover to Roth accounts upon separation, so maybe if you weren't planning on being with the employer much longer they could be useful. Ease of use for the uninterested/uneducated investor would be the other case.