After Tax 401k Contributions vs Roth IRA?

[guppy]

I was recently speaking with someone about how I wanted to open up a Roth IRA and they didn't seem that impressed with the idea. I tried to explain how it'd be nice to make contributions after taxes so that 1) I wouldn't be taxed on the money when I do decide to withdraw it for retirement and 2) in an absolute emergency, I would have access to my contributions. Compared to my husband's 401k and my 403b, those seemed like good incentives. This person then said how they contribute to their 401k after taxes to get the same benefits as the RothIRA, so there'd be no reason for them to open a Roth. My husband and I both checked with our employers, and we don't have this option.

Do any of you have this option and is it necessarily better than a ROTH IRA?

[MonkeyMama]

I suppose you are referring to a ROTH 401k?

A ROTH IRA is generally better than a ROTH 401k. It is a lot less restrictive. You can invest anywhere, and don't have to roll it over when you change employers, etc. (401ks tend to have hidden fees, as well).

The perks of 401ks are that you can contribute more (max is $16,500) and that sometimes they are matched by an employer.

It just depends on the situation.

[disneysteve]

nevermind

[jIM_Ohio]

Originally Posted by guppy

I was recently speaking with someone about how I wanted to open up a Roth IRA and they didn't seem that impressed with the idea. I tried to explain how it'd be nice to make contributions after taxes so that 1) I wouldn't be taxed on the money when I do decide to withdraw it for retirement and 2) in an absolute emergency, I would have access to my contributions. Compared to my husband's 401k and my 403b, those seemed like good incentives. This person then said how they contribute to their 401k after taxes to get the same benefits as the RothIRA, so there'd be no reason for them to open a Roth. My husband and I both checked with our employers, and we don't have this option.

Do any of you have this option and is it necessarily better than a ROTH IRA?

There could be many different terms your co workers are missing

a) There are before tax 401k contributions
b) there are after tax 401k contributions
c) there are Roth 401k contributions which are taxed

all 3 are different. They have different taxation rules

a) and b) are pre-tax going in
a) is taxed 100% coming out
b) only gains are taxed coming out
---
the reasons people do this range from not having a Roth 401k option, to meeting/exceeding the yearly max

Do not muddy the reasons to do this with the "facts" of what the rules are.

c) is taxed going in and not taxed coming out
c) can be rolled into a Roth IRA (rollover) at retirement. If you pass the 5 year test (account existed for more than 5 years) I believe you can withdraw Roth 401k contributions similar to Roth IRA contributions. There are no RMDs on a Roth IRA.

A Roth 401k and a Roth IRA will work the same with different contribution limits (401ks have higher contribution limits).

IMO the benefit of the Roth includes no RMDs at age 70.5- gives the person owning the assets much more freedom to access the money.


Much of the 401k vs Roth choice comes down to 3 decisions... one does not trump the other, you just need to make best decision based on these 3 factors for your situation.

1) Taxes (now, future working years and in retirement)
401k gives you a tax break now
Roth gives you tax free income later

2) Withdraw rules
Roth accounts have no RMDs at age 70.5, traditional 401k and traditional IRAs do. If a person has a pension coming to them, they really need to look at this issue carefully.

3) Choices- not all 401ks are considered equal. I have had 5 401ks, and all had top notch funds which make many others jealous. But I read posts all the time on 5 different boards on 401ks with nightmare selections. If you cannot get access to quality investments (or build a quality portfolio) in your 401k, you have other issues to consider, and this makes an IRA (traditional or Roth) more attractive.


A fourth consideration is inheritance rules, but I would not want to muddy waters with those issues, as I think the 3 above are more important.

[guppy]

Monkey Mama - I think it was a regular 401k, not a Roth 401k that he was speaking of.. is that possible?

[MonkeyMama]

Originally Posted by guppy

Monkey Mama - I think it was a regular 401k, not a Roth 401k that he was speaking of.. is that possible?

No. If it's funded after taxes, it's a ROTH 401k, plain and simple.

I do agree with Jim, that this person likely has no idea what they are talking about. IT could be a regular 401k and they just don't understand that it's funded pre-tax.

[guppy]

Thanks Jim and MonkeyMama for the info!

[jIM_Ohio]

Originally Posted by MonkeyMama

No. If it's funded after taxes, it's a ROTH 401k, plain and simple.

I do agree with Jim, that this person likely has no idea what they are talking about. IT could be a regular 401k and they just don't understand that it's funded pre-tax.

MM-
Some 401ks allow non deductable contributions similar to a traditional IRA with no tax deduction. I have only read about them, and have never seen one, so its possible I am out of line here....

It could be funded after taxes and not be a Roth unless you can prove I am wrong. I did not agree with your wording of response I quoted here.

[MonkeyMama]

You may be technically correct Jim, but I have personally never seen anyone exercise this option (as a tax professional and as retirement plan auditor). Basically, I don't really know why anyone would do this. If so, it has got to be a rare situation. Nothing that the average taxpayer would be doing.

I suppose it makes even less sense with the creation of the ROTH 401k. & the ROTH IRA. My feeling is that this might have been some tax strategy pre-1998 (pre ROTH). I have been a tax professional since 2000. Would explain why I have never heard of it.

So um, I have no idea why anyone would contribute to a 401k after-tax. My original answer stands. A post-tax 401k contribution is a PITA, mostly, if you ask me, with no useful benefit to the average middle class American. At least a ROTH 401k has some merits.

[fruitbowlk]

We have the Roth 401k

The Roth 401(k) is a type of retirement savings plan. It was authorized by the United States Congress under the Internal Revenue Code, section 402A,[1] and represents a unique combination of features of the Roth IRA and a traditional 401(k) plan. As of January 1, 2006 U.S. employers have been free to amend their 401(k) plan document to allow employees to elect Roth IRA type tax treatment for a portion or all of their retirement plan contributions. The same change in law allowed Roth IRA type contributions to 403(b) retirement plans. The Roth retirement plan provision was enacted as a provision of the Economic Growth and Tax Relief Reconciliation Act of 2001

[disneysteve]

Originally Posted by MonkeyMama

So um, I have no idea why anyone would contribute to a 401k after-tax. My original answer stands. A post-tax 401k contribution is a PITA, mostly, if you ask me, with no useful benefit to the average middle class American. At least a ROTH 401k has some merits.

Just thinking out loud here, but if your company doesn't offer a Roth 401k and you earn too much to fund a Roth IRA (or you've already maxed your Roth IRA), might you want to fund a 401k with after-tax money in order to avoid paying taxes in retirement when, possibly, the tax rates will be higher?

[MonkeyMama]

Originally Posted by disneysteve

Just thinking out loud here, but if your company doesn't offer a Roth 401k and you earn too much to fund a Roth IRA (or you've already maxed your Roth IRA), might you want to fund a 401k with after-tax money in order to avoid paying taxes in retirement when, possibly, the tax rates will be higher?

No, because if you make too much to fund a ROTH IRA, you need the tax break NOW! Tax deductible 401k all the way. I mean, you would be insane to give up a current tax break in that tax bracket.

[MonkeyMama]

It was driving me nuts because I couldn't find anything.

I finally found that this is something offered by mega corporations (my other theory since those are a whole other animal), mostly as an investment tool. There is no mention of this specifically in the 401(k) tax code. The "benefit" is to invest after tax in the "Same place as your pre-tax 401k" (you can invest over the $16,500 limit - it really has nothing to do with 401k rules) and the benefit is that Corporations offer funds at low cost that you couldn't invest otherwise, or couldn't get at a discount otherwise.

The tax treatment is virtually identical to non-deductible IRAs.

You would only do this after all your tax-deductible options were maxed out. So you could max out your pre-tax 401k and THEN fund an after tax 401k (this is the piece I Was missing before).

So they say - it's all greek to me. But, it's interesting.

[jIM_Ohio]

Originally Posted by MonkeyMama

No, because if you make too much to fund a ROTH IRA, you need the tax break NOW! Tax deductible 401k all the way. I mean, you would be insane to give up a current tax break in that tax bracket.

If a Roth 401k is not an option
and plan allows post tax contributions, it would be useful in same sense that a traditional (non deductable) IRA would be used AND it offers the added benefits that some 401k plans give access to money before age 59.5 (penalty free).

[MonkeyMama]

Originally Posted by jIM_Ohio

If a Roth 401k is not an option
and plan allows post tax contributions, it would be useful in same sense that a traditional (non deductable) IRA would be used AND it offers the added benefits that some 401k plans give access to money before age 59.5 (penalty free).

I don't agree 100%.

An IRA you can contribute pre-tax or post-tax. Either or. People only make post-tax IRA contributions out of *desparation,* when they have no other tax shelter options. IT's a pretty crappy tax shelter.

A 401k you can do both pre-tax and post-tax. So it's not really apples to apples. No one in their right mind is going to give up the tax shelter of a pre-tax 401k for a post-tax 401k. I certainly wouldn't recommend it. If you want it penalty free, put it in a taxable account. No one keeps good tax records on these and many people end up double taxed with these types of accounts because they didn't keep their tax records for 50 years.

But as I said, I realize now that the post-tax is being presented as an option after the pre-tax 401k is funded. That makes sense. Then it's back to desparation for tax shelters. Crappy, but it works.

[jIM_Ohio]

Originally Posted by MonkeyMama

I don't agree 100%.

An IRA you can contribute pre-tax or post-tax. Either or. People only make post-tax IRA contributions out of *desparation,* when they have no other tax shelter options. IT's a pretty crappy tax shelter.

A 401k you can do both pre-tax and post-tax. So it's not really apples to apples. No one in their right mind is going to give up the tax shelter of a pre-tax 401k for a post-tax 401k. I certainly wouldn't recommend it. If you want it penalty free, put it in a taxable account. No one keeps good tax records on these and many people end up double taxed with these types of accounts because they didn't keep their tax records for 50 years.

But as I said, I realize now that the post-tax is being presented as an option after the pre-tax 401k is funded. That makes sense. Then it's back to desparation for tax shelters. Crappy, but it works.

Can't an IRA be partially deductible?
That was covered in my tax class last year... something about pre-1982 IRAs or something like that???
If part of my IRA was deductible
and part of my IRA was NOT (maybe not eligible for Roth and used a traditional instead?)

then a distribution is partially taxed and not fully taxed.

As an example of an IRA being partially deductible and partially taxed.

I was not suggesting it be among the top options to consider- but it does have the advantages an IRA does not in terms of age 55 access (if plan allows it).

Yes keeping track of deductible vs non deductible contributions is an issue with this technique. There are lots of issues to discuss (such as is a taxable account better).

I could come up with other examples where highly compensated employees or others might want to consider this option.

[creditcardfree]

This doesn't answer the OP's question, but this year my husband and I will max out our ROTH ira's, but also contribute to my husband's TSP, military's version of 401K. Because his earnings will be in a combat zone, the contributions we make will be after tax contributions, or like a non deductible IRA. When we go to pull money out at retirement our withdrawals will be prorated, with some of the money being taxable and other not taxable.

I was planning to contribute this money, even though there is no tax benefit. The benefit is that this money will be set aside for retirement and invested without paying dividends and capital gains.