top of page
Writer's picture Treavor Dodsworth CFP®, CPA, CKA®

#95 - The Little Known 401k Contribution


Little Known 401k Contribution

At some point throughout someone's working career, they will likely have the option to contribute to a 401k or similar type of account. These accounts oftentimes allow for at least two options - contributing on a traditional or pre-tax basis (generally tax deduction today but pay tax later) or Roth basis (generally no tax deduction today but tax-free later). Occasionally a few of these accounts may allow for a third type of contribution - after-tax contributions. Although after-tax contributions are occasionally confused with the Roth, it is not the same. Like the Roth contributions, there is no tax deduction for contributions but unlike the Roth contributions earnings grow tax-deferred (generally pay ordinary income tax on them later) instead of tax-free. Also, unlike the Roth option contribution limits can potentially be much higher (over $50,000 a year). There are two primary reasons to be aware that these contribution types exist.

  1. Although there are likely other investment vehicles you would consider first, after-tax contributions to a 401k can potentially be quite lucrative. Primarily because it is occasionally possible to do an in-service distribution and roll the after-tax contributions to a Roth IRA (effectively getting $50K+ into a Roth IRA). Even if that is not possible to do while working, it is likely possible that you could move the after-tax contributions to a Roth when you separate from service. Once in the Roth, growth changes from being tax-deferred to tax-free. There are many nuances here (how earnings are treated, etc.) and this won't make sense for everyone even if it is an option.

  2. To a certain extent, some of the tracking of contribution types falls on the individual investor. Let’s say you made an after-tax contribution and didn’t realize it and later you rolled that money to a Traditional IRA. If you didn’t track the basis in your Traditional IRA, you may accidentally pay tax on that money twice when you later withdraw it from the Traditional IRA.

For many, after-tax contributions will never be relevant but for others, the impact can be very substantial.

 

Interesting Article(s) or Video(s)

  • Randy Alcorn shares a brief summary of Stanley Tam’s incredible example. I hope this read is challenging, humbling, and motivating for you.

 

Thank you for reading!

Comentários


Thanks! Message sent.

All written content on this website is for information purposes only. Opinions expressed herein are solely those of Sycomore Financial, unless otherwise specifically cited.  Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. The owner of this website takes great care to thoroughly research the information provided to ensure that it is accurate and current. Nonetheless, the content on this website is not intended to provide tax, legal, accounting, financial, or professional advice, and readers are advised to seek out qualified professionals that provide advice on these issues. All information or ideas provided should be discussed in detail with an advisor, accountant, legal counsel, and/or other pertinent professionals prior to implementation. In addition, the owner cannot guarantee that the information on this website has not been outdated or otherwise rendered incorrect by subsequent new research, legislation, or other changes in law or binding guidance. Neither Sycomore Financial or it's owner shall have any liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on this website. In addition, any advice, articles, or commentary included on this website do not constitute a tax opinion and are not intended or written to be used, nor can they be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. Any mention of an investment product or solution is not a recommendation to buy or sell. ETFs that are mentioned may not accurately reflect the market segment mentioned. Past performance is not a guarantee of future results. Any mention of rates or return should not be seen as a guarantee those rates or return will be received.

bottom of page