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Education | Jul 18, 2017

Is the After-Tax Option Available in Your Retirement Plan?

Steven Kohler

CFP®, CPFA®

If you are fortunate enough to be able to max out your contributions to a 401(k) and/or Roth IRA, you should look for more options on where to put your extra money. Even if you are not a high-net worth investor maxing out your contributions, you may want to consider the benefits of after-tax contributions.

Although very few employers offer it, there is potential of contributing significantly more to your retirement plan as part of an after-tax option. The IRS employee contribution limits are $18K if under 50 years of age and $24K if you’re over 50. However, the maximum that may be contributed to tax-deferred employer retirement plans is $54,000 (or $60,000 if you are age 50 or older). That could mean an additional $36,000 to your 401(k) plan whether you are under or over 50 and this money stays tax-deferred.

Newer IRS regulations on how after tax monies are handled when they’re rolled over into an IRA make such contributions more attractive than they were before. If your plan allows after- tax contributions and you follow the correct steps when converting them to a Roth IRA, the after-tax contributions can essentially become Roth IRA contributions after conversion.

So, in addition to tax-deferred compounding of assets, you are now able to segregate the after-tax assets from the pretax monies at the time of rollover into an IRA. Pretax 401(k) assets can be rolled into a Traditional IRA, whereas the after-tax dollars accrued can be converted into a Roth IRA. Gains on the after-tax contributions will be taxed in the year converted.

Why is this important?

Again, under the new IRS regulations, investors can effectively steer more assets into the Roth column than they otherwise could by converting their after tax 401(k) contributions into a Roth IRA. Once the rollover is complete, all those assets can begin compounding on a tax-free basis, and withdrawals will be tax-free based on Roth IRA rules. Importantly, Roth IRA assets aren’t subject to required minimum distributions, either.

By making after tax contributions that are eventually converted to Roth IRA assets, you will be able to build a higher level of Roth assets than is allowed with direct Roth IRA and 401(k) contributions alone.

While we like the after-tax option, it may not be for everyone. First-of-all, not every plan allows for after tax contributions. In addition, things can get complicated for investors who don’t roll over their entire 401(k) balances. For this reason, such rollovers of after-tax funds to Roth IRA need to be balanced against other strategies that are negatively impacted by doing a rollover. For example, you will be losing the ability to avoid the early withdrawal penalty on 401(k) plan distributions after age 55 and before 59 ½.

Because of its complexity, we suggest you work with your financial advisor to determine whether such an option is appropriate for you. Together, you can decide which funds are appropriate to convert, what should be rolled over and what employer plan options apply.

This material has been provided for general, informational purposes only, represents only a summary of the topics discussed, and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice or recommendations. Rather, they simply reflect the opinions and views of the author. D. B. Root & Company, LLC. does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation. There can be no assurance that any particular strategy or investment will prove profitable. This document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such sources, and take no responsibility therefore. This document contains certain forward-looking statements signaled by words such as "anticipate," "expect", or "believe" that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the expectations, beliefs, views and opinions expressed in this document will come to pass. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. All investment strategies have the potential for profit or loss. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

Steven Kohler

CFP®, CPFA®

Chief Planning Officer

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