about 401k Before-Tax savings (or After)

great replies in my other question - thank you

our company provides a match for the amount they throw in to the 401k plan, ie. I contribute 3%, they kick in 3% now, I can also contribute on my own any amount over that, 5, 7 or 10% or more

besides that I can also contribute After Tax is there any general advice on how much to stuff into the various categories?

currently I submit 3% before tax and nothing after tax if I also submitted 3% after-tax, is that better because of some tax strategy as opposed to making it 6% before tax and nothing after tax?

Reply to
Jim
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I understand this to be like a post-tax (non-deductible) IRA. I'd sequence the preference to be; 401(k) up to matching, Roth IRA, finish 401(k) pre-tax. JOE

Reply to
joetaxpayer

No, there is a limit on how much you can contribute before tax, depending on a number of factors, including your age.

The general advice is to save as much as you can, at a minimal getting all the free money (i.e. company match) first. I would then put as much as legally allowed into the before tax category. Anything after that, I myself prefer to use a different account.

Reply to
PeterL

what's the age limit? something like up to 20k/year if you're 50 or over?

Reply to
Jim

In 2007, $15500 for under 50, and $20500 for 50 and older. Dare I say it? The chart for this and IRA numbers is at

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JOE

Reply to
joetaxpayer

Stay away from making after-tax contributions to a 401(k) plan. It's a bad idea from a tax standpoint, and it'll complicate your record-keeping for years to come.

If you want to hedge against tax rates going up in the future, a better strategy is to contribute enough to your 401(k) plan to get the full company match, and then make after-tax contributions to a Roth IRA instead. The Roth gives you more options about how to invest and when to withdraw the money, and saves you the headaches of keeping track of both before- and after-tax contributions in the same account.

If you still have money left after that, go back and max out the before-tax contribution to your 401(k) plan.

If you still have money to save after *that* (lucky you!), you're best off just dumping that money into a regular brokerage account. Index funds and muni bonds are tax-friendly investments to hold in such an account because they don't generate much taxable income or capital gains. Alternatively, some other good things you can do with your money are:

  • Do you have any debt? Credit cards and car loans should be paid off as quickly as possible. Student loans and mortgages next.
  • Do you have an emergency fund? Having 3-6 months living expenses tucked away in a bank or money market account gives you a cushion against having to go into debt if you should lose your job or have some other emergency.
  • If you don't already own a home, do you want to buy one?
  • Do you have any old traditional (before-tax) IRAs sitting around, or
401(k) money sitting around in an old employer's plan? Doing a Roth IRA conversion on those moneys and using your extra cash to pay the taxes due on the conversion is the same as putting that extra cash directly in the Roth, and a way to bypass the limit on regular Roth contributions.

-Sandra the cynic

Reply to
Sandra Loosemore

this I've read somewhere but did not understand fully.

so what you're saying is that I can take my 20k in a traditional IRA and having already contributed after-tax 2006 & 2007 Roth IRA maximums, I can still roll over the

20k from IRA --> Roth IRA and just pay with cash the taxes now ?

assuming (for an example) that I did this in May 2007, I would pay taxes this year and report these payments on my 2007 tax return when I file in 2008 ? did I understand the steps correctly ?

Is it possible to pay the taxes for the IRA to Roth IRA with parts of the 20k or will I pay taxes with different funds? (ie. cash)

Reply to
Jim

Any conversion now goes on 2007 return next April.

Jim - there are multiple issues at play here. If you are not maxing out your 401(k) and Roth, (15500+4000 for under 50) this wont apply (well, it could, but first things first).

If you are maxed out, and find you have extra cash, it may make sense to take IRA money, and convert to Roth. You pay the tax on money that was pretax deposited, as well as all gains. (read that - the only non taxed money is if you made any post tax deposits). The Roth, then won't be taxed again. You should not use the IRA money to fund the tax payments. Only consider the conversion if you have side money to pay, otherwise the money taken out is penalized as well.

A Roth conversion is a great idea, more so if you have situations where your tax bracket changes and you convert while in a lower bracket. But as fellow poster Elizabeth points out, there are other benefits where long term, it makes sense regardless of bracket changes. I still maintain a caution that if you happen to have a lot of money, say $100K to convert, a bit of planning and converting over two or three years may be more beneficial than the all at once. JOE

Reply to
joetaxpayer

Yes. The only restriction is that your AGI (excluding the Roth money you're converting) has to be under $100K in the year you do the conversion. The limit is going to go away in another year or two, though, so even if you have too much income to do that now, you'll be able to do it in another couple of years.

More or less. Depending on your situation, you may or may not need to pay estimated taxes to avoid getting hit with a penalty for insufficient withholding when you file your 2007 return. One way you can avoid that is to increase your withholding instead. IIRC, if your withholding is sufficient to fully cover *last* year's taxes, that's sufficient to avoid penalties, and you can just pay the balance when you file your return.

It's possible, but dumb. :-P A Roth conversion only makes sense if you have cash outside the IRA account to pay the taxes. If you have to withdraw money from the IRA account itself to do so, you're not only throwing away the main benefit of doing the conversion (tax-sheltering more of your savings), but you'll have to pay an early withdrawal penalty on the part of the IRA money that goes to paying taxes, too.

-Sandra the cynic

Reply to
Sandra Loosemore

appreciate all the comments, in my case I have just the 20k so maybe my situation is a bit simpler

is there an easy back-of-the-enveloper estimator/calculator where I could try to estimate what the tax bill might be on a sum of just 20k? in my case, this represents just 2 years of 4k (total 8k) of salary so my gain is 12k and original tax deducted money is 8k

Reply to
Jim

The $8K was all pre-tax money? Then if you do a Roth conversion, you owe taxes on the whole $20K. If you're in the 28% bracket, say, you'll owe (0.28 * 20000) = $5600 to the IRS. Plus whatever state taxes are due, too.

If you made non-deductible contributions to your IRA, you should have saved the form 8606 you filed with your taxes in the years you made the contributions. These show your total "basis" in the IRA, and you can subtract that from the amount you have to report as taxable income. For instance, if your $8K was all non-deductible contributions, then you'll only owe (0.28 * (20000 - 8000)) = $3360 in taxes.

-Sandra

Reply to
Sandra Loosemore

hmm... not pre-tax but I (this goes back 15-20 years) paid from my checking account 4k during two years into a traditional IRA and reported it on my tax return that year and took the deduction as instructed

does that make it clearer? IOW, I paid with after-tax dollars but took IRS instructed tax deduction that year.

probably still owe about 5.6k

now, since I routinely get back 3k per year, it wouldn't be such a big deal as I would just owe 2.6k new tax filing time

Reply to
Jim

If you took the IRA deduction, then the money is "pre-tax", and you need to pay taxes on the full amount if you do a Roth conversion.

Yes.

If you decide to do a Roth conversion, I suggest setting aside the cash for taxes right away when you send in the conversion paperwork to your IRA custodian, even if you don't need to send the money to the IRS right away. It's possible to un-do ("recharacterize") a Roth conversion before the end of the year, if you change your mind or discover you don't have the enough leftover money to pay taxes after all, but it's extra hassle.

-Sandra the cynic

Reply to
Sandra Loosemore

What's his benefit to do a Roth conversion? Thumper

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Reply to
Thumper

It's a way to tax-shelter some extra money. $20K in a traditional IRA isn't worth as much as $20K in a Roth IRA, because 28% (or whatever your tax bracket is) of the money in the traditional IRA really belongs to the IRS instead of to you. OTOH, all of the money in a Roth IRA belongs to you. By converting a $20K traditional IRA to a $20K Roth IRA by paying the taxes out of some other non-tax-sheltered cash account, you've effectively added the amount of the taxes to your tax-sheltered investment.

Roth IRAs are also more flexible than traditional IRAs with respect to withdrawals. And some people might want to do a Roth conversion if they believe their tax rates will be higher after retirement than they are now.... maybe because they figure they'll have higher income in retirement or because tax rates now are historically low and are more likely to go up again than down.

-Sandra the cynic

Reply to
Sandra Loosemore

In addition to what Sandra (who appears more the realist than cynic to me) wrote, the Roth can be used as a method of managing one's tax burden, watch your bracket carefully (see

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for this) and you can make Roth conversions to stay in your bracket but not go over it. If you have post tax savings as well as pretax, you can manage your IRA withdrawals to avoid a phantom 50% tax bracket, which occurs as social security benefits get taxed. By having much of your money converted prior to retirement, this trap is avoided.JOE

Reply to
joetaxpayer

You aren't telling the whole story. Assuming a 28% tax rate, you are investing 28% more than the Roth and it compounds at a higher rate. If your tax rate drops to 15% in retirement you must keep a Roth for

12 years after conversion WITHOUT WITHDRAWALS to break even. Of course if your bracket remains the same the period is much shorter.

Remember, you have to have the money to pay your taxes when you convert or take it out of your IRA. There are many other considerations.

This is a good article on conversion.

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and another.
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All I'm saying is that converting is not for everyone and is highly personal. Generally it helps wealthy people more. THumper

Reply to
Thumper

Probably a stupid question, but... Is the after-tax contribution you're allowed actually a Roth 401(k) contribution? In that case, this could be a good idea. If not, then I agree with Sandra that it probably is not a good idea to contribute to your 401(k) after tax.

-Will

Reply to
Will Trice

AFAIK, it's just a regular 401k, not Roth 401k but I surmise from all the replies I won't submit anything after-tax

Reply to
JD

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