Shot of a couple going over paperwork together at home
Are you maximizing your employer’s pension contributions? Did you know that you may have some extra after-tax money to invest in your plan? (The 2021 annual IRS limit on the total of all annual dues is the lower of 100% of your compensation, or $ 58,000 plus $ 6,500 if you are 50 or older.) If you check with your retirement plan provider, you might be surprised to determine that this option is available. Here are some factors to help you decide whether this is an option worth considering.
Are you maximizing your input tax and / or Roth contributions?
You probably want to make sure first that you are making up your pre-tax or Roth contributions. Roth contributions are also after tax, but the income is tax-free from the age of 59 1/2, provided the account has been in existence for at least 5 years. Income from post-tax contributions, however, is still taxable when withdrawn.
For pre-tax contributions, post-tax contributions can only arise through a significantly higher tax rate for withdrawals. In this case, it may be better to pay the contribution tax now rather than later. However, you need to wonder how likely this is, considering that retired people typically have lower incomes and many of your withdrawals from retirement accounts may be taxed at lower levels. Additionally, this benefit is at least partially offset by the fact that you can afford to save more pre-tax, as those contributions have less of an impact on your paycheck than after-tax contributions, which reduce your paycheck one dollar at a time.
Would you end up paying more taxes and fines on the after-tax account?
Even if you are maximizing your input tax or Roth contributions, it may be better to put money in a taxable account for several reasons. First, under current tax law, you end up paying a lower rate of tax on long-term capital gains (except possibly for collectibles) on a taxable account because after-tax income from the retirement account is taxed at higher ordinary income tax rates they are withdrawn. This is less of a problem if you invest the post-tax account in bonds, as the interest is taxed at ordinary income rates anyway.
Second, having a taxable account gives you more flexibility because you can withdraw all your money anytime, for any reason, without worrying about prepayment penalties. On the flip side, even if your retirement plan allows you to withdraw from the account after tax, a prorated percentage of your withdrawals will be treated as income and potentially subject to a 10% penalty if you are under 59 1/2 years old. This is an important factor if you may need the cash beforehand.
Would you like to contribute more to a Roth?
However, there is a really good tax reason to contribute to an after-tax account. That’s the ability to add extra dollars to your retirement plan that can later be converted or converted into a Roth account, which can then become tax-free after 5 years and 59 1/2 years of age. (This is often referred to as mega backdoor roth.)
If your employer offers you a Roth option, you may be able to convert it to a Roth while you are still on the job. Otherwise, you can roll the after-tax money into a Roth IRA, which gives you more investment flexibility and the ability to withdraw the converted amount at any time without tax or penalties. (The income can be converted into a traditional pre-tax IRA.)
Does your retirement plan offer superior investment opportunities?
Taxes aren’t everything. You may want to add more to your retirement plan than a taxable account if it has a unique investment opportunity you want to take advantage of or mutual funds at a lower cost than you can buy overseas. These are also sound arguments in favor of an after-tax balance sheet.
Are you still not sure whether post-tax contributions make sense for you? Consider consulting with an unbiased and qualified financial planner. Your employer may even offer you free access to some through a financial workplace wellness program.