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What Is an After-Tax Contribution?
Let me explain what an after-tax contribution really means for your retirement planning. It's simply money you put into a retirement or investment account after you've already paid income taxes on those earnings. When you're setting up a tax-advantaged retirement account, you have choices: defer taxes until retirement with a traditional account, or pay them upfront in the year you contribute if it's a Roth account.
If you're a higher earner, you might even add after-tax money to a traditional account on top of the max pre-tax amount. You won't get an immediate tax break, and mixing pre-tax and post-tax funds requires careful tracking for taxes.
Key Takeaways
You need to know the basics here. Retirement accounts can have pre-tax or after-tax contributions—traditional ones use pre-tax, while Roth uses after-tax. If you anticipate lower income in retirement, go traditional; if higher, consider Roth. There's a yearly limit on contributions to these plans, adjusted for inflation, and if you're over 50, you can add extra catch-up amounts.
Understanding After-Tax Contributions
The government pushes us to save for retirement with tax perks through plans like employer-offered 401(k)s and IRAs you can open yourself at a bank or brokerage. Most people get to pick between two main types.
With a traditional account, you contribute pre-tax money, meaning no taxes that year—it lowers your taxable income. Taxes hit when you withdraw, usually in retirement. The Roth, on the other hand, is after-tax: you pay taxes now, taking a hit to your current paycheck, but after five years from your first contribution, the whole balance is tax-free in retirement. Roth options include IRAs, 457(b)s, 403(b)s, and some 401(k)s, but high earners might not qualify for Roth IRAs.
Post-Tax or Pre-Tax?
Deciding between post-tax Roth and pre-tax traditional comes down to your future tax situation. Roth appeals if you think you'll face higher taxes later, due to income or rising rates—plus, you can withdraw contributions anytime without penalty, though earnings wait until 59½.
The downside is smaller paychecks now. Traditional gives you a tax cut this year and less impact on current income, but all withdrawals count as taxable income, including earnings.
Contribution Limits
Both types have annual caps set by the IRS, adjusted for inflation. IRAs have lower limits than 401(k)s, and those over 50 get higher catch-up allowances. Remember, early withdrawals from traditional accounts before 59½ mean taxes plus a 10% penalty.
Special Considerations
For after-tax contributions to traditional IRAs, withdrawals shouldn't be taxed, but you must file IRS Form 8606 every year you contribute and until the balance is gone to track it properly. This mixes taxable and non-taxable parts, complicating required distributions more than pure pre-tax setups.
What Are the IRA Limits?
IRA limits adjust yearly for inflation, and if you're over 50, you can make catch-up contributions on top.
Can I Contribute to Both a Traditional IRA and a Roth IRA?
Yes, you can contribute to both, as long as your total doesn't exceed the IRS overall limit for IRAs.
Is It Better to Do Pre-Tax or After-Tax Contributions?
It depends on your finances—pre-tax often suits higher earners now, while after-tax works for those expecting a higher bracket in retirement.
The Bottom Line
After-tax contributions can pay off if you expect higher taxes in retirement, but it's not universal. A mix of account types gives you flexibility for tax benefits now and later—consider your situation carefully.
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