Would you like to have more $$ growing in a tax-free account forever? Let me show you how:
- Maximize your 401(k) contributions, $19,500 for 2021 into your Traditional 401(k) [or maybe the Roth 401k]
- Add after-tax contributions to your 401(k). Maybe 5%, $10,000 or even $30k. Whatever you are allowed within your employer’s plan.
- Immediately roll those after-tax contributions to the Roth “side” of your 401(k) plan.
- Enjoy tax-free compounding growth and tax-free distributions in retirement!
Your 401(k) account is a great place to save money for your retirement. These accounts are typically used to save from your current income, get current tax deductions and grow your money for retirement.
You are limited as an employee to contribute $19,500 to your 401(k). But some employer plans allow you to put in more money “after-tax”, which means you don’t get the tax deduction on those contributions, but they can grow tax-free towards retirement.
But the best part is if you can immediately roll these after-tax contributions over to the Roth side of your 401(k) plan. Since you have already paid taxes on these contributions, there is no change to your tax situation.
Now instead of having money growing in a taxable account, it’s hidden in a tax-free account!
401ks, we know these are employer tax, deferred accounts, traditional 401ks, many 401k plans have both a traditional and Roth side. So you, as the employee can now decide, Oh, do I want to make contributions to the traditional and take it off my taxes or to the Roth 401k and I'll pay taxes, but then it's in a tax-free
account right. Julie we've been over a traditional and Roth in multiple episodes. Now maybe the difference between those two.Julie: [:Mike: [:
And it's done automatically for you on your W2. So you don't even have to worry about it, some 401k is now offer a Roth 401k. So you can take that same 10,000 and contribute it to the Roth portion of the 401k and yeah, it's in a tax-free account now. You don't get the deduction now. You're going to pay taxes on it, just like your Roth IRA.
So maybe we haven't gone over that.Julie: [:Mike: [:
That's another thing that will be in that benefits package is talking about. Oh, you're allowed to make after-tax contributions to your 401k.Julie: [:Mike: [:Julie: [:Mike: [:
and then if you have the option, if it's going into the traditional side of the 401k or the Roth side of the 401k. Now, any employer matching. So anything that the employer puts in from profit sharing or matching will always be on the traditional side, not on the Roth. So only the employee has the option of putting money into the Roth 401k.Julie: [:
But to get more information in depth in terms of how to navigate what your 401k looks like, where you can put your money, it might make sense to have a financial person. Look it over for you rather than asking HR.Mike: [:
So w you can go back and listen to that episode around, which is better for made Traditional or Roth. And do you want to pay taxes when your taxes are lowest. So you have to , I think about . Where's my income and my career. And so go back and listen to that episode around Traditional and Roth.
And that will give you some pointers into same thing for the 401k. Good questions.
. So we've got the 401k, you've got the employee contributions. We just talked about do Traditional or Roth potentially. Now you're limited to $19,500 as an employee contribution that's if you're under 50, over 50, you get extra $6,500 as a catch-up and then the employer can also put in money now that after tax, if you're allowed to do that, just briefly explain it is you're literally just doing that.
You're taking money that is in your checking or savings account. You've already paid taxes on it. It's sitting there and your brokerage or checking or saving, and you are going to add it to the 401k. So you could take maybe $10,000 and say, I'm going to take $10,000 for my savings account and add it to my 401k.
It's literally that easy. It's an after-tax 401k contribution. Now the immediate question is what, why would I do that? That's what we're going to get into today. Why would I do that? The reason quite simply instead of the money sitting in your taxable account, that $10,000, you can get it into a 401k where the taxes are deferred. And hopefully the real reason to do this is once you put it into the 401k, then you can roll it over to the Roth side. And now it's in a tax-free account forever. Okay, I'm going to talk about how that works, but let me give you a quick example, because I like to always start with, why do we care about this topic?
So say I have the capability of adding to my 401k after tax contributions. So instead of 25,000 sitting in my checking account, that is, or, my brokerage it's earmarked for retirement. So I saved it into the total us stock market, $25,000. I'm going to put it into an index fund for retirement?
Instead if I had the capability, I could put the $25,000 after tax contribution in my 401k plan, I can roll the $25,000 from, it has to go in after tax contributions on the traditional side. Then you can immediately do an in-plant conversion of just that $25,000. Now it's in the Roth side of my 401k and it grows tax-free forever.
So just one time twenty-five thousand dollar. After tax contribution after 20 years could put more than $20,000 of additional tax savings in your pocket.Julie: [:Mike: [:
Hey, you made a hundred dollars of interest, so you put it on your taxes, right? So those are called taxable accounts. Any capital gains or anything is paid every year. You have tax deferred accounts where you have not yet pay taxes. This is your traditional 401k for 403(b) traditional IRA. You put in the contributions, you take it off your taxes, it grows tax free, but you haven't paid taxes on it.
That's why it's called tax deferred. The third type is tax-free. These are your yup. Go ahead.Julie: [:Mike: [:
And when you sell things, you get capital gains, you're going to pay, whereas the Roth or the tax-free accounts and HSA has fall in here as well. Tax-free they grow tax-free. And then when you use it, it's tax-free as well. Okay. So those are three account types.Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:
It's going into a 401k plan. There's all kinds of plan rules. You're not going to be able to withdraw it, basically until you're retired, that's what it's for. So the rules around that, so you're locking it up. Where's the taxable your checking or savings. You can use that at any time. So it is money
that is for the future. Sure. So that's one, one sort of catch, you gotta be careful about, making sure you have money in the meantime, you have to make sure you can roll it in plan to the Roth side of the 401k and then it's in that Roth side forever.Julie: [:Mike: [:
So they have the capability for saving more money. So I'm thinking large tech companies and Microsoft has been doing this forever for their employees very automatically. It's been awesome. And so it's becoming, little more, but people really don't know about it.Julie: [:Mike: [:
They're matching, some percentage or some profit sharing they put in 10,000. So now we're at saved $29,500. Now the employee, again, maybe they put it into the Roth side or the traditional side depends on your situation, where you want to do that. But the total saved is $29,500 between employee and employer.
Now in 401k plans, there is a cap. All right. It's called the 415 limit. It's $58,000. So between employees and employers, that's the total that can be put in there. If you've got a great employer, Julie, they might put in all $58,000 for you. That'd be all. Awesome.Julie: [:Mike: [:
Cause it's between both 58,000. So in this example, there's $29,500 between the employee and employer. So if they allow it, you can put in that employee can put in another 28,500 as an after-tax contribution. And then immediately tell the plan sponsor. I'd like to, contribute this and write them a check and send it in.
And then you tell them, I would like to roll this over now in the roll over process between this is inside the 401k, it goes from just one side of the house to the other. And when you do that one big difference between we've talked about doing a conversion of IRAs traditional to Roth, and there's this whole tax problem.
If you haven't paid taxes on it yet, then you take this pro-rata and all kinds. It gets very complicated. In this one it is not complicated because you can earmark those dollars and just say these after tax dollars, I want to transfer them over. And so therefore you don't owe any additional taxes.Julie: [:Mike: [:Julie: [:Mike: [:
We've now got it into a tax-free account, compounding tax-free forever. So fantastic. And a lot of great savings. Now, how does this show up on your statements? So when you have a 401k plan with both traditional and Roth sides, you will get statements that show you how much money is in each of those.
So if you have $50,000 that saved in your 401k, it'll say $20,000 is pretax on the traditional and $30,000 is in the Roth and it'll show you that breakdown. So when you add these contributions and roll them over, it'll show up on those statements. Now, some plans allow you to control which investments.
are on which side, so you can say, Oh, my Roth side, I want to invest in XYZ. And the traditional side, I want to invest in these other things , you could do that. And it's a really good idea, but for individuals, it gets pretty complicated to pick well, which should be in Roth and which should be in traditional.
So maybe we'll have another podcast on which assets should be in which type of account, those three different types that we talked about. Where should you hold? Which types of investments.Julie: [:Mike: [:
So both husband and wife can max out their employee contributions of $19,500 company matches 10,000, say both of their companies do that. So that's the same totals , $29,500 for each of them. Then they can each make that after-tax contribution. Same as a before 28,500 after tax into their 401ks.
They both do the IRAs. And now as a couple, you can save up to $128,000 into tax deferred and tax-free account. So significant can amount of money is able to be put away normally think, Oh, my 401k limit is 19,500. Maybe we got a couple of working people and they're putting it in there, but look how much we can get up to, into these tax deferred and tax free accounts.
If you have the capability of adding after tax contributions.Julie: [:Mike: [:
Maybe I can do the IRA, but I'm pretty much spending, the rest of my salary. As long as you have the salary and that's an important point. , these savings have to be from salary. Okay. So you have to make at least 128,000 to be able to save it into these accounts. But as long as you have that income, even if you're spending it in your just day-to-day living, you could still transfer after tax contributions from , your brokerage account over to your 401k.
So it's not necessarily oh, I don't have the money this year, from my income. If you have that taxable savings, this is a way of shoving it into, better accounts for less tax payments.Julie: [:Mike: [:
Where you can turbocharge a lot of this stuff as well. So say we have one person who has both working for a company, but also as a side hustle, has a business or something else on the side. So you can max out your 401k contributions to your employer. $19,500 and the company matches 10,000.
So you still get 29 five you could do after tax contributions. 28, five still is same as before. But if you have a side business where you're making say $75,000, that business could open a solo 401k, and you can't contribute as an employee because you're max out at 19,500, no matter how many 401ks you have.
So you can split it up and say, I'll do something to this 401k and some of this other one, but you can't do more than 19 five total across all your 401ks, but you can do after tax contributions. So you could put in another $58,000 as after tax contributions, or maybe that self-employment in the 401k of profit sharing.
So maybe the employer is putting in some, and then you can bump up the rest with after tax, roll it over to the Roth. And so you can still save over $120,000, even as a single self-employed, if you have access to a couple of these employer plans. So again, yeah,Julie: [:Mike: [:Julie: [:Mike: [:
on that, just to that,Julie: [:
Then you can't contribute more than 20,000 on that side because your income from that business was only 20,000. So you could do after tax contributions of 20,000, but not more than that.Julie: [:Mike: [:
. But that's important point, having, you have to have the income. The other thing to mention is that required minimum distributions. Once you reached the age of 72, you are required to take distributions from 401ks.
It doesn't matter if they're traditional or Roth. . The Roth. You're not going to pay taxes on that, but we'd rather leave the money in there if you didn't need it that year, that you turned 72. So the way to do that is to roll the 401k Roth balance into a Roth IRA. And you can do that again. The 401k plan sponsor, you let them know.
I want to take this 300,000 that's in the Roth side, I have 200,000 in traditional and 300 in the Roth. I'd like to roll the 300 into my own Roth IRA because Roth IRAs do not have minimum distributions. Does that make sense?Julie: [:Mike: [:Julie: [:
regular Roth.Mike: [:Julie: [:Mike: [:
$150,000 there. And typically you're not looking at the breakdown, which is on which half it's just, Oh, I've got 150,000 saved. Some of it's Roth, some of it's traditional. Okay. Now you can dive into that. Like I said, when you get your statements, you can see, Oh yeah. 50,000 is on the Roth side, a hundred thousands on the traditional side, but it's usually lumped together at the very top of that piece of paper.Julie: [:Mike: [:
As an individual plan, both traditional Roth can be applied to both 401k and IRA.Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:
When we know how that works, tax-free forever into a Roth IRA. Oh. Which is the exact same tax-free forever. So the government says, yes, you're allowed to do that because we're not losing out on any of our taxes. So as much as you want to roll from your Roth, 401k into your own Roth IRA, you're allowed to do that.
No problem, because it's all the same to you now. Difference though that I highlighted is that the 401k plan documents will make you take required minimum distributions, and they don't care where it comes from. They're saying you just have to take it. So we want to get that into the IRA because the IRA doesn't have that.Julie: [:Mike: [:
Account types. Here's the important thing. If your plan document allows you to make after-tax contributions to your 401k and do in plan Roth conversions. You want to look at that? I could have said that right at the top.Julie: [:Mike: [:Julie: [:Mike: [: