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    4. Updated—Roth 401(k) vs. After-Tax 401(k)

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    Article

    Updated—Roth 401(k) vs. After-Tax 401(k)

    Feb 25, 2019

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    By Mark Hannon

    While a Roth 401(k) and after-tax 401(k) involve making contributions using after-tax dollars, the two differ in a few key ways.

    How does a Roth 401(k) work?

    A Roth 401(k) is a type of employer-sponsored retirement savings plan in the US that combines features of a traditional 401(k) with those of a Roth IRA. An employer may match contributions and determine vesting schedules. Employees must use the financial institution or broker that the employer selects.

    Isn’t a Roth 401(k) the same as an after-tax 401(k)?

    First, Roth 401(k) contributions are subject to the usual 401(k) contribution limits. In 2024, that limit is $23,000, plus a $7,500 catch-up limit for individuals aged 50 and older. After-tax 401(k) contributions are not considered to be “deferrals” and are not subject to the $23,000/$30,500 limit. Therefore, after-tax 401(k) contributions can be higher as long as total 401(k) contributions don’t exceed $69,000 (or $76,500 if you’re 50 or older and making catch-up contributions).

    The IRS may adjust the contribution limits annually for inflation.

    The tax treatment of Roth 401(k) contributions and after-tax contributions is also different at withdrawal. While both contributions are tax-free at withdrawal, any earnings generated on Roth 401(k) contributions are tax-free but earnings generated on after-tax contributions are only tax-deferred and are taxed as ordinary income at the time of distribution.

    What happens to after-tax 401(k) contributions when I leave my job or retire?

    Your after-tax contributions can be rolled into a Roth IRA and any earnings can be rolled into a Traditional IRA. If you want to convert any of the earnings to Roth, taxes would be due—on the earnings portion only.

    Can you contribute to an IRA and 401k?

    Yes—these two account types are independent of each other and managed separately. Contributing to both is a savvy strategy for investors who can afford it, but may present challenges. For example, you may encounter limits on your ability to deduct contributions based on your income, and deducting your IRA contributions may not be straightforward if you participate in both types of plans. Both plans require you to stay within your accounts’ contribution limits.

    Who qualifies for a Roth 401(k)?

    A Roth 401(k) is generally available to any employee whose employer offers this retirement savings option as part of their benefits package. It may be a better option, compared to a traditional 401(k), for lower-income employees who anticipate moving into a higher tax bracket in the future, as a Roth 401(k) allows the individual to pay taxes on contributions at their current lower rate.

    What is this “back door” business with after-tax 401(k) contributions?

    A back door Roth IRA is a method used by taxpayers to place retirement savings in a Roth IRA, even if their income is higher than the maximum the IRS allows for regular Roth IRA contributions. After-tax 401(k) contributions can eventually be converted to Roth IRA without including earnings. This allows individuals whose income exceeds IRS Roth IRA contribution limits a “back door” to Roth IRA.

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    The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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