People planning to setup or contribute to a retirement account, might be interested in learning all about after tax 401k contributions. Traditional 401k plans are tax-exempt, meaning you contribute money that hadn’t been taxed, and instead pay taxes when you withdraw your money. There are two main alternatives to these types of 401k contributions: after tax contributions, and contributions into Roth 401k plans. Unlike a traditional 401k, if you make contributions to either of these plans, you will have to pay taxes on the funds you invest. You have the option to make contributions to traditional 40k plans, after tax plans, and Roth 401k plans at the same time, provided your plan administrator allows this option.
Employers sometimes provide employees with the option to contribute after tax dollars to a 401 k account. These contributions are taken from an individual’s net pay, or from money that has already been taxed. After tax contributions do not lower your taxable income, nor do they provide the benefit of accruing interest tax free, so you will have to pay taxes on interest when you make a withdrawal. However, you are able to contribute amounts into these funds beyond the IRS imposed limits on traditional and Roth 401k plans. Another advantage is that because you make after tax contributions to these 401k accounts, the restrictions on withdrawing money prior to retirement age (59-and-a-half) are slightly less stringent than if you deposited the money tax deferred. Despite these advantages, you will often net higher earnings by investing in mutual funds or stocks, rather than by making after tax contributions to a 401 account. Before you elect to make after tax contributions, research other investment options.
A Roth 401k plan is an alternative to a traditional 401k plan. Just like a Roth IRA, interest earned in these accounts grows tax free, and is not subject to taxation upon withdrawal. Rather than providing investors with up-front tax savings, these savings are postponed until retirement. Investing in a Roth 401k, if your employer provides this option, is almost always a better option than making after tax contributions to a traditional 401k plan, because interest earned on after tax contributions is still taxable.
The IRS imposes yearly contribution limits on both traditional and Roth 401k plans. For 2011, the annual contribution limit is $16,500 for individuals under 50 years of age. Individuals over 50 can make catch-up contributions of $5,500, which allows them to make a total yearly contribution of $22,000 per year. Contributions that exceed these limits can be made as after tax contributions, or the excess can be returned before the end of the tax year. However, if you fail to stipulate that excess funds are part of an after-tax contribution, the IRS will tax you twice, once when you invest the funds, and a second time when you make a withdrawal. Thus, it’s important to keep track of how much you are contributing to 401k accounts, especially if you work multiple jobs, and are actively contributing to more than one account.