After-Tax Contribution is a type of deposit made into specific accounts like a Roth IRA or a 401(k) after taxes have already been deducted from your income.
After-Tax Contribution Explained
When planning for retirement or other long-term goals, contributions to savings plans are generally top of mind. But not all contributions are created equal. After-Tax Contribution is a type of deposit made into specific accounts like a Roth IRA or a 401(k) after taxes have already been deducted from your income.
In simpler terms, this is the money you invest that you’ve already paid taxes on.
Because these contributions are made with after-tax dollars, they hold a distinct advantage: the distributions (withdrawals) are usually tax-free, depending on the specific account rules and conditions.
This can be a real boon during retirement when a lower tax liability can significantly impact your financial well-being.
Why is this crucial to know? After-tax contributions offer a unique balance of benefits and trade-offs. While you pay taxes upfront, your future self could reap the rewards of tax-free withdrawals.
The after-tax approach is a powerful strategy for individuals expecting to be in a higher tax bracket during retirement, making it a popular choice for strategic tax planning.
An Example Of An After-Tax Contribution
If you earn $100,000 annually and are in a 25% tax bracket, you’ll have $75,000 left after taxes. If you decide to contribute $5,000 to a Roth IRA, this is considered an after-tax contribution, as it comes from your already taxed income.
Can I make both pre-tax and after-tax contributions?
Yes, some accounts like 401(k)s allow for both types of contributions, depending on your employer’s plan rules.
Are there limits on how much I can contribute after-tax?
Yes, contribution limits are set annually and vary depending on the type of account. For example, Roth IRAs have different limits than 401(k) plans.
How do after-tax contributions affect my tax returns?
Since these contributions are made with money that’s already been taxed, they typically don’t affect your tax liability for the year in which they’re made.