Using Roth and After-Tax Investing to Your Advantage

When it comes to planning for retirement, there's a lot to consider. The world of after-tax investing can seem like a maze, with various options and turns like Roth IRAs, Roth 401(k)s, and after-tax 401(k) contributions. But don't worry – we're here to break it down for you in simpler terms.

The Smart Approach to Retirement Planning

Have you ever noticed that people who are really good at saving for retirement tend to have a certain mindset? They're optimistic about the future but also realistic about what it takes to get there.. . These savvy investors understand that preparing for retirement requires careful planning and consistent effort, and for good reason! When it comes to investing in retirement accounts, there are numerous considerations. Mistakes or oversights can lead to expensive consequences. That's why it's crucial to understand your options and make informed decisions.  So, let's dive into the world of after-tax investing. We'll explore Roth IRAs, Roth 401(k)s, and those less-known "after-tax" 401(k) contributions. By the end of this article, we hope you'll have a clearer understanding of these options and be better equipped to choose the right path for your retirement savings.

Roth 401(k)s: A Powerful Tool for Retirement Savings

Roth 401(k)s are relatively new on the retirement scene, having appeared not too long ago. They combine features of traditional 401(k)s and Roth IRAs, making them a versatile option for many savers.  Here's what you may want to know about Roth 401(k)s:

1. They're employer-sponsored, like traditional 401(k)s.

2. Contributions are made with after-tax dollars.

3. Your money grows tax-free, and you won't pay taxes when you withdraw it in retirement.

4. There are no income limits for contributions (unlike Roth IRAs!)

5. Many employers offer a match on your contributions!

6. For 2024, you can contribute up to $23,000 if you're under 50, or $30,500 if you're 50 or older.

Roth 401(k)s are particularly attractive if you expect to be in a higher tax bracket in retirement or want to not give the government tax on this money in the future.  By paying taxes on your contributions now, you're setting yourself up for tax-free withdrawals in the future, pretty awesome right?

Roth IRAs: Flexibility and Control

Roth IRAs offer some unique advantages that make them popular among retirement investors. While they don't allow as big of contribution as Roth 401(k)s, they provide more flexibility in terms of investment choices and access to your money as certain ages.  Some key points about Roth IRAs:

1. You can access the money you’ve put into your Roth IRA as any age.  We’ve seen this be very valuable for people when retiring early or get into a financial pinch.

2. Roth IRAs are not employer-sponsored so don’t work through your company.

3. You can use the full Roth IRA contribution limit as well as your full 401(k) contribution limit.

4. Contributions are made with after-tax dollars, mean you don’t get a tax deduction the year you make the contribution.

5. Your money grows tax-free, and withdrawals in retirement are tax-free!

6. There are income limits for contributions. For 2024, if you're single and your Modified Adjusted Gross Income is over $146,000 (or $230,000 for married filing jointly), you may phase out and can’t contribute to a Roth IRA (yes, there are backdoor Roth strategies if you’ve heard of that)

7. The contribution limit for 2024 is $7,000 if you're under 50, or $8,000 if you're 50 or older.

Roth IRAs are great for those who want more control over their investments and appreciate the flexibility of being able to withdraw contributions (but not earnings) without penalties before retirement.

After-Tax 401(k) Contributions: An Often-Overlooked Option.

Now, let's talk about a lesser-known player in the after-tax investing game: after-tax 401(k) contributions. This option isn't available in all 401(k) plans, but if your plan offers it, it can be a powerful way to boost your retirement savings.  Here's what you should know about after-tax 401(k) contributions:

1. You can make these in addition to your regular pre-tax or Roth 401(k) contributions.

2. The money goes in after you've paid taxes on it so no tax deduction.

3. Your earnings grow tax-free, but you'll owe taxes on those earnings when you withdraw them.

4. There are no income limits.

5. The combined limit for all 401(k) contributions (pre-tax, Roth, and after-tax) is much higher than the standard limit.

Roth IRA Investing: What to Buy in Roth Accounts

When it comes to Roth IRA or Roth 401(k) investing, it's important to make the most of the tax-free growth potential. Here are some ideas for what to buy in Roth accounts:

1. Growth stocks: Companies with high growth potential can really benefit from the tax-free growth in a Roth account.  More growth in tax free accounts the more tax free assets you have!

2. Real Estate Investment Trusts (REITs): These typically pay high dividends, which can grow tax-free in a Roth.

3. High-yield bonds: The interest from these would normally be taxed at your ordinary income rate, but not in a Roth!

4. Small-cap stocks: These can be volatile but have high growth potential, making them ideal for long-term, tax-free growth.  If you’re comfortable with ups and downs but the potential for lots of growth small-cap stocks could be something to consider in your Roth accounts.

Remember, the key is to focus on investments that have the potential for significant growth or generate a lot of taxable income. This way, you're making the most of the tax-free nature of Roth accounts.

Choosing the Right After-Tax Option for You

With all these options available, how do you choose the right one for your situation? Here are some factors to consider:

1. Does your employer offer a Roth 401(k) or after-tax 401(k) contributions?

2. Are you eligible for a Roth IRA based on your income?

3. Do you expect to be in a higher tax bracket in retirement?

4. How much control do you want over your investment choices?

5. How much can you afford to save each year?

Remember, you're not limited to just one option. Many investors and planners like to use a combination of Roth accounts alongside pre-tax and taxable accounts to create a diversified retirement tax savings strategy.

The Bottom Line: Taking Control of Your Financial Future

Understanding after-tax investing options is an important tool in preparing for your financial future. Whether you choose a Roth 401(k), a Roth IRA, after-tax 401(k) contributions, or some combination of these, the important thing is that you're taking steps to prepare for retirement.  Here are some key takeaways:

1. Roth accounts offer tax-free growth and tax-free withdrawals in retirement.

2. Roth 401(k)s have higher contribution limits than Roth IRAs but may offer fewer investment options.

3. After-tax 401(k) contributions can allow you to save even more for retirement if your plan offers this option.

4. When investing in Roth accounts, focus on investments with high growth potential or those that generate a lot of taxable income.

Remember, while this guide can help you understand your options, it's not a substitute for personalized financial advice. Your situation is unique, and what works for one person might not be the best choice for another. It's always a good idea to learn as much as you can or consult with a fiduciary professional financial advisor who can help you navigate your specific financial situation.  By taking the time to understand these options and make informed decisions, you can really help set yourself up for a more financially improved retirement. It may take some effort now, but your future self will thank you for the careful planning and smart choices you're making today. 

Disclosures and Sources:

Sources: https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy. AI (artificial Intelligence) sourced articles may be prone to error, due to the vast information they assemble from the internet. Always confirm any questions or concerns you may have with an experienced professional. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual

Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.

Stock investing includes risks, including fluctuating prices and loss of principal

Asset allocation does not ensure a profit or protect against a loss.

 This is not considered tax advice.  Work with a tax professional.

 The prices of small cap stocks are generally more volatile than large cap stocks. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.