The phrase “after tax contributions” as it pertains to retirement accounts can often be a bit confusing. This article will discuss some of the common aspects of after tax contributions.
You might find it easier to understand the phrase if you think of after tax contributions as being voluntary contributions. These are contributions that you deposit into a retirement account or annuity after you have paid the required state and federal taxes on it.
Conversely, before tax contributions are those funds that you put into an account that have not been subject to taxes. When this money is withdrawn later on you will have to pay that tax at that time.
Generally speaking, most people prefer after tax contributions because when they withdraw the money they will not be taxed again. There is some belief (and perhaps rightly) that taxes only go up as time passes by, and that if they wait to pay the tax on their contributions later the tax will be higher.
Another important issue between the two is that if you take money out of a before tax account that amount of money will be added to your stated annual income for that year. In other words, if you make a salary of $40,000 and you take out $20,000 of before tax contributions your income tax for this year will be for the full $60,000, which can place a heavy burden on you when tax time comes around.
On the other hand, if your money was in an after tax contributions account, you can take that money out and since the taxes have already been paid on it, you face a much lower tax burden. You may have to pay some tax on the interest that has accrued, but that is all. Any money that you remove from an after tax account will come to you in full, just as if you were taking it out of a savings account.
As you can see, the differences between these two plans can be dramatic, so it is important to get the right plan for your needs. One way to make the best decision is to speak with a financial planner who can go through the various scenarios with you and help you decide which type of contribution program will benefit you the most.
You can also speak with the HR people at your work. They may be able to give you further insight into which plan is best for a person in your circumstance. They may also tell you that you have no choice but to use the program that they have set up. Even if you find yourself using a plan that you would rather not have, it is best to know how the programs can affect you should you ever need to take money out of your account, especially if you have to withdraw that money before retirement age. Learning more about after tax contributions can only help you later on when you need to use the money that was put into the account.