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Deductibility Limits on Traditional IRA Contributions & IRA Contribution Limits from 2002 to 2012
Hardship Withdrawals and Accessing 401(k) Loans
401(k) Rules – Contribution Limits, Catch-Up Contribution Rules, Vesting Rules, 401k Eligibility Rules
Salary Deferral Contributions Made to 401(k) Retirement Account
Important Year End Statements for Individual Retirement Account (IRA) Holders
5 Things Every 401(k) Plan Should Have
The Roth 401(k) – How After-Tax Contributions Work, Comparisons with Roth IRA, Future Tax Rates, Contribution Limits & Frequently Asked Questions
What is a Traditional IRA? History of IRAs, Eligibility Requirements, Ineligible Compensation, Distributions from a Traditional IRA & How Income Tax Deductions Work
How to Invest in Real Estate using your Individual Retirement Account (IRA)
Rolling your 401(k) – Trustee to Trustee Direct Rollover, Modified Adjusted Gross Income (MAGI) Income Limits for Deductible Contributions to a Traditional IRA
401(k) Vesting – How It Works, Vesting Schedule, Number of Years of Service
401(k) Lump Sum Distributions – Tax Advantages, Rollover to IRA, Tax Deferred Contributions and more
401k Rollovers to an Individual Retirement Account (IRA) – Things to Consider Before You Rollover, Avoid Transfer Penalties, Move Employer Stock, etc.
401(k) Withdrawals – Early Withdrawal Penalties, Rollover Withdrawals, Exceptions and Tax Consequences
Understanding the Rules for Participating in a 401(k) Plan, Beneficiary Appointment, 401(k) Plans for High Paid Employees

Most Popular Articles

Pre-tax versus After-tax 401(k) and IRA Contributions

WealthCycles.com - Gold & Silver Investing News

(August 27th, 2009)

Pre-tax 401k contributions are any contributions made to a 401k account from your bi-weekly gross income before any taxes are deducted. By making 401k contributions, you are getting a tax benefit now because you are lowering your current taxable income. For instance, if you earn $6,500 a month gross wage and contribute 15% of this to your employer sponsored 401(k) plan, this totals:

Your monthly taxable income before making 401(k) contributions =

$6,500
401k contributed amounts = $975 ($6,500 x 15%)
Your current lowered taxable income = $5,525

This is one of the main advantages of contributing to a 401k plan on a pre-tax basis; the fact that you can get an instant deduction on your income tax return. Thus, instead of paying taxes on your $6,500 wages every month, you will be taxed on $5,525 only! Nice isn’t it?

Another useful example is say you earn $75,000 a year gross wage and contribute 15% of this to your employer sponsored 401k plan. Note your total taxable income will be $63,750.

Annual Gross Income =
$75,000
Contribution Percent = 15%
Total annual contributions = $75,000 x 15% = $11,250
Taxable Income = $75,000 - $11,250 = $63,750

On the other hand, after-tax 401k contributions are contributions that you make to your retirement plan after you have paid taxes. For instance, consider you earn $75,000 this year and are in the 25% tax bracket. Here is how your calculations would work out:

Annual Gross Income =
$75,000
Taxable Percent = 25%
Taxes deducted = $18,750
Net Income $75,000 - $18,750 = $56,250
401k Contributions (15%) = $56,250 x 15% = $8,437.50

From these calculations, you see that you are making a contribution of $8,437.50 on a net income of $56,250 after you have taken care of the taxes. What this means is that when you retire and turn 65 years old, you will be able to withdraw this $8,437.50 plus investment gains on it without having to pay taxes again. This is one of the main advantages of contributing on an after-tax basis; you take care of the taxes now and do not have to worry about them upon retirement.

Summary of Differences between Pre-tax and After-tax 401(k) Contributions

Pre-Tax Contributions

After-Tax Contributions

- Contributions made from your gross income before taxes are paid.

- Lowered current taxable income as you receive a deduction from taxes

- Taxed as ordinary income upon withdrawal when you turn 65 years or upon retirement.

- Any withdrawals made before the age of 59 and ½ are subject to a 10% early withdrawal penalty and taxes.

- Contributions are made from your net income after you have paid taxes now.

- Your current taxable income is not lowered because you make contributions after having paid taxes.

- When you retire at 65, you will not be taxed during that time. Any earnings you have made on these contributions will be taxable as ordinary income upon withdrawal. For example, say you contributed $10,000 after paying taxes, and earned 10% on this contribution totalling $1000.

- Upon retirement when you make the withdrawal, you will be taxed in the ordinary tax bracket for $1000 and your $10,000 will not be taxed because you have already paid taxes on it once (before making the contribution).

- After-tax 401k contributions can be withdrawn if you meet any hardship withdrawal requirements.


 

 


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