Here’s What To Think About When Deciding What To Do With Your Old 401k

April 11, 2025

If you have an old 401(k) account from an old job (or maybe even 2 or 3), you’re not alone – the number of people that work (or plan to work) for the same company for their entire career continues to shrink and that trend appears likely to continue. That doesn’t mean you shouldn’t be taking advantage of the opportunity to save in a tax-advantaged way through payroll deductions at each job. It just means you could have one more loose end to tie up when you switch jobs.

There are several options for your old 401(k) money – for some people the answer may be obvious, but for others a bit more nuanced. Let’s take a look at those options, along with the pros and cons of each to see which makes the most sense for you.

Option 1: Leave the account where it is

Many companies will allow you to keep your retirement savings in their plans after you leave your job (although most require your balance to be above a minimum level, typically $5,000). If you haven’t taken any action yet because you are deciding what to do next, this “default” option may work out fine as there are some good reasons to leave your account right where it is. The good news is that you can always change your mind and move it at a later time.

Reasons you’d choose this option:

  • Separation of service rules: If you leave your job in or after the year you turn 55, you are able to take withdrawals from your current 401(k) account without penalty prior to reaching age 59 ½, which is the normal age to access retirement savings without penalty.
  • Investment options: If you like the investment options within your former employer’s plan, you can stick with that familiarity. In some cases, that plan may offer unique investment options that you may not be able to hold in an IRA or your current job’s plan.
  • Lower costs: Many large employer-sponsored plans offer low-cost institutional share class mutual funds and index funds, which are generally less expensive to own than what’s available in individual accounts. While saving 0.5% each year on mutual fund expenses may not sound like much, it can really add up over a long period of time.

The thing to look out for:

  • Some employers opt to stop covering specific administrative fees for the accounts of former employees, so keep your eye on your statements after you’ve left, and if you start seeing a fee, that would be a reason to explore options 2 or 3.

Option 2: Roll it into your new employer’s plan

Rolling your account into the 401(k) plan with your new employer likely includes the same benefits as keeping it with the old plan. However, old retirement accounts are often neglected over time since you are no longer making contributions to the plan. Rolling (or transferring) the money into the new plan can offer some additional advantages as well.

Reasons you’d choose this option:

  • Simplicity: Having all your retirement savings together in your new plan could make it easier to track your progress while having everything under one log-in.
  • Ability to borrow: While borrowing from your retirement plan while still working is not usually recommended, many plans allow you to take 401(k) loans. Often this loan has a reasonable interest rate, and you pay the interest back to yourself, not the employer or 401(k) company. Rolling your old plan into your new one can give you a larger base from which to borrow should the need arise. Be careful though! Borrowing from your 401(k) comes with risk to your retirement and must be considered very carefully.

It should be noted that you will want to do this as a direct rollover, moving money directly from plan to plan. This makes your life easier by completing the rollover while also making sure the move does not become taxable.

Option 3: Roll over to an Individual Retirement Account (IRA)

Much like moving the funds to your new employer’s plan, you can instead roll the money directly into an IRA. The pre-tax money would be deposited into a traditional rollover IRA and Roth funds into a Roth IRA. Alternatively, you could roll pre-tax money into a Roth IRA, though it’s important to consider that rollover conversions of pre-tax money are taxed as income.

Reasons you’d choose this option:

  • Control: This option allows you to have the account at the financial institution of your choice. Many people like this idea as they feel they have more control of the funds and may have a larger selection of investment options beyond the limited menu of choices their employer’s plan may offer.

Reasons to NOT choose this option:

  • No separation of service rules: Once you move your money out of your 401(k) and into an IRA, you lose the ability to access the funds penalty-free if you left your job at or after age 55 – you’d have to wait until 59 ½.
  • Possible higher costs: Unless you work for a very small company with a limited 401(k) plan, your costs are likely to be higher overall with an IRA than with an employer-sponsored plan that can take advantage of institutional pricing.
  • The pro-rata rule for pre-tax IRAs: If you’ve ever considered using the “back-door” Roth IRA strategy, be aware that the presence of a pre-tax IRA can trigger tax consequences due to the pro-rata rule. Make sure you’re clear on how that works if you anticipate a higher income along with a desire to continue saving into a Roth IRA.

Option you should avoid unless absolutely necessary: Taking the money as a cash distribution

This is the least appealing option and should only be considered in the most extreme cases of financial hardship. Cash distributions are fully taxable and may be subject to a 10% penalty if you are under age 59 ½. This option is especially tempting when you have a small balance, but do your best to avoid it. Those small amounts add up!

So, if you are considering a job change – or have already made a change – consider all of your options in terms of the retirement account(s) you have left behind. And remember, you have time to make this decision, assuming your account balance exceeds the minimum rules.

NUA – One Overlooked Benefit Of Employer Stock In Your 401(k)

April 11, 2025

Should you own stock in your current or former employer? There are mixed opinions out there regarding the risk of holding too much stock in the same company that provides your paycheck, but before you liquidate a large holding in your 401(k), keep reading.

One little known benefit of holding company stock in a 401(k) plan is the ability to have the “net unrealized appreciation” of the stock or “NUA” taxed at a lower tax rate. Normally, when you take money out of a traditional 401(k), it’s taxed at your ordinary income tax rate. However, the gain in employer stock can be taxed at the lower long term capital gains rate if you meet several conditions:

Here’s how NUA works

1) You have to reach a triggering event. This can be death, disability, separation from service, or reaching age 59 ½. You can’t take advantage of this at any time. Most people take advantage of it upon retirement or after.

2) You have to take a lump sum distribution of the entire account. You can’t just withdraw the shares of stock. However, you can choose to roll the rest of the money into an IRA or another retirement account, while moving the company stock shares to a regular brokerage account.

3) The employer stock has to be distributed “in kind.” Basically, this means you can’t sell the shares and then withdraw the cash as you would typically withdraw money from a 401(k). Instead, you have to transfer the shares of stock into a brokerage firm.

If you meet the criteria above, then when you do a withdrawal of the company stock, you will pay ordinary income taxes on the cost basis of the stock (essentially the value of the stock when you purchased or received it) at that time. You may choose to hold the stock or liquidate some or all of it at that point. When you do so, you’ll pay taxes at the lower long term capital gains rate on any growth in the value of the shares beyond what you paid for them (regardless of how long you actually held them).

Be aware that withdrawing a large amount of stock could push you into a higher tax bracket for that year, so you’ll want to be strategic about when you make this move. However, removing the stock from your retirement account would also reduce the amount of required minimum distributions you’d have to take starting at age 73. (Incidentally, the capital gain would not be subject to the 3.8% Medicare surtax on investment income, but the stock would not benefit from a step-up in basis when you pass away.)

It’s about more than just the taxes

As the saying goes, don’t let the tax tail wag the dog. This is not a reason to load up on company stock. After all, individual stocks are always a lot riskier than diversified mutual funds since an individual stock can go to zero and never recover. This is even more true when it’s the company that your job is tied to. A good rule of thumb is to never have more than 10-15% of your portfolio in any one stock, especially your employer’s.

That being said, it could be a good reason to keep some money in company stock, especially if you already have shares that have appreciated quite a bit. In fact, this is one of the main reasons you may not want to roll a former employer’s retirement plan into an IRA or a new retirement plan while still working.

How to decide whether NUA is right for you

You can calculate the value of doing an NUA distribution versus an IRA rollover here. If you’re still not sure whether this makes sense for you, see if your employer offers access to an unbiased financial planner who can help you with what can be a complex decision, or consult your own financial advisor if not.

Why You Should Treat Your HSA Like an IRA

March 27, 2025

Would you raid your Roth IRA or 401(k) to pay for car repair bills? I suppose if you have no other choice, you might. But ordinarily, we want to use our tax-advantaged retirement accounts only as a last resort because we want that money to grow tax-free or tax-deferred for as long as possible. The HSA is the only account that allows us to make pre-tax contributions and withdraw them tax-free. Why then are we so willing to tap into our HSAs for medical expenses? Continue reading “Why You Should Treat Your HSA Like an IRA”

What To Do With Your Old Employer’s Retirement Plan

March 26, 2025

Have you ever had to leave a job and couldn’t decide what to do with your retirement plan? I recently got a Helpline call from a woman who was about to leave her company and had to make that exact decision. Let’s look at the pros and cons of the options:

Option 1: Cash it out

This is generally the worst decision since you have to pay taxes on anything you take out and possibly a 10% penalty if you’re under age 59 ½ and left your employer before the year you turned age 55. If you’re still working at a new job, the tax rate you pay is likely to be higher than it would be if you waited until retirement and if the balance is large enough, it could even push you into a higher tax bracket. You also lose the benefits of future tax-deferred growth.

That being said, if you absolutely need the money to get caught up on bills or to pay off debt, it may be your only choice.

Option 2: Roll it to an IRA

This option generally provides the most flexibility. It allows you to continue deferring the taxes while giving you more investment options than you may have in your current retirement plan. You also have the ability to use the money penalty-free for education expenses and for a first-time home purchase (up to $10k over your lifetime) or to convert it into a Roth IRA to grow potentially tax-free.

Option 3: Roll it into your new employer’s plan

If you want to keep things simple and consolidate everything into one account, this may be the choice for you. Just make sure the new plan allows it. It can also be the best choice if the new plan provides unique investment options that you’d like to take advantage of with this money or if you’d like to have the option of borrowing against it.

Option 4: Leave it where it is

As long as you have at least $5k in the account, most plans will allow you to keep the money there. If you have company stock or any unique investment options that you’d like to keep, this may be the best option for you. It also gives you time to decide during what is likely to be a hectic time in your life. After all, you can always roll it into an IRA or your new employer’s plan later. Just keep in mind that having too many retirement accounts in different places can make it harder to manage them.

In this particular case, the woman decided to simply leave it where it was because she had turned 55 and wanted to have the option to take penalty-free withdrawals if she needed to. If she rolled it into an IRA or a new employer’s plan, she would have had to wait until age 59 ½ to avoid the penalty.

That doesn’t mean it’s the best choice for everyone. Every situation is different. The key is to understand your options so you can make the best choice for you.

The 401(k) Self-Directed Brokerage Window

February 09, 2025

Are you a hands-on investor seeking investments beyond your 401(k) plan’s core list of investment choices? If so, you may have a self-directed brokerage account (SDBA) option in your retirement plan.

Who typically uses a self-directed brokerage account in a 401(k) plan?

SDBAs are intended for experienced investors who are comfortable making their own investment decisions. This option is generally popular among savers with larger retirement plan balances or who work with an outside financial advisor. For example, Schwab recently reported that the average account balance of those using this option is just over $273,000. Compare this to Fidelity’s reported average balance of all 401(k) participants, which is just under $104,000.

What does a self-directed brokerage account offer?

The main benefit is that SDBAs give you more flexibility regarding the investment options available. Wider access can be a refreshing alternative if you are generally unhappy with the currently available investment options.

For example, let’s say your 401(k) plan doesn’t include target-date or asset allocation funds. With the SDBA, you can add those funds to your retirement portfolio. This can be appealing if you’re trying to access asset classes not represented in your core portfolio. Examples include emerging market stocks, international small cap, and value or growth-oriented funds. SDBAs can even help you diversify with alternative asset classes such as real estate and commodities.

Beware of the paralysis of too many choices

But as behavioral finance studies on the paradox of choice have shown us, too many options can hinder participation. This is true for 401(k) plans as well. Choosing the right investments for your goals, risk tolerance, and time horizon also requires discipline. Most investors lack a written game plan or investment policy statement. As a result, many individual investors are prone to the “behavior gap” and underperform the actual funds they own due to mistakes related to emotional decision-making and market timing. 

Self-directed brokerage accounts are designed for advanced investors who know how to research and manage their investments. Bankrate warns investors that the additional choices commonly associated with self-directed accounts do not lead to better outcomes for most investors. In order to follow a disciplined investment plan, focus on things within your control, such as asset allocation, contribution rates, minimizing costs, and asset location (i.e., pre-tax vs. Roth 401(k)).

Pay attention to the fees

It’s important to note that while SDBAs offer greater investment flexibility, they may also come with higher fees. These fees can include transaction fees, account maintenance fees, and trading commissions. So, carefully consider the costs and benefits of an SDBA and your investment objectives and risk tolerance before opening one.

Minimizing your overall investment costs is one thing you have some control over as an investor. So, it’s equally important to understand all fees and expenses as it is to know your core 401(k) plan expenses.

Some 401(k) plans charge an annual maintenance fee for using the mutual fund or brokerage window. It is also necessary to identify if there are any commissions and transaction costs associated with trades made through SDBA accounts. You can check your plan’s fee disclosure to better understand the actual costs related to your 401(k) plan.

Check mutual fund expenses

In some cases, you may also see increased mutual fund expenses when you go outside your core investment options. This is because most funds available in the SDBA are retail share classes. Retail share classes tend to be much more expensive than the institutional funds many large retirement plans provide access to. On the other hand, if your 401(k) plan has expensive mutual funds, the self-directed brokerage account is a potential remedy.

How does its performance compare?

Finally, it is important to note that there is a reason self-directed brokerage accounts are underutilized. The average investor is often better served by simplifying their investments as much as possible. That is why it is important to establish benchmarks to track your performance.

Self-directed brokerage accounts give you an opportunity to try to outperform or diversify your plan’s core options. But if you choose to take the self-direct route and find that your investment performance consistently lags behind the core investment portfolio, you may need to take a simpler approach to your retirement savings plan.

Mega Roth Conversions

February 09, 2025

What Is An HSA And Why Should I Participate?

February 09, 2025

An HSA is a type of tax-deferred account designed to help you save for your health care costs for current and future years. An HSA essentially works like an IRA for medical expenses. However, it differs from a Flexible Spending Account (FSA) in that money not spent in a calendar year can remain in the account to be used in future years – or retirement.

HSAs are only available to you if you have coverage through a qualifying high-deductible major medical health plan, referred to as an HDHP. If you can participate in an HSA, you should know these facts:

  • HSAs can be funded with pre-tax income up to certain IRS limits. The money can be withdrawn tax-free for qualified medical expenses, including prescription drugs.
  • You can reimburse yourself right away for qualified medical expenses, or at any time in the future, as long as your HSA was open when the expense was incurred. Just hold on to your receipts, bills, or explanation of benefits.
  • You can also make contributions directly to an HSA via deposit for the prior tax year up until the tax filing deadline (generally April 15th).
  • You may not contribute to an HSA if you are covered by a non-high deductible medical plan including Medicare, TRICARE, a spouse’s family plan, or an FSA or HRA (yours or your spouse’s, unless it is limited purpose).
  • The amount of your HSA contribution directly reduces your taxable income for federal tax purposes, and in most states (CA and NJ are exceptions), so you will pay tax on less income overall.
  • Any money not spent in the year contributed grows tax-free (for federal and most states) in the investment funds you choose, if an investment option is available.
  • If withdrawn for non-qualified medical expenses before age 65, the money will be taxed as ordinary income and will incur a 20% penalty as well. However, once you turn 65, the money may be withdrawn for non-qualified medical expenses without this penalty (only the taxes will be due).
  • HSA accounts may be transferred if you change employers, similar to a rollover from one 401(k) to another.

ACTION ITEMS:

1. Consider participating in an HSA if you want to save money by paying for qualified medical expenses with tax-free dollars or you are looking for other ways to save for retirement on a tax-preferred basis.

2. Be aware that a high-deductible health plan with an HSA may not be the best option for those who have ongoing medical conditions and treatments, or for those who do not have sufficient funds set aside to pay the higher out-of-pocket costs.

3. If you plan to defer much of your HSA balance until retirement, make sure to invest for the long term among the investment options available to you.

Why You Should Max Out Your HSA Before Your 401(k)

February 09, 2025

Considering that most employers are offering a high-deductible HSA-eligible health insurance plan these days, chances are that you’ve at least heard of health saving accounts (“HSAs”) even if you’re not already enrolled in one. People who are used to more robust coverage under HMO or PPO plans may be hesitant to sign up for insurance that puts the first couple thousand dollars or more of health care expenses on them, but as the plans gain in popularity in the benefits world, more and more people are realizing the benefit of selecting an HSA plan over a PPO or other higher premium, lower deductible options.

For people with very low health costs, HSAs are almost a no-brainer, especially in situations where their employer contributes to their account to help offset the deductible (like mine does). If you don’t spend that money, it’s yours to keep and rolls over year after year for when you do eventually need it, perhaps in retirement to help pay Medicare Part B or long-term care insurance premiums.

Not just for super healthy people

But HSAs can still be a great deal even if you have higher health costs. I reached the out-of-pocket maximum in my healthcare plan last year, and yet I continue to choose the high-deductible plan solely because I want the ability to max out the HSA contribution. Higher income participants looking for any way to reduce taxable income appreciate the ability to exclude up to IRS limits each year. It beats the much lower FSA (flexible spending account) limit.

Even more tax benefits than your 401(k)

Because HSA rules allow funds to carryover indefinitely with the triple tax-free benefit of funds going in tax-free, growing tax-free and coming out tax-free for qualified medical expenses, I have yet to find a reason that someone wouldn’t choose to max out their HSA before funding their 401(k) or other retirement account beyond their employer’s match. Health care costs are one of the biggest uncertainties both while working and when it comes to retirement planning.

A large medical expense for people without adequate emergency savings often leads to 401(k) loans or even worse, early withdrawals, incurring additional tax and early withdrawal penalties to add to the financial woes. Directing that savings instead to an HSA helps ensure that not only are funds available when such expenses come up, but participants actually save on taxes rather than cause additional tax burdens.

Heading off future medical expenses

The same consideration goes for healthcare costs in retirement. Having tax-free funds available to pay those costs rather than requiring a taxable 401(k) or IRA distribution can make a huge difference to retirees with limited funds. Should you find yourself robustly healthy in your later years with little need for healthcare-specific savings, HSA funds are also accessible for distribution for any purpose without penalty once the owner reaches age 65. Non-qualified withdrawals are taxable, but so are withdrawals from pre-tax retirement accounts, making the HSA a fantastic alternative to saving for retirement.

Making the most of all your savings options

To summarize, when prioritizing long-term savings while enrolled in HSA-eligible healthcare plans, I would strongly suggest that the order of dollars should go as follows:

  1. Contribute enough to any workplace retirement plan to earn your maximum match.
  2. Then max out your HSA.
  3. Finally, go back and fund other retirement savings like a Roth IRA (if you’re eligible) or your workplace plan.

Contributing via payroll versus lump sum deposits

Remember that HSA contributions can be made via payroll deduction if your plan is through your employer, and contributions can be changed at any time. You can also make contributions via lump sum through your HSA provider, although funds deposited that way do not save you the 7.65% FICA tax as they would when depositing via payroll.

The bottom line is that when deciding between HSA healthcare plans and other plans, there’s more to consider than just current healthcare costs. An HSA can be an important part of your long-term retirement savings and have a big impact on your lifetime income tax bill. Ignore it at your peril.

Should You Contribute To Pre-Tax Or Roth 401k?

February 07, 2025

For all the efforts that companies undertake to make participating in their retirement plan benefits easy, there’s no simple way to help employees decide whether the money they contribute from their own paychecks should be traditional (also called pre-tax) or Roth (also sometimes called after-tax Roth). The answer can be very nuanced depending on your situation, and for the most part, we won’t know whether we chose correctly until it’s too late. We’ll only really know if we got the answer right when it comes time to withdraw and we actually know our taxable income, current tax brackets, and lifestyle needs.

Since my crystal ball seems to be broken, I’ve attempted to distill the various factors in a way that makes more sense. Keep in mind that many of the factors listed in the chart below are just different ways of saying the same thing, but the intention is to present it in the way that makes the most sense to you.

The biggest factor affecting this decision: taxes

If we all could just know what tax rates will be when we retire and start withdrawing from our retirement savings, along with what our own income will be at that point, this would be a simple choice – if you knew your tax rate would be lower when withdrawing from your retirement account, you’d choose pre-tax and avoid paying taxes on the money today so that you could pay at a lower rate in the future.

On the flip side, if you knew that tax rates would be higher when you’re withdrawing and you’d be paying more in taxes, choose Roth to pay today’s lower rates, then enjoy your savings without tax consequences in the future.

Predicting the future of tax rates

I’m personally making Roth contributions right now in my 401(k) because I believe that we are currently experiencing the lowest tax rates I’ll see in my lifetime. And while I very well may have a lower income in retirement, the tax brackets themselves may be different, so even if I have a lower income, I think I might have a higher tax rate in the future. (keep in mind that I could be wrong about this – reason tells me that tax rates will have to go up in the future, but Congress has surprised us before!)

I like that I can change this strategy at any time. For example, when my husband sold some stock he’d been given as a child for a big capital gain, I switched to pre-tax for the rest of that year in an effort to lower our overall taxable income.

Income limits and the ability to withdraw without taxes

I also like the idea of having investments available to me in retirement that I can liquidate and withdraw without concern for the tax consequences, and my husband and I have too high of a combined income to contribute to Roth IRAs, so I like that the Roth 401(k) doesn’t have an income limit.

Now, there is a way around those income limits using a “back-door” Roth IRA, but that doesn’t work for me because I also have a rather large rollover traditional IRA.

Another consideration: access to the contributions for early retirement

You can’t withdraw Roth 401(k) contributions before 59 1/2 without penalty. However, you can withdraw contributions to a Roth IRA early. If you’re lucky enough to retire before then, you can always roll your Roth 401(k) into a Roth IRA. Then, tap those contributions if necessary, without concern for taxes or early withdrawal penalties. That’s another reason you want to at least have some retirement savings as Roth, regardless of tax rates.

Factors to consider:

Factor:Traditional (pre-tax)Roth (after-tax)
You think your taxes are higher today than they’ll be when you withdrawMakes more senseMakes less sense
You think your taxes are lower today than they’ll be when you withdrawMakes less senseMakes more sense
You want to avoid required distributions after age 73Makes less senseMakes more sense, as long as you roll to a Roth IRA
You think your income tax bracket will be lower when you withdrawMakes more senseMakes less sense
You think your income tax bracket will be higher when you withdrawMakes less senseMakes more sense
You need more tax deductions todayMakes more senseMakes less sense
You have a long time until withdrawal and plan to invest aggressivelyMakes less senseMakes more sense
You’d like access to your contributions before the traditional retirement ageDoesn’t make senseMakes sense

Splitting the difference

If you’re unsure or thinking about it makes your head hurt, you could always split your contributions between the two. In other words, if you’re putting 10% away, you could do 5% pre-tax and 5% Roth. The contribution limit applies as a total for both. However, there’s no rule that you have to put your money into just one bucket or the other at a time.

One more thing to know

No matter your contribution type, any matching dollars or employer contributions will always be pre-tax, per IRS rules. So even if you put all your own contributions into Roth, you’ll still have pre-tax money if you receive any from your job. Now, you may be able to convert those contributions to Roth, depending on plan rules. But if you do that, you’ll have to pay taxes on the amount converted, so plan carefully.

Why You Should Treat Your HSA Like An IRA

February 07, 2025

Would you raid your Roth IRA or 401(k) to pay for car repair bills? I suppose if you have no other choice, you might. But ordinarily, we want to use our tax-advantaged retirement accounts only as a last resort because we want that money to grow tax-free or tax-deferred for as long as possible.

The HSA is the only account that allows us to make pre-tax contributions and withdraw them tax-free. Why then are we so willing to tap into our HSAs for medical expenses?

Making the most of your HSA

Yes, there’s no tax or penalty on those withdrawals since that’s what they’re meant to be used for. But HSAs can also be a tax-free retirement account since the money grows to be tax-free if used for medical expenses at any time, including retirement.

Since there’s a pretty good chance you’ll have some health care costs in retirement, you can count on being able to use that money tax-free. (If you keep the receipts for health care expenses you pay out-of-pocket, you can also withdraw that amount tax-free from the HSA later since there’s no time limit between the medical expense and the withdrawal.) You can also use the money penalty-free for any expense after age 65, although it would be taxable just like a pre-tax retirement account.

An example

Let’s say you contribute $3k per year to an HSA and don’t touch the money for 30 years. If you just earn an average of 1% in a savings account, you will have over $105k. But if you invest that $3k each year and earn a 7% average annual return, you’ll end up with over $300k or almost 3 times as much!

That’s why I recently decided to take advantage of our company’s switch to a new HSA custodian by transferring my HSA funds from a savings account to an HSA brokerage account. Since I don’t intend to touch this money for a few decades, I can invest it more aggressively and hopefully earn a higher rate of return. In the meantime, I’ll just pay my health care costs out of my regular income and savings.

Take care with any fees

One little hiccup that I noticed is that my custodian charges a $3 fee for the brokerage account if I don’t keep at least $5k in the savings account. At first glance, it’s tempting to keep $5k in the savings account to avoid that fee but the $36 a year in fees is only .72% of the $5k. That means if I can just earn more than an extra .72% in the brokerage account, I’ll be ahead. Given historical returns, I think that’s a pretty good bet.

Guidelines for making the most of your HSA

Here are some guidelines to make the best use of your HSA:

  1. First, make sure you have an adequate emergency fund to cover health care expenses. If not, ignore everything in this blog post until you do.
  2. If you have the option of a health care plan with an HSA, consider getting it. The premiums are lower so you generally save money in the long run if you’re in good health.
  3. Try to max out your contributions. (If you do it through payroll deductions into a section 125 cafeteria plan, you can also avoid FICA tax on the contributions). Aside from getting the match on your 401(k) and paying off high interest debt, this is generally the best use of your money because  the contributions are both pre-tax and can be withdrawn tax-free (for health care expenses).
  4. If you have a brokerage option, invest as much of your HSA as you can in a portfolio that’s appropriate for your time horizon and risk tolerance. (Make sure your expected returns justify any fees you may have to pay.)
  5. Don’t touch your HSA money unless you absolutely need to. Instead, use your regular savings (see #1) to cover medical expenses.
  6. Keep the receipts for any health care expenses you pay out-of-pocket since you can withdraw those amounts from your HSA tax-free anytime.
  7. Have tax-free money to help cover health care expenses in retirement!

How To Contribute to a Roth IRA If You Make Too Much

February 07, 2025

There are multiple reasons to contribute to a Roth IRA, but if you make too much money, the Roth may not seem to be an option. However, there are a few things to keep in mind before completely writing off the Roth IRA.

The limit is based on MAGI, not total income

One is that the income limits are based on MAGI (modified adjusted gross income). That means if you contribute enough to a pre-tax 401(k) or similar qualified retirement plan, you may be able to bring your MAGI below the income limits.

Income limits apply to contributions, but not to conversions

The bigger point here for people whose MAGI far exceeds the income limits is the fact that there is no income limit to converting a traditional IRA into a Roth IRA. This is the key that allows people who make too much money to put money directly into a Roth IRA to still participate.

How it works

You can simply contribute to a traditional IRA and then convert your traditional IRA into a Roth IRA. Anyone can contribute, regardless of income levels, but many people don’t because it’s not tax-deductible if you earn too much to contribute to an IRA and are covered by a retirement plan at work.

This is called a “backdoor” Roth IRA contribution. Since it’s really a conversion rather than a contribution, you may have to wait 5 years before you can withdraw the amount you converted penalty-free before age 59 1/2. You’ll have to file IRS Form 8606 to document the non-deducted contribution to the traditional IRA, which will offset the 1099-R form you’ll receive for the conversion.

If you already have a traditional IRA, beware the pro-rata rule

There is a potentially huge caveat to this strategy though. If you have other funds in a traditional (pre-tax) IRA already that you aren’t converting, you have to pay taxes on the same percentage of the conversion amount as you have in total IRA dollars that are pre-tax. That means you could end up owing taxes on the conversion even if all the money you convert was nondeductible and thus after-tax.

Here’s what I mean

For example, let’s say that you have an existing IRA with $95k of pre-tax money and you contribute $5k to a new IRA after-tax. Since 95% of your total IRA money is pre-tax (because it was already there before and presumably contributed pre-tax), 95% of any money you convert to a Roth IRA is taxable even if you convert the new IRA with all after-tax money.

In other words, the IRS looks at all of your IRAs as if they were one account and taxes your conversions on a pro-rata basis. In this case, you would owe taxes on 95% of the $5k you convert — basically you’d have $4,750 of taxable income. So you can still do it, and $250 would be converted without causing a tax effect. It’s just not a tax-free transaction.

One way to avoid the pro-rata rule

The good news is that there may be a way to avoid this. If your current job’s retirement plan will allow you to roll your existing IRA money into your existing employer’s retirement plan, then you’d be eliminating the need to pro-rate by no longer having an existing pre-tax IRA. If you move your IRA into your 401(k), then complete the “backdoor” transaction, the only IRA money you would have in this example would be the $5k after-tax IRA, so you won’t pay any taxes on the conversion since 0% of your total IRA money is pre-tax.

Still not a bad deal

Even if you can’t avoid the tax on the conversion, it’s not necessarily a bad deal. After all, you or your heirs will have to pay taxes on your IRA money someday. By converting some (or all) of it into a Roth, at least future earnings can grow tax-free. It’s probably not worth it if you have to withdraw money from the IRA to pay taxes on the conversion.

So there you have it. You can contribute to a Roth IRA one way or another as long as you have some type of earned income. Otherwise, you won’t be able to contribute to a traditional IRA either.

Is It The Right Time To Convert To Roth?

February 06, 2025

Are you wondering if you should convert your retirement account to a Roth by the end of the year? After all, there’s no income limit on IRA conversions. Many employers are now allowing employees to convert their company retirement plan balances to Roth while they’re still working there. At first glance, it may sound appealing. Earnings in a Roth can grow tax-free, and who doesn’t like tax-free? However, here are some reasons why now might not be the time for a Roth conversion:

3 reasons you might not convert to Roth this year

1) You have to withdraw money from the retirement account to pay the taxes. If you have to pay the taxes from money you withdraw from the account, it usually doesn’t make financial sense as that money will no longer be growing for your retirement. This is even more of a tax concern if the withdrawal is subject to a 10% early withdrawal penalty.

2) You’ll pay a lower tax rate in retirement. This can be a tricky one because the tendency is to compare your current tax bracket with what you expect it to be in retirement. There are a couple of things to keep in mind though. One is that the conversion itself can push you into a higher tax bracket. The second is that when you eventually withdraw the money from your non-Roth retirement account, it won’t all be taxed at that rate.

You can calculate your marginal tax bracket and effective average tax rate here for current and projected retirement income. (Don’t factor in inflation for your future retirement income since the tax brackets are adjusted for inflation too.) The tax you pay on the conversion is your current marginal tax bracket. However, the tax you avoid on the Roth IRA withdrawals is your future effective average tax rate.

3) You have a child applying for financial aid. A Roth conversion would increase your reported income on financial aid forms and potentially reduce your child’s financial aid eligibility. You can estimate your expected family contribution to college bills based on your taxable income here.

Of course, there are also situations where a Roth conversion makes sense:

6 reasons to consider converting to Roth this year

1) Your investments are down in value. This could be an opportunity to pay taxes while they’re low and then a long-term investment time horizon allows them to grow tax-free. When the markets give you a temporary investment lemon, a Roth conversion lets you turn it into tax lemonade.

2) You think the tax rate could be higher upon withdrawal. You may not have worked at least part of the year (in school, taking time off to care for a child, or just in between jobs), have larger than usual deductions, or have other reasons to be in a lower tax bracket this year. In that case, this could be a good time to pay the tax on a Roth conversion.

You may also rather pay taxes on the money now since you expect the money to be taxed at a higher rate in the future. Perhaps you’re getting a large pension or have other income that will fill in the lower tax brackets in retirement. Maybe you’re worried about tax rates going higher by the time you retire. You may also intend to pass the account on to heirs that could be in a higher tax bracket.

3) You have money to pay the taxes outside of the retirement account.  By using the money to pay the tax on the conversion, it’s like you’re making a “contribution” to the account. Let’s say you have $24k sitting in a savings account and you’re going to convert a $100k pre-tax IRA to a Roth IRA. At a 24% tax rate, the $100k pre-tax IRA is equivalent to a $76k Roth IRA. By converting and using money outside of the account to pay the taxes, the $100k pre-tax IRA balance becomes a $100k Roth IRA balance, which is equivalent to a $24k “contribution” to the Roth IRA.

Had you simply invested the $24k in a taxable account, you’d have to pay taxes on the earnings. By transferring the value into the Roth IRA, the earnings grow tax free.

4) You want to use the money for a non-qualified expense in 5 years or more. After you convert and wait 5 years, you can withdraw the amount you converted at any time and for any reason, without tax or penalty. Just be aware that if you withdraw any post-conversion earnings before age 59½, you may have to pay income taxes plus a 10% penalty tax.

5) You might retire before age 65. 65 is the earliest you’re eligible for Medicare so if you retire before that, you might need to purchase health insurance through the Affordable Care Act. The subsidies in that program are based on your taxable income, so tax-free withdrawals from a Roth account wouldn’t count against you.

6) You want to avoid required minimum distributions (RMDs). Unlike traditional IRAs, 401ks, and other retirement accounts that require distributions starting at age 73 (or 70½, depending on your age), Roth IRAs are not subject to RMDs so more of your money grows tax free for longer. If this is your motivation, remember that you can always wait to convert until you retire, when you might pay a lower tax rate. Also keep in mind, Roth conversions are not a one-time-only event. You can do multiple conversions and spread the tax impact over different tax years if you are concerned about pushing your income into a higher tax bracket in any particular year.

There are good reasons to convert and not to convert to a Roth. Don’t just do what sounds good or blindly follow what other people are doing. Ask yourself if it’s a good time for you based on your situation or consult an unbiased financial planner for guidance. If now is not the right time, you can always convert when the timing is right.

What is a 403(b) Plan?

February 06, 2025

What is a 403(b) Plan?

If you have ever worked for a nonprofit organization, you likely have heard the term 403(b) retirement plan. While not as common as the 401(k), a 403(b) shares many of the same benefits that make it a very powerful retirement tool for those working for public schools and other tax-exempt organizations.

The Details

As noted above, 403(b) plans have much in common with the 401(k) plan, which is very common in the private sector. Participants that may have access to 403(b) include:

  • Employees of public schools, state colleges, and universities
  • Church employees
  • Employees of tax-exempt 501(c)(3) organizations

The 403(b) plan has the same caps on annual contribution as 401(k) plans.

Employers can match contributions based on the specific plan details, which vary from employer to employer. 

Employees may also be able to contribute to a pre-tax 403(b) and/or Roth 403(b), as both options may be available based on the plan details. A traditional 403(b) plan allows employees to have pre-tax money automatically deducted from each paycheck and deposited into their retirement account. The employee receives a tax break as these contributions lower their gross income (and income taxes owed for the year). The taxes will be due on that money only when the employee withdraws it in retirement.

A Roth 403(b) is funded with after-tax money, with no immediate tax advantage. But the employee will not owe any more taxes on that money or the profit it accrues when it is withdrawn (if they are 59 ½ and have a Roth for five years).

Pros and Cons

Being able to save for retirement automatically is a tremendous benefit of the 403(b) construct. The tax-deferred (pre-tax) or tax-free growth(Roth) nature of these savings is also a huge incentive for employees to save as much as possible – not to mention the free money an employer match may provide. Many 403(b) plans will have a shorter vesting period relative to their 401(k) cousin, which allows. This means employees will have access to the matching funds quicker should they change employers.

On the downside, withdrawing funds before age 59 ½ will likely result in a 10% early withdrawal penalty. And many 403(b) plans offer a more limited range of investment options than other retirement plans.

Summary

Like the 401(k), the 403(b) retirement plan is critical to retirement planning and saving for individuals with access to them. The automatic saving nature of the plan makes it very convenient to save for the future. Saving early, often, and as much as you can afford will set you up for your coveted retirement. Happy Saving!

Working In the U.S. Temporarily? Here’s What You Need to Know About Retirement

February 05, 2025

We get many retirement benefits questions on our financial coaching line from professionals working in the United States but plan to return eventually to their home countries or take another ex-pat assignment. Frequent questions include: should I participate in my company’s 401(k) plan, and if so, should I choose to make a pre-tax, Roth, or after-tax voluntary contribution? In addition, how can I access my savings when I leave the US?

Get professional tax advice

If you’re a professional from another country working legally in the United States and do not have permanent resident status (e.g., a “green card”), the US taxation system can seem like a maze: one wrong move, and you’re stuck in a corner. Do not try and navigate this yourself. Instead, seek professional tax advice from a tax preparer experienced in ex-pat/non-citizen issues. You’ll need guidance on federal and state withholding, tax treaties, tax filing, benefits choices, and what to do when you leave the US.

Ask ex-pat colleagues first for referrals to a tax professional with experience working with people like you. It’s not expensive and could save you from financial and legal problems later. For a basic overview of types of US tax preparers, see How to Find a Good Tax Preparer.

What do I need to know about US retirement savings programs?

The US retirement savings system is made up of Social Security, defined contribution plans (401(k), 403(b) or 457), traditional pension plans (defined benefit), and individual retirement accounts (IRA and Roth IRA).

Social Security

This is the government-sponsored retirement system, similar to what’s often called a “public pension” in other countries. As a non-citizen employee, you will likely pay the same taxes as US citizens into Social Security and Medicare, which you will not recoup unless you continue to be a US resident. Your employer will also make contributions on your behalf.

If you do not plan to live in the US when you retire, you may or may not be able to receive Social Security income benefits. It depends on how long you paid into the system, your immigration status, country of residence, and whether you started receiving payments before leaving the US.

401(k), 403(b), and 457 plans

Most large employers offer employer-sponsored retirement savings plans, such as 401(k) and 403(b) plans. Employees may contribute a percentage of their gross pay each period to a tax-advantaged account. Frequently, the employer will match up to a set percentage of what you contribute or will sometimes make contributions regardless of whether you make your own contributions.

In addition, you’ll get to choose how your contributions are invested from a menu of mutual funds or other investment vehicles. You may also choose whether you contribute your money into a pre-tax (traditional), after-tax (Roth), or after-tax voluntary account. See tips below for determining what works for you. 

IRA and Roth IRA

If you are considered a resident for US tax purposes (have US earned income, have a Social Security number, and meet the substantial presence test), you may open a traditional or Roth IRA. However, if you are a non-citizen and don’t plan to seek US citizenship or permanent residency, you may not be able to reap all the benefits of an IRA or Roth. If you’re eligible, you may contribute up to certain limits.

IRA  limitIRA catch-up amount401(k)/403(b) limit401(k)/403(b) catch-up amountSIMPLE limitSIMPLE catch-up amountSEP
2025$7,000$1,000$23,500$7,500$16,500$3,500$70,000
2024$7,000$1,000$23,000$7,500$16,000$3,500$69,000

Traditional pension plans

These are no longer widely available to new employees, but some larger companies and state/local government jobs still offer them. A pension may be fully funded by employer contributions or by combining employer and employee contributions. Typically, it takes 10-20 years to be “vested” in a pension, where the employee is eligible to receive a fixed monthly payout at retirement.

Should I enroll in my 401(k)?

Saving in your employer-sponsored retirement plan has multiple benefits, even if you don’t plan to continue working and living in the US later in your career. If there’s a match on your contributions, that’s like earning additional income. There’s the potential for tax-deferred or tax-free growth, depending on the type of contributions you make. Plus, you can’t beat the ease of contributions deducted automatically from your paycheck!

Always consider your future taxes.

For non-citizens making decisions about which retirement contribution type to choose, you’ll need to consider where you will be living when you withdraw the money, how old you will be when you plan to withdraw it, and whether you think you’ll be a US permanent resident or citizen at that time. If you still expect to be a non-citizen when you withdraw the money, note that you must file a US tax return in any year in which you have US income, including retirement plan withdrawals. According to the IRS, “Most U.S.-source income paid to a foreign person are subject to a withholding tax of 30%, although a reduced rate or exemption may apply if stipulated in the applicable tax treaty. You may or may not owe that rate in taxes, but the funds will be withheld from the distribution regardless.

If you’ve overpaid through the withholding, you will get a refund after filing your tax return for that year. See this IRS US Tax Guide for Aliens for in-depth reading. Now, do you see why I say you need a tax advisor if you’re an ex-pat working in the US?

If by the time you withdraw the money, you have become a US citizen or a permanent resident but are living overseas, you won’t be subject to the 30 percent withholding. You will, however, have to file a US income tax return every year regardless of your income.

For U.S. citizens, check out this article about what you need to know about taxes while working and living abroad. 

Pre-tax, Roth, or After-tax voluntary contributions?

The financial planning goal is to minimize taxes and penalties. Your company’s matching or profit-sharing contributions to your retirement plan are always pre-tax, so they will be taxed when you withdraw them. How much of your retirement contributions will be taxed depends on how you contribute:

Traditional pre-tax contributions are deducted from your taxable income, so you’ll pay less in income taxes today. Earnings grow tax-deferred for retirement. After age 59 1/2, you may withdraw them without penalty, paying US income taxes on whatever you take out. Before that, you may withdraw them only if you a) retire, b) leave the firm, or c) have an extreme financial hardship.

Roth contributions: Roth 401(k) contributions are made after-tax and grow tax-free for retirement if withdrawn 1) after 5 years and 2) after age 59 ½. Therefore, if you meet those requirements for distribution, your Roth distribution would not be included in your taxable US income. See this IRS tool to see if your Roth distribution could be taxable. However, your home country (or country of residence) could tax it, depending on the tax treaty with the US.

If your plan allows, you can leave the funds in the account until after age 59 ½. If you must take an earlier distribution after leaving the firm, you will only be taxed and penalized on the related growth and company contributions, not your original contributions. See this IRS Guide to Roth 401(k)s for more information.

After-tax voluntary contributions: Many employer-sponsored plans permit after-tax voluntary contributions above, or as a substitute for, Roth or pre-tax contributions. This will give you some flexibility, as you may withdraw those contributions at any time (although the growth of your funds will be subject to tax). If you plan to withdraw contributions after leaving the firm, taxation is similar to the Roth 401(k). Your retirement plan may also permit you to convert after-tax voluntary contributions to the Roth account, which could come in handy if you end up staying in the US, or roll them over to a combination of a traditional IRA and Roth IRA when you leave the firm.

On the downside, you typically won’t receive an employer match on voluntary contributions. Your original contributions can be withdrawn at any time tax-free, but any earnings or growth made in the account will be taxed when withdrawn. (That means gains withdrawn before 59 ½ will be taxed and subject to an additional 10 percent penalty.)

If you leave the US, are you required to take distributions?

If you leave to work and reside overseas, you would be able to take a distribution from your company’s retirement plan but are generally not obliged to take any until age 73. If possible, leave it to continue to grow, protected from taxes. Pre-tax contributions later distributed are included in your taxable income and, if taken before age 59 1/2, may be subject to an additional 10% penalty.

Ask for guidance

If your company offers a workplace financial wellness benefit, talk through the pros and cons of your choices with a financial coach. Your financial coach can help you understand the implications of your options, given your personal situation. Also, while you’re working in the US, don’t forget to use a tax advisor experienced in non-resident taxation., such as a certified public accountant or an enrolled agent. This is well worth the relatively low cost of getting good tax advice.

Is It Ever OK To Borrow From Your 401K?

February 05, 2025

Ideally, never…or at least rarely. Plundering our retirement piggy banks can be tempting when a financial emergency arises or perhaps when we are looking for cash to finance a home purchase or to pay off some high interest credit cards.

Although IRS rules do allow for retirement plan loans, the maximum loan size is either (1) the greater of $10,000 or half of your vested 401(k) balance or (2) $50,000, whichever is smaller. While borrowing from yourself in this way can be convenient and seem relatively harmless, this type of short-term fix may have some long-term consequences that are more expensive than we realize.

401(k) loans seem attractive…at first. On the one hand, borrowing from our company retirement plans is tempting for several reasons:

  • No credit check is required and consequently, it will not affect your credit score.
  • The interest rate is potentially lower than that of a traditional loan.
  • You pay back the loan conveniently through payroll deduction.
  • You are borrowing your own money and paying yourself back with interest. Where’s the harm, right?

Then things can get ugly. A closer examination of exactly how all of the moving parts work as well as some of the things that could potentially go wrong might lead you to conclude that getting a bank loan, borrowing against home equity, selling other assets, or even borrowing from family might be better for you in the long run. Here are some of the reasons to think twice before taking out a 401(k) loan:

You will pay taxes on the same money twice. It is true that you pay yourself back with some interest, but you also use after tax dollars to make those interest payments. In the future, when you spend your pre-tax 401(k) money in retirement, those future interest distributions will be taxable as ordinary income, meaning you actually pay taxes twice on that money.

Lost growth and compounding. The money you borrow from your 401(k) is temporarily removed from the underlying investments, missing out on any market growth, interest, dividends, etc. The double whammy comes from the missed opportunity for this growth to be reinvested and earn even more through compounding, which is the financial superpower that comes from investing – and staying invested – over time.

Treating your 401(k) like an ATM. Once you dip into your retirement stash and use it to relieve some type of financial pain, you can begin to slide down a slippery financial behavior slope. Having rewarded yourself once with a relatively easy source of cash, you run the risk of training your brain to think of this strategy as a reasonable substitute for creating and maintaining better financial habits, such as regularly saving cash in an emergency fund, sticking with a budget, or increasing your retirement plan contribution rate. Staying faithful to healthier financial priorities helps you avoid disturbing your retirement plan’s progress by treating it like an automated teller machine and dipping into it multiple times.

Less take-home pay. While you are repaying your loan, your paycheck will be reduced by the amount of the loan repayment. If your cash flow was tight before raiding your retirement fund, you may soon discover that it becomes even more challenging with a reduced paycheck.

Severe taxes and penalties. If you leave your employer for any reason – whether it is your idea or if your employer fires you – you might have to repay the entire remaining loan balance within as little as 60 to 90 days. This requirement varies from plan to plan. Some company retirement plans allow you to continue making the scheduled loan repayments without having to pay it all back early.

However, your payments obviously will no longer come from payroll deduction once your job ends. If your period of unemployment is lengthy, you might not be able to keep up with the required repayment schedule.

Once you default on a 401(k) loan, the IRS then treats any remaining balance as a taxable distribution. If you are under age 59 ½ at that time, there may be an additional 10% tax penalty for taking an early withdrawal from your retirement plan. What was once a temporary financial fix could quickly become an expensive tax bomb.

It might be okay to borrow once, if:

You have high interest rate (think double-digit) debt and you have exhausted all other opportunities to refinance or negotiate a lower interest rate. The ongoing challenge will be to reduce any temptation to begin using the same high interest credit cards or loan sources again and recreate the problem. Once you pay back the 401(k) loan, take that monthly loan payment you were making and redirect it to a savings account at your bank, building up an emergency fund you can use for future financial emergencies, rather than raiding your retirement plan like a pirate.

You owe the IRS back taxes. With interest and penalties stacking up on overdue taxes, this financial burden can become very serious over time. In this case, a 401(k) loan might be your saving grace. However, you may qualify for relief under the IRS guidelines for alternate payment plans and hardship.

You are in real danger of defaulting on a student loan. In most cases, bankruptcy is not an option for these.

You are facing imminent bankruptcy or eviction from your home. Talk to a nonprofit consumer credit counselor (nfcc.org) about alternatives to bankruptcy. If a 401(k) loan can buy you some valuable time while you restructure your cash flow and other investments to support a sustainable strategy and repay your 401(k) loan, this might be an appropriate financial move.

The important thing to keep in mind regarding loans from your retirement plan is to make sure you address the underlying need for cash rather than simply assuming the 401(k) loan will solve the immediate problem. Otherwise, you could find yourself on an unhealthy financial treadmill where you repeatedly borrow from your 401(k) and begin to seriously jeopardize your ability to retire on time, comfortably, or both.

A good way to see just how damaging and expensive a retirement plan loan can be to your financial future is to use a 401(k) Borrowing Calculator. This calculator shows how much less money you may have for retirement if you borrow from your retirement plan versus not taking out a 401(k) loan.

Bottom line: make sure you have carefully considered all other alternatives before you undo much of the hard work you have already invested in growing your retirement nest egg.

This post was originally published on Forbes.com, August 3rd, 2017.

Why You Need to Start Saving Money RIGHT NOW

February 05, 2025

Pretty much every personal finance resource will tell you that the earlier you start saving, the better off you’ll be due to the effect of compound interest. It’s a bit of a, “well, duh,” thing, but there’s more to it than just the fact that you’ll have longer to save if you start early. The thing is, the earlier you start, the earlier you can actually stop saving if you want to. Continue reading “Why You Need to Start Saving Money RIGHT NOW”

Employer Retirement Plan Backdoor Roth Conversions

February 02, 2025

One increasingly popular strategy we have seen is the backdoor Roth conversion through an employer’s workplace retirement plan. If your employer’s plan allows, this strategy will enable you to convert after-tax voluntary 401(k) contributions to a Roth 401(k). When is it a good idea to contribute to an after-tax voluntary 401(k) and convert to a Roth 401(k)? Here are some factors to evaluate if you are considering this strategy:

  • Your plan allows after-tax voluntary contributions, and you want to save more than the pre-tax/Roth 401(k) 2025 elective deferral contribution limit of $23,500 or $31,000 if you’re over 50 years old.
  • You have a fully-funded emergency savings account, a reasonable debt situation, and do not need the liquidity.
  • You make too much to contribute to a Roth IRA but still want to save Roth dollars for your retirement.
  • You don’t want the hefty tax bill of a taxable conversion of pre-tax to Roth.
  • And most importantly, you love TAX-FREE money for your retirement!

The Basics

At a fundamental level, converting after-tax voluntary 401(k) money to a Roth 401(k) allows employees to save significantly more, tax-free, for retirement.

You don’t get a current-year tax deduction for the money deposited after-tax and then converted to a Roth 401(k), but the funds grow and are distributed tax-free as long as you hold the account until the age of 59.5 and it has been 5 years since your initial contribution into the Roth 401(k).

After-tax Voluntary Contributions in Work Retirement Plans

Some employer retirement plans allow employees to make three types of contributions 1) pre-tax, 2) Roth, and 3) after-tax voluntary. After-tax voluntary contributions have already been subject to income tax.

Generally, employees can contribute up to $23,500 (plus a $7,500 catch-up contribution if over 50, or $11,250 if age 60 – 63) to their pre-tax and/or Roth portion of the 401(k) in 2025. The combined annual IRS contribution limit is $70,000 in 2025 for most employer-sponsored retirement plans. Further, if your plan allows it and depending on whether your employer contributes or not, you may be able to make after-tax voluntary contributions above the basic limit.

It’s a good idea to work with your retirement plan administrator to find out exactly how much you can contribute (if the plan allows) to the after-tax voluntary account, but to get an idea, use the following equation:

After-tax Contribution Equation
$70,000 is the IRS limit in 2025MinusPre-tax and/or Roth Contribution $23,500 (+$7,500 if over 50 years)MinusEmployer Contribution(Discretionary and/or Non-Discretionary)EqualsPotential After-tax voluntary Contribution Allowable

Backdoor Roth 401(k) Conversion

In addition to contributing to the after-tax voluntary portion of your 401(k), your company’s plan may allow you to convert this contribution to your Roth 401(k). You may be able to contribute up to $46,500 in 2025 of after-tax voluntary dollars and then convert all of it to your Roth 401(k)! That’s right – up to $46,500 growing tax-free for retirement. Some plans also allow you to roll this money outside the plan via a rollover to a Roth IRA.

What if my 401(k) Doesn’t Allow an In Plan Conversion?

If your plan doesn’t allow the backdoor option while working, you’ll have to wait until you separate from your employment. Typically, you can then roll after-tax voluntary contributions to a Roth IRA and after-tax voluntary earnings to a pre-tax Traditional IRA account, or you can convert the earnings and pay tax on that portion of the conversion.

Example

Henry has a great job as a software engineer. He earns a significant income and lives a simple life. He maxes out his pre-tax contribution to his 401(k), which is $23,500 in 2025, and his company contributes $9,500. Henry also contributes an additional $37,000 to the after-tax voluntary portion of his 401(k).

After-tax Contribution Equation Example
$70,000 is the IRS limit in 2025MinusPre-tax and/or Roth Contribution $23,500 (+$7,500 if over 50 years)MinusEmployer Contribution(Discretionary and/or Non-Discretionary)EqualsPotential After-tax Voluntary Contribution Allowable
$70,000–$23,500–$9,500=$37,000

His retirement plan allows him to convert the after-tax voluntary contributions to his Roth 401(k). In fact, if his plan allows, Henry can set up his conversions to happen automatically as soon as he contributes his after-tax voluntary dollars. He continues to convert the money to his Roth 401(k), building up tax-free funds for retirement.

Conclusion

The 401(k) Backdoor Roth Conversion is an excellent opportunity to save more for retirement in your 401(k) than the pre-tax and Roth contribution limits will allow.  It makes the most sense for those who already have a stable financial foundation and do not anticipate liquidity needs before retirement.

 Notes

* There are always exceptions to the rules, so before conversion, seek advice from a tax expert that will help you understand the conversion’s tax implications to your specific situation.

* There may be plan-specific rules. Please check with the administrator for your workplace retirement plan.

* There are different distribution rules for after-tax voluntary contributions made before 1987. Consult your tax advisor for more information.

* Conversions may affect net unrealized appreciation (NUA) treatment on employers’ stock positions.

How To Save For Retirement Beyond The 401(k)

February 02, 2025

Preparing for retirement is an essential part of financial planning. Employer-sponsored retirement plans, such as 401(k) plans, are a common tool for saving. While contributing to a 401(k) can be a great way to save for retirement, it’s important to consider other options as well.

First things first

Are you fortunate enough to work for a company that offers to match employer-sponsored retirement plan contributions? If so, you should put the required minimum into the account to get that free money. Doing less is basically like turning down a raise!

Once you’re doing that, there are reasons that you may want to save additional funds outside the 401(k). Of course, if you don’t have a match or a 401(k) available, you may also need another way to save. Besides not having a 401(k) option, the most common reason to invest outside a 401(k) is investment selection. So, here are some other common options:

IRA

 For the self-employed, there are actually many different tax-advantaged retirement accounts you can contribute to. If you work for a company that doesn’t offer a retirement plan, you can still contribute to an IRA. If this is the case, you can contribute up to $7,000 (or $8,000 if 50+) to an IRA. Additionally, you can deduct traditional IRA contributions no matter your income. However, income limitations exist on deducting contributions when you already have a 401(k) or 403(b) available.

A popular choice these days is the Roth IRA. This is partially because of the tax benefits. However, there is also more flexibility in accessing Roth IRA money early versus traditional or even Roth 401(k)s. For example, you can withdraw your Roth IRA contributions without taxes or penalties. Another benefit is your ability to withdraw up to $10k in growth for a first-time home purchase. You don’t have that option with a 401(k), at least not without tax consequences.

HSA

If you have access to a high-deductible health insurance plan, you can contribute to a health savings account (HSA). Contributions are limited to $4,300 per person or $8,550 per family (plus an extra $1,000 if age 55+). The contributions are tax-deductible, and the money can be used tax-free for qualified health care expenses. If you use the money for non-medical expenses, it’s subject to taxes plus a 20% penalty. However, the penalty goes away once you reach age 65, turning it into a tax-deferred retirement account that’s still tax-free for health care expenses (including most Medicare and qualified long-term care insurance premiums). You may also consider avoiding using the HSA even for medical expenses and investing it to grow for retirement.

US Government Savings Bonds

Each person can purchase up to $10k per year in Series EE US Government Savings Bonds. For Series I Savings Bonds, that limit is also $10k. The federal government guarantees these tax-deferred bonds, which don’t fluctuate in value. As such, they can be good conservative options for retirement savings. However, you can’t cash them in the first 12 months, and you lose the last 3 months of interest if you cash them in the first 5 years. Interest rates may remain low, but the I Bonds are based on inflation, which is slowly creeping up.

Regular account

If you’ve maxed out your other options, you can always invest for retirement in a regular taxable account. You can minimize taxes by investing according to your tax bracket. For example, invest in tax-free municipal bonds if you’re in a high tax bracket. Holding individual securities for at least a year will keep capital gains taxes low. You can also choose low-turnover funds like index funds and ETFs. Another strategy is to use losses to offset other taxes, including up to $3k per year from regular income taxes. The excess carries forward indefinitely. Just be aware that if you repurchase an identical investment within 30 days, you won’t be able to take the loss off your taxes.

Regardless of how you choose to save for retirement, the most important thing is that you save enough. Run a retirement calculator to see how much you need to save. Then, increase contributions through payroll or direct deposit. If you can’t save enough now, try gradually increasing your savings rate each year. Like it or not, your ability to retire depends on you.

Rolling Voluntary 401(k) After-Tax Money To Roth IRA

February 02, 2025

Using after-tax 401(k) contributions to execute backdoor conversions to a Roth IRA can be an effective strategy if you want to utilize these funds to retire early. When do employees think about executing this strategy?  Consider the following factors:

  • You want to retire early
  • A large portion of your net worth is tied up in retirement accounts
  • Your work retirement plan allows for after-tax contributions to your 401(k) into a separate account
  • Your plan also allows in-service direct rollovers from the after-tax account to a retirement account outside of the plan
  • You have (or will have) savings or investments in outside retirement accounts that can help to supplement your early retirement

The Basics

At a fundamental level, after-tax Roth IRA conversions allow folks who retire early access to retirement principal without the 10% penalty typically assessed on early withdrawals from these accounts.

In a Roth IRA, you can access contributions anytime because you have already paid tax on the money. You can access the after-tax conversion basis directly rolled into your Roth IRA from your 401(k) without penalty as well. However, each taxable conversion has its own 5-year rule, and if you withdraw the funds within the first five years, unless you have a qualifying reason, the withdrawal may be penalized.

Investments in Roth IRAs have the potential to grow with the market, and earnings are distributed tax-free as long as you hold the account until the age of 59.5 or 5 years, whichever is longer. You may be able to withdraw from your Roth IRA if you have a qualifying reason to take the money out.

Early withdrawals are subject to Roth IRA ordering rules for distribution:

  1. Contributions
  2. Conversions (taxable then after-tax)
  3. Earnings

Seek tax advice before any conversion so you understand the tax implications for your specific situation.

After-tax Contributions to Work Retirement Plans

Certain employer retirement plans allow employees to make three types of contributions:

  1. Pre-tax/regular
  2. Roth
  3. After-tax voluntary

Employees can contribute up to $23,500 (plus a $7,500 catch-up contribution if over 50 years of age, or $11,250 if age 60 – 63) to the pre-tax and/or Roth 401(k) portion of the retirement plan in 2025.

In addition, if your plan allows it and depending on if your employer contributes or not, you may be able to contribute up to another $46,500 to the after-tax voluntary bucket. The IRS aggregate limit of employer and employee contribution increased to $70,000 in 2025 for most workplace retirement plan accounts like 401(k)s.

Use the following equation to figure out how much you can contribute to the after-tax bucket in your retirement plan through work:

After-tax Contribution Equation
$70,000 is the IRS limit in 2025MinusPre-tax and/or Roth Contribution$23,500 (+$7,500 if over 50 years)MinusEmployer Contribution(Discretionary and/or Non-Discretionary)EqualsPotential After-tax Contribution Allowable

In-Service After-tax Voluntary Conversion to a Roth IRA

Generally, when completing a 401(k) after-tax voluntary conversion to a Roth IRA, the conversion principal from a direct after-tax rollover is deposited into a Roth IRA, and earnings are rolled over into a Traditional IRA. However, earnings can also be converted to a Roth and tax paid.

When money is converted from the after-tax voluntary bucket of a 401(k) to a Roth IRA over a series of years, employees can build a significant amount of converted principal available to be accessed in early retirement that would otherwise likely be locked up until age 59.5. Though the conversion basis can be accessed, if conversion earnings are distributed before 59.5 and/or five years, whichever is longer, the gains are taxed and penalized.

Why can’t I access these converted funds in my Roth 401(k)? *

In most cases, pre-retirement pro-rata distribution rules apply to unqualified early distributions from a 401(k). If you have a Roth 401(k) and take an early distribution, it will most likely be a mix of taxable (with penalty) and nontaxable funds.

After-tax conversions work in Roth IRAs because distribution rules are ordered as follows:

  1. Contributions
  2. Taxable Conversions
  3. After-tax Conversions
  4. Earnings

How and when can I access money from a Roth IRA without penalty?

  • Always access your contributions penalty-free
  • Taxable conversions are penalty-free five years after the conversion
  • You can access the nontaxable conversion principal penalty-free at any time
  • Access earnings free and clear after 59.5 or five years, whichever is longer

Let’s say you are 30 years old and looking to retire before the age of 50. Having money in a retirement account that is accessible, without penalty, is important regardless of age. Each year for 10 years, you make after-tax contributions to your 401(k)  of $10,000, which grow to $11,000 before you request an in-service conversion rollover of this money into a Roth IRA. You invest the Roth IRA for growth, and it earns another $10,000. That growth will be tax and penalty-free as long as you wait until age 59.5 and at least five years to withdraw the earnings. However, the basis that you have converted over the years from your after-tax voluntary 401(k) account can be taken out without penalty or tax, regardless of age.

Here is what happens if you decide to withdraw the entire amount prior to age 59.5:

401(k) Contributions and Gains
After-tax contributions to 401(k) – $100,000
Total gains realized on after-tax contributions – $10,000

Backdoor Conversion to Roth IRA
Basis converted to Roth IRA – $100,000
Growth converted to Roth IRA and taxed upon conversion – $10,000

Withdrawal from Roth IRA prior to age 59.5
Contributions (tax and penalty-free) – $0
Taxable Conversion (10% penalty if held less than 5 years) – $10,000
After-Tax Conversion (tax and penalty free) – $100,000
Gains realized after conversion to Roth IRA (taxable and 10% penalty) – $10,000

Important Notes

* There may be plan-specific rules. Please check with the administrator for your work retirement.

* There are always exceptions to the rules, so before conversion, please seek advice from a tax expert that will help you understand the conversion tax implications.

* There are different distribution rules for after-tax contributions made before 1987. Consult your tax advisor for more information.

* Conversions may affect net unrealized appreciation (NUA) treatment on employer’s stock positions.

Should You Take a Hardship Withdrawal?

January 21, 2025

If you are considering a hardship withdrawal, by definition you have a challenging, time-sensitive financial problem. You are probably feeling very worried and anxious about your situation. When money is tight, it is tempting to look to your retirement plan for resources to solve the problem.

Under certain limited circumstances, you may be able to access funds in your 401(k) or 403(b). However, just because you could withdraw funds doesn’t mean that you should do it. A hardship withdrawal should only be used as a last resort, in a truly urgent situation. Why?

It is expensive both now and later. You will pay income taxes on the amount you withdraw, as well as an additional 10% penalty if you are under age 59½. If the withdrawal is large, it could bump you up into a higher marginal income tax rate. Plus, you’re taking away funds that should grow to provide income in retirement for your future self.

Here are some questions to help you to find the best choice for your situation:

1. Does this have to be paid right away?

Sometimes a need is urgent, very important and immediate. Some examples include preventing eviction or foreclosure, paying for medical treatment, or repairing your home after a natural disaster so you can live in it. In those cases, a hardship withdrawal for the amount of the need may be the only way you could stay in your home or get the care you or a family member needs. If the bill does not have to be paid all at once, such as a past-due medical expense or a home purchase you could defer, it may be better not to take a hardship withdrawal.

2. Do I have any other sources of funds?

Have you considered all your options? While your cash situation isn’t ideal, make sure you have thought about all things you could sell or places you could borrow from to raise funds:

  • Do you have any non-retirement investments you could liquidate such as stocks, bonds, or CDs even if it means you would take a loss? Taking a loss on an investment is usually much less costly over the long run than withdrawing funds from your retirement plan.
  • Do you have a Roth IRA? If so, you can withdraw the contributions – but not the earnings – without taxes or penalty.
  • Can you borrow against your home equity or take a personal loan?
  • Do you have non-essential personal property you could sell to raise some cash? Some examples might include a second car, motorcycle, art, collectibles or jewelry.

3. Could you take a retirement plan loan?

Before deciding on a hardship withdrawal, explore taking a loan from your 401(k) or 4013(b). Many, but not all, employer-sponsored plans permit loans that allow you to borrow up to fifty percent of your vested balance up to a cap, whichever is less, for a one to five year period. Some plans also permit longer term loans for the purchase of a home.

The interest rate is usually low and paid into your own account, payments are deducted from your paycheck, and it’s not reported to the credit bureaus. A retirement plan loan has downsides, but they’re not as impactful as a hardship withdrawal.

4. Would the IRS consider your situation an allowed “hardship?”

A hardship is something that causes suffering or privation. The IRS allows hardship withdrawals from qualified retirement plans when the employee has immediate and heavy financial need, limited to certain:

  • Medical expenses incurred by you, your spouse or dependents
  • Payments to avoid eviction from or foreclosure of your primary residence
  • Post-secondary education expenses for you, your spouse, children or other dependents
  • Funeral expenses for you, your spouse, children or other dependents
  • Expenses to repair damage to your primary residence
  • Costs to purchase a primary residence

Note that credit-related needs such as satisfying payday loans, title loans or credit card debts are not covered under the definition, nor are tax bills or business expenses. See IRS guidelines here.

5. Are you taking out funds to purchase a home or pay tuition?

Finally, just because the IRS considers a home purchase or tuition payment a hardship does not mean it’s always wise to take a withdrawal for those reasons. A hardship withdrawal is meant for a true emergency. If the only way you can purchase a home is by taking a hardship withdrawal from your retirement plan for the down payment, you may not be financially ready yet to be a homeowner. As for tuition, consider exploring other options listed in #2 and #3 first, such as borrowing against your home equity or taking a retirement plan loan.

Once you’ve worked through these questions, if it seems like a hardship withdrawal is the best choice for you, know that you’ll have to go through an application process to move forward. You may be required to demonstrate heavy and immediate financial need, that you’ve considered a retirement plan loan but the payments would be burdensome, and that your financial need can’t be satisfied through other channels. Expect the process to take a few weeks.

If you do take a hardship distribution, you won’t be able to pay the money back and you may be precluded from contributing to your plan for six months. Your distribution will be included in your taxable income, plus you’ll pay an additional 10% penalty if you’re younger than 59½. If you have access, consider contacting your workplace financial wellness or employee assistance program (EAP) for financial coaching, to help you put together a plan to manage your cash flow so you can get back on track.