01 Nov Want to save more? Do it smart

Q. My job offers after-tax contributions to my retirement plan. I already do the max pre-tax. I can afford another 2 to 3 percent, but would I be better off using an IRA instead of the after-tax choice? What do I need to think about?
— Retirement saver

A. Congratulations on being such a diligent saver.

By contributing the maximum pre-tax amount to your plan, you’re helping to ensure a comfortable retirement.

Contributing an additional 2 to 3 percent of your pay toward retirement can make a dramatic difference in the ending balance of your account, thanks to the magic of compounding, said Gene McGovern of McGovern Financial Advisors in Westfield.

For that reason, he said, it’s certainly an excellent idea.

You don’t specify what type of retirement plan you have, or what type of after-tax contributions are available to you, but it’s likely you have a 401(k) or 403(b) plan. Some of these plans allow for after-tax contributions by employees, McGovern said.

“Under that type of plan, when you later withdraw money in retirement, your original after-tax contributions are not taxed again, but the earnings on those contributions are taxed,” he said. “Other retirement plans allow for Roth contributions, which also are made after-tax but which feature tax-free withdrawals of both contributions and the earnings.”

If you’re considering pre-tax contributions to a traditional IRA as an alternative to after-tax contributions at work, whether Roth or non-Roth, numerous factors can affect your decision, McGovern said.

First, are you eligible? If you’re covered by a retirement plan at work, income limits apply if you want to make a deductible IRA contribution, he said.

“If you’re single, and your so-called `Modified Adjusted Gross Income’ in 2017 is $62,000 or less, you can still take a deduction for the IRA contribution even if you have a retirement plan at work,” he said. “If you make $72,000 or more, no deduction is permitted.”

In between those amounts, a partial deduction is permitted, and for married couples, the phase-out of deduction eligibility lands between $99,000 and $119,000, he said.

McGovern said there are no restrictions on making after-tax contributions to a traditional IRA even if you’re covered by a retirement plan at work. You might also consider a Roth IRA.

Next, McGovern said, you’ll want to consider the investment alternatives available to you inside your retirement plan at work versus in an IRA.

“Most 401(k) or 403(b) plans have a limited set of investment alternatives, although some of those alternatives can be attractive investments available only to institutions like employers,” he said. “IRAs, on the other hand, can invest in nearly any mutual fund, ETF, or other security, as well in a wide variety of alternatives.”

You should also consider that plans such as 401(k)s and 403(b)s often allow for hardship distributions and for loans against your assets in the plan, while IRAs do not, he said.

Also, IRAs and employer plans differ in the some of the exceptions to the 10 percent penalty for early withdrawals before age 59½.

“For example, if you leave your current employer after turning age 55, you can withdraw money from the 401(k) plan without paying the 10 percent penalty,” he said. “IRAs have no corresponding provision.”

On the other hand, IRAs allow for early withdrawals without penalty to pay for higher education or first-time homebuyer expenses, while employer plans do not, McGovern said.

“Finally, no one knows what future tax rates will be,” he said. “It’s therefore a good idea to have some tax diversity in your retirement accounts with a mix of taxable and nontaxable withdrawals available to you.”

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The post was originally published in November 2017.