US Tax/401k questions

[Mephistopheles]

As for the IRA taxation that isn't right. I hope you filled out a form 8606 for you non deductable contributions. Non deductable contributions is post tax money.  That amount is basis and is deducted from your account to derive your gains which is taxed when you withdraw.  Form 8606 is a federal form so it means it apples to federal taxation. no? if not I am really wrong on my tax planning.

 

Right, the 8606 is for non deductible contributions for Federal purposes. But take a Traditional IRA which is fully deductible at the Federal level (up to $6k or whatever it is). Then you wouldn't need a 8606 because it's not post tax money for federal purposes right?

 

But in some states, there is no such thing as IRA deductions. In which case that amount is deducted from gains as you say. I don't know what the form is for NJ, I'll have to check.

[Mephistopheles]

 

Now run through the same example at a slightly higher rate for an unsecured loan (7-8%?) and see which one you're better off with. Nobody is saying you're not double-taxed, but avoiding double-taxation isn't the point of taking a loan. The point of taking a loan is financing a need at the lowest cost available and unless if you're taking some form of secured debt (like a mortgage), the 401(k) loan is probably going to have the lowest total cost of anything else available even considering the double taxation.

 

This is why I hate it when people bring up the point. It's an immediate dismissal of a form of financing without doing any comparative analysis to other forms of financing.

 

TwoCities, I thought in my first reply you understood I agreed with your point. Why are you beating me over the head with it a second time? LOL

 

Sorry - was quoting that more for Mephistopheles and less for you. Not trying to beat you over the head with it - just demonstrating that even once you have a full understanding of the double taxation, that it doesn't really matter.

 

Haha thanks, I got what you're saying :)

[randomep]

As for the IRA taxation that isn't right. I hope you filled out a form 8606 for you non deductable contributions. Non deductable contributions is post tax money.  That amount is basis and is deducted from your account to derive your gains which is taxed when you withdraw.  Form 8606 is a federal form so it means it apples to federal taxation. no? if not I am really wrong on my tax planning.

 

Right, the 8606 is for non deductible contributions for Federal purposes. But take a Traditional IRA which is fully deductible at the Federal level (up to $6k or whatever it is). Then you wouldn't need a 8606 because it's not post tax money for federal purposes right?

 

But in some states, there is no such thing as IRA deductions. In which case that amount is deducted from gains as you say. I don't know what the form is for NJ, I'll have to check.

 

Ok this is my situation: I have a 401k, and I contribute the max to a traditional IRA. Because I have a 401k the IRA is non deductable, therefore I fill out the 8606. I help my friend do her taxes and she has no 401k so her IRA is deductable, and she doesn't fill out the 8606. That's just what I do, but I definitely am not a tax professional.

 

I think I get your case about the NJ state tax system. If they do not have the same recognition of tax deductability for IRA contribution as the IRS, then they would need their own separate version of the 8606.

 

 

 

 

 

[ERICOPOLY]

That point may be correct but there are other ways to top up the 401k.  In my company 401k there is nothing stopping you from contributing double the yearly IRS contribution limit. The IRS contribution limit is the max amount of tax deferred contribution you may make.  The rest is post tax money.

 

Me too.  I always maxed out my post-tax 401k contributions.

 

Then when I quit my job, I rolled my 401k plan into two separate accounts at the same time.

 

The pre-tax contributions all went into a Rollover IRA.

The post-tax contributions all went into a Roth IRA.

 

Pretty cool.  The post-tax 401k contributions were all allowed to go directly to a Roth IRA once I quit the job.  It was not considered a "Roth conversion", and as such was not restricted by income limits.  It's what some people call a "back door" Roth contribution.

 

[Mephistopheles]

That point may be correct but there are other ways to top up the 401k.  In my company 401k there is nothing stopping you from contributing double the yearly IRS contribution limit. The IRS contribution limit is the max amount of tax deferred contribution you may make.  The rest is post tax money.

 

Me too.  I always maxed out my post-tax 401k contributions.

 

Then when I quit my job, I rolled my 401k plan into two separate accounts at the same time.

 

The pre-tax contributions all went into a Rollover IRA.

The post-tax contributions all went into a Roth IRA.

 

Pretty cool.  The post-tax 401k contributions were all allowed to go directly to a Roth IRA once I quit the job.  It was not considered a "Roth conversion", and as such was not restricted by income limits.  It's what some people call a "back door" Roth contribution.

 

 

Are you legally able to allocate 100% of the pre-tax to the Rollover and 100% of the post-tax to the Roth?

 

The reason I ask is because if you want to do a Roth conversion from a Traditional IRA, I'm pretty sure you can't do just the post-tax portion and ignore the rest. Meaning, you have to do it proportionally from what I know. So if only 10% of your total IRA assets are post-tax, only 10% of every conversion you do can be considered tax free. I may be wrong on this though, or the rules may be different for 401k transfers.

 

But I know for sure this is true with state taxes in NJ; you can't just count your entire Roth conversion as the post-tax contribution amount, has to be proportional.

[ERICOPOLY]

That point may be correct but there are other ways to top up the 401k.  In my company 401k there is nothing stopping you from contributing double the yearly IRS contribution limit. The IRS contribution limit is the max amount of tax deferred contribution you may make.  The rest is post tax money.

 

Me too.  I always maxed out my post-tax 401k contributions.

 

Then when I quit my job, I rolled my 401k plan into two separate accounts at the same time.

 

The pre-tax contributions all went into a Rollover IRA.

The post-tax contributions all went into a Roth IRA.

 

Pretty cool.  The post-tax 401k contributions were all allowed to go directly to a Roth IRA once I quit the job.  It was not considered a "Roth conversion", and as such was not restricted by income limits.  It's what some people call a "back door" Roth contribution.

 

 

Are you legally able to allocate 100% of the pre-tax to the Rollover and 100% of the post-tax to the Roth?

 

The reason I ask is because if you want to do a Roth conversion from a Traditional IRA, I'm pretty sure you can't do just the post-tax portion and ignore the rest. Meaning, you have to do it proportionally from what I know. So if only 10% of your total IRA assets are post-tax, only 10% of every conversion you do can be considered tax free. I may be wrong on this though, or the rules may be different for 401k transfers.

 

But I know for sure this is true with state taxes in NJ; you can't just count your entire Roth conversion as the post-tax contribution amount, has to be proportional.

 

I was a tax resident of Washington state where there is no state income tax.

 

Here you are:

https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans

 

Distributions sent to multiple destinations at the same time are treated as a single distribution for allocating pretax and after-tax amounts (Notice 2014-54). This means you can roll over all your pretax amounts to a traditional IRA or retirement plan and all your after-tax amounts to a different destination, such as a Roth IRA.

[Mephistopheles]

That point may be correct but there are other ways to top up the 401k.  In my company 401k there is nothing stopping you from contributing double the yearly IRS contribution limit. The IRS contribution limit is the max amount of tax deferred contribution you may make.  The rest is post tax money.

 

Me too.  I always maxed out my post-tax 401k contributions.

 

Then when I quit my job, I rolled my 401k plan into two separate accounts at the same time.

 

The pre-tax contributions all went into a Rollover IRA.

The post-tax contributions all went into a Roth IRA.

 

Pretty cool.  The post-tax 401k contributions were all allowed to go directly to a Roth IRA once I quit the job.  It was not considered a "Roth conversion", and as such was not restricted by income limits.  It's what some people call a "back door" Roth contribution.

 

 

Are you legally able to allocate 100% of the pre-tax to the Rollover and 100% of the post-tax to the Roth?

 

The reason I ask is because if you want to do a Roth conversion from a Traditional IRA, I'm pretty sure you can't do just the post-tax portion and ignore the rest. Meaning, you have to do it proportionally from what I know. So if only 10% of your total IRA assets are post-tax, only 10% of every conversion you do can be considered tax free. I may be wrong on this though, or the rules may be different for 401k transfers.

 

But I know for sure this is true with state taxes in NJ; you can't just count your entire Roth conversion as the post-tax contribution amount, has to be proportional.

 

I was a tax resident of Washington state where there is no state income tax.

 

Here you are:

https://www.irs.gov/retirement-plans/rollovers-of-after-tax-contributions-in-retirement-plans

 

Distributions sent to multiple destinations at the same time are treated as a single distribution for allocating pretax and after-tax amounts (Notice 2014-54). This means you can roll over all your pretax amounts to a traditional IRA or retirement plan and all your after-tax amounts to a different destination, such as a Roth IRA.

 

That's awesome, thanks!

[Jurgis]

What Eric said might be true when you roll over from 401(k) into IRAs, but it doesn't apply when you convert IRAs to Roth. IRA conversion to Roth is proportional like you said. For it not to be proportional, you'd have to put the pre-tax portion into 401(k) and then it's not counted in the proportion.

[ERICOPOLY]

What Eric said might be true when you roll over from 401(k) into IRAs, but it doesn't apply when you convert IRAs to Roth. IRA conversion to Roth is proportional like you said. For it not to be proportional, you'd have to put the pre-tax portion into 401(k) and then it's not counted in the proportion.

 

It's why I think people should contribute post-tax to the 401k if available rather than post-tax to an IRA... that is, if funds are limited such that one can't contribute to both.

[ERICOPOLY]

People say it's a bad idea to borrow from your 401(k) because of that double-taxation, but the point that I made above is that ALL forms of borrowing are paid post tax, so if you're going to have to borrow, that shouldn't be what keeps you from doing a lower interest option.

 

It's not the principle being repaid that people get hung up on (after all, you are just returning the pre-tax money that you borrowed).  Whether or not you spent the pre-tax money that you borrowed and are then repaying it with other money is just a shell game argument -- the dollars are fungible.

 

Rather, I think it's the interest payment portion that makes them cringe.  They see it as a contribution to the account using after-tax dollars.

 

In that regard, not all loans are made equal.  And the 401k loan is at a potential disadvantage here.

 

Compare it to a margin loan, for example.  The interest on a margin loan (if used to purchase investments) can be paid pre-tax using the investment income.

 

However if you make the same investment using the proceeds from a 401k loan, you cannot deduct the interest if the plan was funded with elective deferrals (which they generally are).