Q. I have made after-tax contribution to my company's 401k plan and intend to convert it to Roth IRA later. What is the tax consequence of doing this?
A. If you have maxed out your pre-tax contribution to 401k, and still have money left to invest, instead of investing that money from your individual brokerage account and pay capital gain taxes, you can contribute after-tax money to your 401k plan (if your plan allows) and convert to Roth IRA, therefore avoid paying tax forever!
However, a little caveat is that the part of gain from your after-tax contribution inside your 401k plan will be treated as your income at the time of conversion, therefore you have to pay income tax for that portion.
If your income tax rate is higher than the capital gain tax rate, this might hurt you a bit. So it's best to do such conversion as soon as possible. However, regulations won't make it easy - a plan may limit the number of conversion each year to only two times.
The bottom line, given the future tax savings you will enjoy, paying a little income tax on that small gain maybe something worthwhile!
A. If you have maxed out your pre-tax contribution to 401k, and still have money left to invest, instead of investing that money from your individual brokerage account and pay capital gain taxes, you can contribute after-tax money to your 401k plan (if your plan allows) and convert to Roth IRA, therefore avoid paying tax forever!
However, a little caveat is that the part of gain from your after-tax contribution inside your 401k plan will be treated as your income at the time of conversion, therefore you have to pay income tax for that portion.
If your income tax rate is higher than the capital gain tax rate, this might hurt you a bit. So it's best to do such conversion as soon as possible. However, regulations won't make it easy - a plan may limit the number of conversion each year to only two times.
The bottom line, given the future tax savings you will enjoy, paying a little income tax on that small gain maybe something worthwhile!
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