Many investors who are able to save a lot of money max out their 401(k) contributions and want to know where the rest of their savings should be invested. Unfortunately, there comes a time when you will have maxed out all your tax-deferred savings! At that point the remainder should go to your nontaxable brokerage account for investing.
That’s not a bad thing. Having a mix of taxable and tax-deferred assets means that you don’t have to withdraw money out of your retirement accounts for emergencies if you’re under 59 ½. So you won’t have to pay the early withdrawal penalty. You may also have some more near-term goals that you can invest in, since you’ve put away all the retirement funds.
But maxing out your 401(k) or TSP doesn’t necessarily mean that you’re finished with retirement accounts, however. There are a few more things you can consider.
After-tax deferral to employer retirement plans
The deductible limit for employer plan contributions in 2020 is $19,500, with the additional catch-up provision of $6,500 for those over 50. Does that mean if you’re over 50 your contribution limit is $26,000?
Not necessarily. That is the deductible limit that you can contribute. Your employer may also provide a match. The limit for all contributions is actually $57,000. Some employer plans will allow you to contribute after-tax dollars until you reach the $57,000 maximum.
Suppose you contribute the full $26,000 and your employer matches a total of $4,000. Contributions are $30,000. If your plan allows, and plans vary when it comes to this, you may be able to contribute an additional $27,000.
Bear in mind that this additional contribution is not tax deductible. However, it is tax-deferred. You won’t receive a current year tax deduction on it, but you won’t pay taxes on it as it’s growing. As you can see, it’s a good choice for investments that generate plenty of current income.
Not sure if your plan allows for it? Check with the TPA (third-party administrator) to see if it’s a fit for you.
IRA retirement contributions
Traditional and Roth IRAs are not considered employer plans. Once you’ve maxed out your employer retirement, you can still make IRA contributions. SEP and SIMPLE IRAs are considered employer plans, so you can’t make additional contributions to them above the $53,000 limit.
As you might recall, additions to a Traditional IRA are 100% deductible for workers not covered by an employer plan. Households filing jointly but covered by an employer plan can deduct their contributions as long as their modified AGI stays under $104,000. Over that, the deductibility phases out until you’re unable to deduct contributions if you make $124,000 or more.
Income limits for Roth IRAs are slightly higher but don’t depend on whether you’re covered by an employer plan. The ability to make contributions starts phasing out at joint AGI of $196,000, and if you make $206,000 or more, you can’t add to your Roth.
However, no matter what your income is, you can always make contributions to a Traditional IRA. The caveat is that they’re not deductible when your income is over $124,000. But you can still contribute and have those contributions grow tax-deferred. Just as with the after-tax deferrals outlined above for employer plans.
You will need to keep good records for your IRA if you contribute both deductible and nondeductible money over time. Many custodians won’t keep the record for you. When it comes time to start withdrawing, you’ll need to be able to show the funds with a non-zero basis. Deductible contributions have zero basis and so they’re fully taxable.
When it comes to withdrawal time, you can’t tell the management company to only withdraw the nondeductible funds. That could lower your taxes, and that would be too easy! Withdrawals will contain a proportional amount of basis and non-basis money. For example, if you have several IRAs and one-third of the funds were nondeductible, then one-third of the withdrawal will come from funds with basis.
529 accounts
These types of accounts are a great way to stash tax-deferred money away. If the funds are used for qualified expenses at a qualified institution, then the withdrawals are tax-free as well. Otherwise you pay a penalty on the gain. Depending on your tax bracket and the size of the gain, it might very well outweigh investing in a taxable account.
Originally the 529 accounts were for college and higher education, but they’re now available for secondary school as well. Contributions are limited by gift tax exclusion rules. In 2020 you can gift $15,000 per person per year. If you have five kids (or grandkids), you could set aside $75,000 tax deferred with no gift tax limitations.
In contrast with UGMA and UTMA accounts, the owner of the 529 account is the adult, not the minor. If you’re concerned that one child may not go to school or may end up with enough scholarships to cover costs, you can simply change the beneficiary of the account when you get to that point.
And the beneficiary can be yourself as well. There are plenty of qualifying golf and cooking schools, for example.
Whether you’re a parent or a grandparent does make a difference. If you’re a grandparent setting up 529s for the grandkids be careful. As you may know, all students applying to American colleges and universities are required to fill out the financial aid form known as FAFSA.
The student’s assets weigh more heavily in the equation, and therefore reduce the amount of student aid that they qualify for. UGMAs and UTMAs are student assets. 529 accounts are not. If parents own the 529, then the account is considered as a parental asset. These have a lighter weighting in the equation.
The grandparent’s 529 isn’t listed on the FAFSA. However, withdrawals from a non-parental account are considered income to the student. Up to half the student’s income is available for college expenses, so it reduces the amount of financial aid required.
However, the FAFSA uses income tax returns from two years prior. As long as the grandparent doesn’t distribute until junior year, the FAFSA won’t recognize the income.
How about retirement contributions to taxable accounts?
After you’ve gone through the above list, you’ve pretty much maxed out the available tax-deferred accounts. The remainder goes into your taxable accounts.
Don’t forget that when you have capital losses, they’re netted out against your capital gains. And as long as you held them for a year or more, you qualify for the more favorable capital gains treatment.
Are you interested in seeing how much you can potentially contribute to tax-deferred accounts? Give us a call at 619.255.9554 or send us an email.