After-tax contributions, also known as voluntary contributions, are funds put into a retirement or annuity account after state and federal taxes have been paid. Withdrawal of these funds at a later time will not be taxed, making them increasingly popular. Pre-tax contributions mean that when the money is withdrawn, taxes will have to be paid on it. It may make sense to have an after-tax contribution account if tax rates increase in the future.
After-tax contributions may also be called voluntary contributions. They consist of any money you put into a retirement or annuity account after state and federal taxes have been paid. Any money you earn that goes into a retirement account still has social security taxes eliminated, at least in the United States. However, pre-tax contributions mean that when you withdraw that money at a later time, especially if it’s before you retire, you’ll have to pay taxes on it.
People have increasingly accepted after-tax contributions because they mean that withdrawal of these funds at a later time will not be taxed. Some assume that taxes can only go up and hopefully your personal income will go up too. Withdrawing money before taxes can mean paying a much higher tax on it at a later time.
For example, if you decide to withdraw some of your pension money to use for relocation, you may have to withdraw some. The amount you eliminate, depending on how it’s spent, can add significantly to your total income for the year. If you earn an annual salary of $60,000 US Dollars (USD), removing $50,000 USD would put you in a much higher tax bracket for the year you withdraw this money. Some might be recouped at the end of the year if the money was spent on medical bills, education, or buying a home, but this might not cover everything.
What happens when a large sum of money is removed from an account on a pre-tax basis is that you will usually pay a large portion of it in taxes. This may not work for you if you need the money right away and find it significantly reduced, even if you can get it back later. If this money is put into an after-tax contribution account, then you have access to all the money you take out. It has already been judged as income and tax in previous years, so there is no further tax on that money, although you may pay a small tax on the interest earned on the money. Any amount you wish to remove from an after-tax account will be released to you in full, just as it would be removed from a savings account to which you made voluntary after-tax contributions.
If tax rates ever increase, you may pay much more in taxes on investment accounts on a pre-tax basis. It may make sense to have an after-tax contribution account for this reason, since money invested can only be taxed once. On the other hand, it is not clear what would happen if a different tax plan were adopted in the future, for example, a tax on purchases instead of income, as proposed by some senators. In these cases, it would be hard to know if the money you removed would be exempt from purchase tax if it had been removed from an after-tax contribution source.
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