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After-tax contributions may also be called voluntary contributions. They consist of any money you deposit in a retirement account or annuity after you have paid state and federal taxes on it. Any money you make that gets deposited into a retirement account still has social security taxes removed from it, at least in the US. Yet before-tax contributions mean that when you withdraw that money at a later point, particularly if it is before you retire, you will have to pay taxes on it.
People have increasingly embraced after-tax contributions because they mean that withdrawal of these funds at a later point will not be taxed. Some assume that taxes can only go up, and that hopefully their personal income will increase too. Withdrawing before-tax money may mean paying a much higher tax on it at a later point.
For instance, if you decide to withdraw some of your pension money for use in relocating, you might have to take out quite a bit. The amount you remove, depending upon how it is spent may greatly increase your total income for the year. If you make an annual salary of $60,000 US Dollars (USD), removal of $50,000 USD would place you in a much higher tax bracket for the year in which you withdraw this money. Some might be recouped at the end of year if the money was spent on medical bills, education or purchasing a home, but this might not cover all of it.
What does occur when a large sum of money gets removed from a before-taxes account is that you’ll generally pay a large share of it in taxes. This might not benefit you if you need the money right away, and find it significantly reduced, even if you’re able to retrieve some of it later. If this money is placed in an after-tax contributions account, then you have access to all the money you take out. It already has been judged as income and taxed in previous years, so there’s no further tax on that money, though you may pay a little tax on interest made from the money. Any amounts you wish to remove from an after-tax account come to you in full, just as they would if you removed them from a savings account to which you made voluntary after-tax contributions.
If at some point, tax rates do increase, you may find yourself paying much more in taxes on before-tax investment accounts. It may make sense to have an after-tax contributions account for this reason, since the money invested can only be taxed once. On the other hand, it’s unclear what would happen if a different tax plan were adopted in the future, for instance a tax on purchases rather than on income, as is proposed by some senators. In these cases it would be hard to tell if the money you removed would be exempt from tax on purchases if it had been removed from an after-tax contributions source.
I completely understand pre-tax and post-tax as it refers to retirement savings. However, when your health benefits offer pre-tax and post-tax options, when would the pre-tax charges be made, and on what?
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