Much has been written about the benefits of retirement savings vehicles – 401(k)s, 403(b)s, IRAs, Roth IRAs, and other tax-advantaged savings plans.

Such vehicles provide a number of benefits. Most offer tax deferral on contributions and on earnings/growth and, for some, the added bonus of an employer match. The Roth IRA and Roth 401(k) have no upfront tax deduction for contributions but offer tax-free earnings/growth. Additionally, because of these benefits, millions of workers, who otherwise might not be saving for retirement, are responsibly saving on a regular basis.

However, the truth for many folks approaching retirement is that a combination of 401(k)/IRA/Roth IRA accounts plus Social Security benefits may not provide enough to fund a comfortable retirement. Where will the rest come from? While a purchased immediate fixed annuity is one option, there is another option that is more flexible and perhaps more attractive from an income tax perspective – after-tax savings and investment accounts.

While it is true that after-tax accounts do not offer upfront tax deductions/credits or tax-deferred growth (or Roth-related tax-free growth), they do offer a number of advantages. These advantages make after-tax accounts attractive complements to standard retirement plans:

• No contribution limits – Standard retirement plans have a maximum annual contribution cap. 401(k) plans this year, for example, are capped at $17,500 plus $5,500 additional for participants age 50 or older. IRAs and Roth IRAs are capped at $5,500 plus $1,000 additional for age 50 or older. After-tax accounts have no contribution limit.
• No income limits – Most tax-advantaged plans have income limits. Employer plans limit the degree of participation for workers with high incomes through anti-discrimination rules. IRAs and Roth IRAs impose income caps which prohibit contributions for years in which the caps are exceeded, although non-deductible IRA contributions are not subject to an income limit. An after-tax account is available to anyone, regardless of income.
• Easy access to funds – Unlike employer retirement plans, after-tax accounts are not burdened by restrictive loan or hardship withdrawal provisions. And, unlike most tax-advantaged plans, they do not involve 10% early withdrawal penalties. Account holders can get at their money when they need or want it.
• Investment flexibility – Participants in employer retirement plans are limited to the investment choices chosen by their employers. Also, many IRA and Roth IRA investment choices are limited by the account administrator. With a taxable account, investment choices are unlimited.
• Tax flexibility – Regular after-tax accounts have a big advantage over tax-deferred retirement accounts: long-term capital gains and most stock dividends are currently taxed by the IRS at low maximum rates – 0% (for 10% and 15% marginal tax brackets), 15% (for 25%-35% tax brackets), and 20% (for the 39.6% tax bracket). These rates are considerably lower than ordinary income tax rates. Contrast this with tax-deferred accounts that ultimately generate taxes on all distributions at ordinary income tax rates – including original contributions, interest, dividends, and appreciation.
• No minimum distribution requirements – Employer retirement plans and IRAs require account owners to take regular distributions starting at age 70-1/2, even if the money is not needed. The same is true, regardless of age, of inherited IRAs/Roth IRAs. Such distributions may elevate the taxpayer’s marginal tax rate and may also cause more Social Security benefits to be taxed. Distributions from an after-tax account are much more “kind” in terms of impacting the income tax bill, both Federal and State.
• Estate planning flexibility – Assets in after-tax accounts can be transferred to heirs at a stepped-up tax cost basis or may be gifted during lifetime in a way that suits the owner(s). Options for employer retirement plans and IRAs/Roth IRAs are much more limited. Lifetime transfers, for example, are not allowed. And while retirement/IRA/Roth IRA assets smoothly transfer on death by beneficiary designation, such transfers to non-spouse beneficiaries require that these beneficiaries take required annual distributions over their lifetimes with an associated tax consequence – all at ordinary income tax rates.

Does all of this imply that after-tax accounts are good and retirement/IRA/Roth IRA accounts are not? No, not at all. Each has its pros and cons. A well-designed financial plan can map out the correct mix of each, depending on an individual’s goals, access to various plans, income level, time to retirement, and other factors. A trusted financial planner should be consulted to help determine what is right for you.