What are Voluntary After-tax Contributions?
After-tax contributions are, as the name suggests, contributions you make to a retirement plan that you are paying taxes on. But wait, you may ask, aren't After-tax contributions called "Roth"?
Not always! A good general rule to remember:
All Roth contributions are after-tax, but not all after-tax contributions are Roth.
In fact, Roth and after-tax contributions are two separate types of contributions.
When you make a Roth contribution, you pay taxes at the time of the contribution. Years down the line, when you're ready to start taking distributions, any Roth funds- both the principal contribution amount and any growth, are distributed from the retirement account tax-free.
When you make an After-tax contribution, you also pay taxes at the time of the contribution. However, years down the line, when you're ready to start taking distributions, only the principal contribution amount is tax free. Any growth/gains on that amount are taxed at the current tax rate.
Note: This is a simplified explanation. For detailed questions regarding when and how to take distributions, you should always work with a qualified CPA/tax professional, to ensure you're following all current IRS rules and guidelines.
In summary, Roth contributions are tax-free and any growth on those funds is tax-free as well (assuming you make a "qualified' distribution). In contrast, after-tax contributions are tax-free but any growth on those funds is taxable. This is why so many clients choose to use the Mega Backdoor Roth Conversion strategy (in essence, converting after-tax contributions to Roth so the growth on those funds is also tax-free).
How do I report After-tax Contributions?
Unlike pre-tax contributions, voluntary after-tax contributions are not reported on your personal tax return (form 1040). Depending on your business structure, you may run your earnings through payroll and give yourself a W-2.
After-tax contributions are also not reported on the W-2. Some employers list the After-tax contribution amount in Box 14 of the W-2 for informational purposes; however, this is optional.
This is another strong case for detailed and immaculate bookkeeping. We always recommend reporting contributions to your Solo 401k by filling out a New contribution form. Sign and date this form, then keep it with your other important documents. Many clients will also upload the form to their Solo 401k dashboard, so that all important documents are easy to access and in a secure place.