When it comes to retirement plans, a penny saved is not only a penny earned. Thanks to generous tax deductions and other government subsidies, it is also a penny invested. This holds true even when you invest after-tax money into an IRA. However, you must follow the Internal Revenue Service's rules if you want to reap the benefits of adding after-tax money to an IRA.
Types of IRAs
There are two main types of IRAs: traditional IRAs and after-tax plans, such as Roth IRAs. The main advantage of tax-deferred plans--no surprise here--is you don't have to pay taxes on your contributions immediately. Taxes are deferred until when you start withdrawing from your plan. With after-tax retirement plans, the money you invest has already been taxed, which can be an advantage if you expect your tax rate to be higher when you start withdrawing from your IRA.
Adding after-tax money to an IRA might make financial sense even though you cannot deduct your contributions from your tax return: If you follow the rules, you will not have to pay income tax on the interest or dividends you earn from your retirement fund. Another advantage of investing your after-tax money in an IRA, as opposed to other retirement plans, is you can have an input in to where your money is invested.
Although you can open an after-tax retirement plan at any time, there are certain requirements you must meet, such as when you make a contribution and how much you contribute. For instance, you may only add money to a Roth IRA during the tax year or by the due date of that year's tax return, if you have taxable income and if your adjusted gross income is less than the maximum set by the IRS. As of 2012, the maximum for those married filing jointly is $179,000. Singles and married people filing separately must earn less than $122,000.
The IRS sets limits on the amount of money you can contribute to an after-tax IRA. Your contribution limit will depend on the IRS rules for the current tax year and whether you also contribute to a tax-deferred IRA. As of 2012, the limit if you only contribute to a Roth IRA is $5,000. This limit is increased to $6,000 for taxpayers over 50. If you also contribute to a tax-deferred IRA, your limit is reduced dollar-for-dollar by whatever amount you contributed to the other IRA.
- Ryan McVay/Photodisc/Getty Images