Author Topic: Cautionary tale - botched mega backdoor Roth  (Read 849 times)

JumpInTheFIRE

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Cautionary tale - botched mega backdoor Roth
« on: January 11, 2018, 08:32:11 AM »
I started making after-tax contributions to my 401k last year in preparation to doing a mega backdoor Roth.   Yesterday I attempted to do the rollover from the after-tax to the Roth and I messed up badly.  On the form I filled out, I thought I indicated that I wanted 100% of the after-tax money to be rolled over into the Roth, but what I actually did was rolled 100% of my 401k (after-tax AND pre-tax) into the Roth, about 100k total.  This is obviously going to have huge tax implications for me, it will mean at least additional 25k in taxes, more if it pushes me into a higher bracket.  I'm not sure of all the implications yet but I think I am going to have to send the IRS money (which I don't necessarily have) to cover this tax bill or pay further penalties.  I guess the moral of the story is make sure you know what you are doing when doing a conversion like this, one little mistake on this form is going to cost me tens of thousands of dollars (particularly since I would probably be paying no tax on it in retirement) and will probably push back my FIRE date by several months if not a year.  :(

terran

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #1 on: January 11, 2018, 08:38:08 AM »
Ouch, bummer. If your company allows in service withdrawals it's usually best to do the rollovers consistently as you contribute to avoid having too much in gains in the first place. Of course, that's not an option if you have to wait until you leave that employer, which may have been the case for you.

JumpInTheFIRE

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #2 on: January 11, 2018, 08:50:12 AM »
I just started making the after-tax contributions last October but wanted to wait until after the new year to do the first rollover so that I didn't have to deal with it on my 2017 taxes.  My plan does allow in-service rollovers so I don't have to wait until I leave to do the rollover. I only had around $2k in after-tax, with maybe $100 in gains that would be taxable.  So instead of paying $25 in taxes for this rollover, I am going to be paying $25,000.  Looks like my cunning plan to funnel money into a Roth to avoid putting money into a taxable brokerage account has failed miserably. 

ixtap

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #3 on: January 11, 2018, 08:56:51 AM »
Has the transaction already happened? Could you stop it?

mskyle

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #4 on: January 11, 2018, 08:59:07 AM »
It might not be too late to fix this - make some phone calls and find out if you can reverse this (it's been one day, right?) or at least recharacterize the rollover somehow. There's a lot of money at stake!

JumpInTheFIRE

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #5 on: January 11, 2018, 09:05:42 AM »
I called the provider this morning, even though the check for the rollover hasn't been cut yet they say it is non-reversible and there is nothing I can do.  The form says pretty much the same thing, "Once an in-plan Roth conversion has been processed, it is irrevocable and cannot be changed".  The person I spoke with seemed to be trying to do what she could (put me on hold a few times to "go to talk to someone to see if there is a way to reverse this") but it looks like I am well and truly screwed.  I guess I'm glad that I didn't have more of my stash in my 401k, this could have been an even bigger screw-up.

mskyle

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #6 on: January 11, 2018, 10:10:58 AM »
Who's receiving the money from the conversion? Have you talked to them about recharacterizing it as a traditional IRA conversion? (I have no idea if this is possible, but it's worth a shot.)

I wouldn't give up yet if I were you, even though I LOATHE making customer service phone calls.

Cpa Cat

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #7 on: January 11, 2018, 10:26:11 AM »
If you can't get them to recategorize it and fix it at the custodian level, I'd try to work the 60 day rule here.

I'd consider the following:

Withdraw the excess money from the Roth.
Contribute the excess money to a traditional IRA as your 60 day rollover.

It seems to me like your 1099-Rs are going to be confusing and probably result in notices from the IRS - but I'm guessing you could get it fixed with some communication with the IRS. I'd probably consider paper filing this particular return (a rarity for me!) with a statement of explanation if the 1099-Rs look likely to trigger a problem.

You have 60 days to complete the rollover - so even if you make mistakes along the way, as long as you get it completed properly within 60 days, you're all good.

Even if you couldn't get it done in 60 days, I think you fall within the general safe harbor of an additional 30 days to fix an error as soon as possible.

JumpInTheFIRE

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #8 on: January 11, 2018, 10:33:10 AM »
It's an in-plan conversion, converting pre-tax and after tax 401k money to Roth 401k.  No IRA involved.  I don't think it's possible to recharacterize 401k contributions/rollovers, I think that is an IRA thing.  I will certainly keep working them for a way to back this out but so far it's not looking likely.  I just set my W-4 preferences to take an additional ~1k per paycheck (which is basically what I take home) so looks like I am getting no paychecks this year.  I guess it will be good practice for FIRE except I still have to go to work every day.

JumpInTheFIRE

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #9 on: January 11, 2018, 10:48:33 AM »
If you can't get them to recategorize it and fix it at the custodian level, I'd try to work the 60 day rule here.

I'd consider the following:

Withdraw the excess money from the Roth.
Contribute the excess money to a traditional IRA as your 60 day rollover.

It seems to me like your 1099-Rs are going to be confusing and probably result in notices from the IRS - but I'm guessing you could get it fixed with some communication with the IRS. I'd probably consider paper filing this particular return (a rarity for me!) with a statement of explanation if the 1099-Rs look likely to trigger a problem.

You have 60 days to complete the rollover - so even if you make mistakes along the way, as long as you get it completed properly within 60 days, you're all good.

Even if you couldn't get it done in 60 days, I think you fall within the general safe harbor of an additional 30 days to fix an error as soon as possible.

Can you please elaborate on that, CPACat?  Is it possible to roll over funds from a Roth 401 to a traditional IRA?  Looking at the IRS page on the 60 day rule (https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions) it's not clear to be exactly what kind of account can be rolled into what other kind of account (but the rollover chart on that page seems to indicate I can't), but this sentence gives me the willies: "Taxes will be withheld from a distribution from a retirement plan (see below), so you’ll have to use other funds to roll over the full amount of the distribution."  My 1099-R is going to show a distribution of 100k, which will be taxable, if I roll that into a traditional IRA is that amount then deductible? 

Cpa Cat

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #10 on: January 11, 2018, 12:54:26 PM »
If you can't get them to recategorize it and fix it at the custodian level, I'd try to work the 60 day rule here.

I'd consider the following:

Withdraw the excess money from the Roth.
Contribute the excess money to a traditional IRA as your 60 day rollover.

It seems to me like your 1099-Rs are going to be confusing and probably result in notices from the IRS - but I'm guessing you could get it fixed with some communication with the IRS. I'd probably consider paper filing this particular return (a rarity for me!) with a statement of explanation if the 1099-Rs look likely to trigger a problem.

You have 60 days to complete the rollover - so even if you make mistakes along the way, as long as you get it completed properly within 60 days, you're all good.

Even if you couldn't get it done in 60 days, I think you fall within the general safe harbor of an additional 30 days to fix an error as soon as possible.

Can you please elaborate on that, CPACat?  Is it possible to roll over funds from a Roth 401 to a traditional IRA?  Looking at the IRS page on the 60 day rule (https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions) it's not clear to be exactly what kind of account can be rolled into what other kind of account (but the rollover chart on that page seems to indicate I can't), but this sentence gives me the willies: "Taxes will be withheld from a distribution from a retirement plan (see below), so you’ll have to use other funds to roll over the full amount of the distribution."  My 1099-R is going to show a distribution of 100k, which will be taxable, if I roll that into a traditional IRA is that amount then deductible?

The mistake appears to be that you rolled over your deductible 401(k) funds into a Roth. So in effect, you did two rollovers:

1) After tax rollover to Roth IRA. (what you wanted to do)
2) pre-tax rollover to Roth IRA (mistake - creates tax liability and you didn't mean to do that)

You're fine with #1.

#2 is an incomplete rollover. Your money hasn't gotten to the place you want it to go - a traditional IRA. We can't reverse it and put it back into your 401(k), but you can make this a deductible-401(k) to traditional IRA rollover. So if you take it out and put it into a traditional IRA account, you complete a 401(k) to Traditional IRA rollover within 60 days. The fact that it  spent a few days in the wrong account shouldn't interfere with your ability to complete the rollover into traditional IRA.

In effect, all that's happened to you is that your #2 rollover landed in the wrong account by accident. The right account is a traditional IRA account. Put it into the right account and complete your rollover.

If they withheld taxes from the deductible-to-Roth rollover, then you're right, it complicates issues - because now you have to find the money to put into the traditional IRA account.

Example:

10,000 after tax 401(k)
20,000 pre-tax 401(k)

All gets rolled over into Roth.

They withhold $5000 for taxes - so only $25,000 lands in your Roth.

You take out $15,000 and add $5,000 of your money to replace the withholding and put $20,000 into a traditional IRA. You have now have of withdrawal of $20,000 from your pre-tax 401(k) which you rolled over into a traditional IRA. The withholding comes back to you when you file taxes.
« Last Edit: January 11, 2018, 12:58:10 PM by Cpa Cat »

terran

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #11 on: January 11, 2018, 01:28:59 PM »
The mistake appears to be that you rolled over your deductible 401(k) funds into a Roth. So in effect, you did two rollovers:

1) After tax rollover to Roth IRA. (what you wanted to do)
2) pre-tax rollover to Roth IRA (mistake - creates tax liability and you didn't mean to do that)

I think the OP actually did an in plan conversion from both pretax and after tax 401k to Roth 401k, so no IRAs involved.

Cpa Cat

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #12 on: January 11, 2018, 01:47:32 PM »
The mistake appears to be that you rolled over your deductible 401(k) funds into a Roth. So in effect, you did two rollovers:

1) After tax rollover to Roth IRA. (what you wanted to do)
2) pre-tax rollover to Roth IRA (mistake - creates tax liability and you didn't mean to do that)

I think the OP actually did an in plan conversion from both pretax and after tax 401k to Roth 401k, so no IRAs involved.

You're right. It looks like I misunderstood his first post.

JumpInTheFIRE

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #13 on: January 11, 2018, 01:50:32 PM »
Yeah, this was an in-plan pre-tax 401k/after tax 401k to Roth 401k.  I have been emailing them and calling them all day, I did finally get someone who said she will "put in a request" to reverse the transaction.  She asked me to fax in a signed letter stating what happened and what I would like to happen, so I am keeping my fingers crossed that they will reverse it, but I don't think the odds are great.  The form states very clearly that this is irreversible and mentions talking to a tax adviser before doing the rollover and this is plainly my fault so I'm not feeling bullish on my chances.


2Birds1Stone

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Re: Cautionary tale - botched mega backdoor Roth
« Reply #14 on: January 11, 2018, 02:54:21 PM »
Oh boy, this thread is giving me anxiety. I am keeping my fingers (and toes) crossed for you.

I screwed up similarly last year when I mixed pre/post tax funds in an IRA triggering the pro rata rule. Luckily Fidelity and Vanguard worked with me to resolve to satisfaction, but those several weeks (maybe upward of a month) of waiting for paperwork and forms to clear, sucked.