First-time possibility for Mega-Backdoor Roth -- Vanguard 401k

[The 585]

I finally moved to an employer with a 401k plan (administered through Vanguard) that looks like it has the necessary components for executing a mega-backdoor roth! After-tax traditional contributions are allowed up to the $55k limit, and all or a part of this traditional after-tax balance can be converted to Roth 401k or Roth IRA after-tax money anytime. Not knowing much about this, I had a couple questions:

1. In a year where the $55k limit is reached and funds are converted to Roth, am I still allowed to contribute the full $5500 to my Roth IRA in addition to the conversion amount?

2. My 401k AND Roth IRA are both through Vanguard, how often should the after-tax contributions be converted to the Roth IRA-- Once at the end of the year, or with each paycheck? Does this incur any sort of taxable event if there are gains?

If someone could point me to a resource on how this conversion can be done completely within Vanguard, that would be fantastic! I'm very excited for the opportunity to finally take advantage of this. Thanks guys!

[terran]

1) Yes, you can still contribute to an IRA

2) Any gains that you rollover from after tax to roth will be taxable in the year in which you make them. Because of this it would be mathematically optimal to rollover as soon as you can after each contribution. That might be a pain depending on how you make the conversions (you might have to call), so it wouldn't be the end of the world to do it once a year. Another possibility is that the IRS allows you to roll the after tax contributions to a roth IRA and the gains to a traditional IRA, so you can check if that would be an option under your plan.

[wawot1]

I think there's a lot of confusion about an in-plan Roth 401(k) conversion  (ie changing an after-tax contribution in your 401(k) into a Roth 401(k) that's still within your 401(k) plan)  vs moving an after-tax contribution from your 401(k) into a Roth IRA. 

For my company's 401k plan, also administered through Vanguard, it's really easy to do the in-plan Roth 401(k) conversion of after tax contributions.   I'm attaching a couple of screenshots for you.  Once you figure out what to do, it takes under a minute to do the conversion online.   Doing this rather than messing with the Roth IRA makes it much simpler and avoids having to deal with traditional IRAs, etc.   The potential downside to this approach, of course, is that you probably have more limited investment options in your Roth 401(k) than you do in a Roth IRA. 


 My company allows for unlimited conversions each year...so you can do it after each pay period if you want.  Yours might not be the same.  If you are only converting after-tax contributions, then you would only have to pay taxes on earnings from those after-tax dollars from the time that you put the money in the plan until the time you converted it.  So, depending on your timing, that's unlikely to be a lot given the short timeframe.

[The 585]

Thanks for the information, guys.

Wawot, since my Roth IRA is also administered through Vanguard, shouldn't that be a simple conversion as well? My concern about converting the funds to Roth 401k instead is that they wouldn't be accessible if I retire early. Correct me if I'm wrong, but converting to Roth IRA is appealing because then the contributions can be accessed before reaching age 59.5.

[wawot1]

I've never tried to convert from 401(k) to Roth IRA, so I can't comment on the mechanics of how to do that....

Check out this in-depth discussion about the pros vs cons of in plan 401(k) --> Roth 401(k) conversion vs 401(k) to Roth IRA conversion.

https://thefinancebuff.com/mega-backdoor-roth-convert-within-plan-or-roth-ira.html

[ixtap]

A big difference between Roth 401k and Roth IRA is the ability to withdraw your contributions before you reach 59.5. This is less important if you plan on retiring between the ages of 55 and 60.

[The 585]

Great information, thanks again guys. Two follow up questions to clear up my decision--

1) Would I be able to convert each of my after tax contributions to Roth 401k within the plan using wawot1's method immediately after funds are deposited, and then periodically (maybe once a year) if it is an option roll those now Roth 401k funds into my Vanguard Roth IRA? Turns it into a two step process, but might be simpler in the end if the Roth IRA conversion is tedious.

2) Say in one pay period I contribute $1000 after tax, but by the time I convert it to Roth, it grows to $1050. Can I still convert that full amount to Roth, but it would just incur taxes on the $50 gain? Getting a little confused on if the $55k contribution limit applies to the initial contributions, or after-growth Roth conversions. And how are things affected if I contribute $1000 after tax, but it loses value to $900 before converting to Roth?

[seattlecyclone]

A big difference between Roth 401k and Roth IRA is the ability to withdraw your contributions before you reach 59.5. This is less important if you plan on retiring between the ages of 55 and 60.

Once you leave the company you'll be able to roll your Roth 401(k) into your Roth IRA when you want to withdraw the contributions, making this difference moot.

Great information, thanks again guys. Two follow up questions to clear up my decision--

1) Would I be able to convert each of my after tax contributions to Roth 401k within the plan using wawot1's method immediately after funds are deposited, and then periodically (maybe once a year) if it is an option roll those now Roth 401k funds into my Vanguard Roth IRA? Turns it into a two step process, but might be simpler in the end if the Roth IRA conversion is tedious.

Probably not. The general rule is that you can't withdraw from a 401(k) while you still work there. Exceptions exist, but I wouldn't expect this to be one of them. However if the funds in your 401(k) are decent there's no real hurry to move the money to an IRA. You can do it at any time after you leave the company.

2) Say in one pay period I contribute $1000 after tax, but by the time I convert it to Roth, it grows to $1050. Can I still convert that full amount to Roth, but it would just incur taxes on the $50 gain?

Yes, exactly this.

Getting a little confused on if the $55k contribution limit applies to the initial contributions, or after-growth Roth conversions.

The limit is on the initial contributions. Conversions are unlimited.

And how are things affected if I contribute $1000 after tax, but it loses value to $900 before converting to Roth?

You would owe no tax on the conversion. My 401(k) provider will keep track of the fact that you lost $100 on that money and will apply that $100 to gains on a subsequent conversion before reporting taxable income to the IRS. No guarantees that every 401(k) provider does the same thing.