Author Topic: have I been screwing up my mega back door?  (Read 993 times)

TheGibberingPotato

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have I been screwing up my mega back door?
« on: October 16, 2020, 02:52:45 PM »
My 401k allows after tax contributions, and so after I max out my pre-tax contributions, I switch over to after tax mode.  These gradually accumulate throughout the year and so eventually I do a roll over, but typically they have accumulated some earnings at this point (can only do a couple roll-over per year).  I have been rolling over my after-tax amount to my Roth IRA, and then rolling over the earnings to my regular IRA.  For some reason, I have been thinking that rolling over the earning to the regular IRA avoids getting taxed on them.  Is this correct?  Or am I misunderstanding this... perhaps the earnings should go to the Roth IRA too (taxes are triggered with the rollover?), or even I just leave them in my 401k?

Ideally, I'd immediately rollover the after-tax amount, before earnings had accumulated.  But, I don't want to have process a roll-over every pay period, and I can only do I think 2 roll-overs per year.  I suppose one alternative option is to shift my after-tax contributions to the max number (90% per my plan) during one pay period, and then immediately roll over... and then only do this twice a year or so until I reach the amount I actually want to contribute... but it's pretty tricky, because I have to not over contribute to my after-tax, or it can prevent my employer from giving the full match.

terran

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Re: have I been screwing up my mega back door?
« Reply #1 on: October 16, 2020, 03:30:28 PM »
Yes, rolling over the gains from the after-tax 401(k) to the traditional IRA continues to defer the taxes on the gains until you withdraw, but rolling over to Roth and then rolling over to traditional doesn't sound right. I'm surprised the vendor is even letting you do that as a recharacterization of contributions is the only time money should flow from Roth to traditional. Is that what you're saying you're doing, or do you mean these are two separate rollovers?

TheGibberingPotato

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Re: have I been screwing up my mega back door?
« Reply #2 on: October 16, 2020, 05:44:32 PM »
Yes, rolling over the gains from the after-tax 401(k) to the traditional IRA continues to defer the taxes on the gains until you withdraw, but rolling over to Roth and then rolling over to traditional doesn't sound right. I'm surprised the vendor is even letting you do that as a recharacterization of contributions is the only time money should flow from Roth to traditional. Is that what you're saying you're doing, or do you mean these are two separate rollovers?

Two separate roll-overs, and a little different than you have said.

I roll over the after-tax portion into my Roth IRA.  This part I think (hope) I am doing right. 
The earning (growth) on the after-tax portion, I have been rolling over into my personal IRA.  At some point I had thought that this would allow me to prevent it form being taxed (until it is withdrawn, years later).

ixtap

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Re: have I been screwing up my mega back door?
« Reply #3 on: October 16, 2020, 06:07:27 PM »
As long as you expect to be in a lower tax bracket in the future, what you are doing makes sense. We roll it all over to Roth and this year that was quite a bit of gains that we will be paying taxes on.

One reason not to do it your way is that you are cutting off the regular backdoor Roth.

terran

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Re: have I been screwing up my mega back door?
« Reply #4 on: October 16, 2020, 08:05:31 PM »
It sounds like you're doing it right and have correctly understood the implications then. Chances are you should continue to do what you're doing as long as you current marginal tax bracket is the higher than you expect your marginal tax bracket to be in retirement. The same thought process as whether you should make Roth or traditional contributions to your 401(k), in other words.

The exception to this might be if your income is too high to make Roth IRA contributions in which case it might be worth paying the tax on the after-tax gains now so you can make a regular backdoor Roth IRA contribution. It's also possible you can roll the traditional IRA back in to your 401(k) which would also let you make backdoor Roth IRA contributions without paying the tax on converting the traditional IRA to Roth.

madmustache

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Re: have I been screwing up my mega back door?
« Reply #5 on: October 18, 2020, 12:09:25 AM »
Does your plan have Roth in-plan conversion option. If you do that you can avoid taxes on the gains as well and just do rollover twice a year. I would check with your custodian and see if they allow in-plan conversion and do it every pay check automatically.

terran

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Re: have I been screwing up my mega back door?
« Reply #6 on: October 18, 2020, 07:45:51 AM »
Does your plan have Roth in-plan conversion option. If you do that you can avoid taxes on the gains as well and just do rollover twice a year. I would check with your custodian and see if they allow in-plan conversion and do it every pay check automatically.

This is incorrect. We do in-plan conversions from from after-tax to Roth in my wife's plan and if there are any gains in after-tax between contribution and conversion they're taxable as they would be if the OP rolled the gains over to the Roth IRA. We receive a 1099R from the plan administrator indicating the taxable amount. Luckily there's no limit on the number of conversions, so she converts the day after her contributions posts meaning the gains are minimal.

TheGibberingPotato

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Re: have I been screwing up my mega back door?
« Reply #7 on: October 18, 2020, 10:24:40 AM »
Does your plan have Roth in-plan conversion option. If you do that you can avoid taxes on the gains as well and just do rollover twice a year. I would check with your custodian and see if they allow in-plan conversion and do it every pay check automatically.

What do you mean by in plan?
The 401k is in Merrill Lynch, but to get into a Roth or personal IRA I have to roll it into a Merrill Edge account.  So it is out of the 401k.

I can check to see if it can be done automatically, but I front-load my pre-tax contributions early in the year and then switch to after-tax contributions later... and then I have to stop at some point before I hit my maximum.

TheGibberingPotato

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Re: have I been screwing up my mega back door?
« Reply #8 on: October 18, 2020, 10:31:41 AM »
Does your plan have Roth in-plan conversion option. If you do that you can avoid taxes on the gains as well and just do rollover twice a year. I would check with your custodian and see if they allow in-plan conversion and do it every pay check automatically.

This is incorrect. We do in-plan conversions from from after-tax to Roth in my wife's plan and if there are any gains in after-tax between contribution and conversion they're taxable as they would be if the OP rolled the gains over to the Roth IRA. We receive a 1099R from the plan administrator indicating the taxable amount. Luckily there's no limit on the number of conversions, so she converts the day after her contributions posts meaning the gains are minimal.

If you check on the MadFientist post on Mega Backdoor, the first respnse comment on the bottom of the post discusses what I am doign/thinking.  I will copy/paste for convenience, but there is some additional discussion beyond what I am posting, so maybe check the page.  As I recall, I think you can send the after-tax growth to a traditional IRA, and dodge the taxes as a result (not dodge, but pay them at a later time, when you withdraw).

I've actually been doing this for some years now... I think.  I started doing it at Fidelity, who have excellent customer support and I think helped guide me to the idea of doing this.  Now I'm at Merrill due to employer change.  They are less knowledgeable but at least seem to have executed my request.

Anyways, I still may be wrong, and am happy to discuss further.

As I'm sure many here can relate, the biggest challenge I face with all of this tax stuff is remembering.  I figure out a loop-hope, and then every year I have to come back and re-learn, and sometimes it just takes a lot of work to make the knowledge stick!  Our tax system is so complicated, but a PITA.  And if you're not taking advantage of loopholes, then you're losing out to the mega-rich who can afford to have a personal accountant find the loopholes for them.


"Great write-up, MF. One additional and important point is that the new guidance also clarifies that you can split off the earnings from the after-tax 401k account and send them into a traditional IRA (while sending the contributions to a Roth IRA). This is important for people who donít have the ability to take in-serve distributions. In addition, I believe for some frugal aspiring early retirees, the approach of letting earnings build up in the after-tax 401k account and then separately rolling the earnings into a tIRA (instead of taking immediate in-service rollovers into a Roth IRA) may be the optimal strategy, because that still shelters the earnings from taxes during the high-income earning years, but allows earlier access to those earnings (as early as five years after retirement, if you fold them into a Roth conversion pipeline immediately upon retirement)Ėand the loss of Roth tax-avoidance on those earnings during retirement does not matter to the frugal early retiree who isnít subject to taxes in any event. We were having a debate about this recently over in the MMM forums."

terran

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Re: have I been screwing up my mega back door?
« Reply #9 on: October 18, 2020, 10:48:34 AM »
Yes, I believe what you're doing is just fine. An in-plan conversion is when you convert straight from after-tax 401(k) to Roth 401(k) without it ever leaving the plan. Some plans allow it, some plans don't. I was objecting to madmustache's comment that you can avoid taxes on the gains -- any gains in after-tax that are rolled over to Roth (whether Roth 401(k) or Roth IRA) are taxable.

It sounds like you're withdrawing from your after-tax 401(k) into a taxable brokerage account, and then from there making a rollover contribution to both a Roth IRA (equal to the amount you contributed to after-tax 401(k)) and to a traditional IRA (equal to the amount of after-tax withdrawn minus the contribution), is that right? This is a 60-day rollover (as opposed to a trustee-to-trustee rollover) since you're in possession of the money being rolled over while it's in your taxable account. These are limited to one every 12-months, so my only concern would be whether each rollover from taxable to the separate IRAs is a rollover or whether the rollover is the distribution and it's fine that you're then rolling over to separate IRAs? I don't know the answer to this, so that would be worth looking into. The one rollover per year rule started in 2015.

Other than that, what you're doing definitely sounds right.

TheGibberingPotato

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Re: have I been screwing up my mega back door?
« Reply #10 on: October 19, 2020, 09:33:53 AM »
Yes, I believe what you're doing is just fine. An in-plan conversion is when you convert straight from after-tax 401(k) to Roth 401(k) without it ever leaving the plan. Some plans allow it, some plans don't. I was objecting to madmustache's comment that you can avoid taxes on the gains -- any gains in after-tax that are rolled over to Roth (whether Roth 401(k) or Roth IRA) are taxable.

It sounds like you're withdrawing from your after-tax 401(k) into a taxable brokerage account, and then from there making a rollover contribution to both a Roth IRA (equal to the amount you contributed to after-tax 401(k)) and to a traditional IRA (equal to the amount of after-tax withdrawn minus the contribution), is that right? This is a 60-day rollover (as opposed to a trustee-to-trustee rollover) since you're in possession of the money being rolled over while it's in your taxable account. These are limited to one every 12-months, so my only concern would be whether each rollover from taxable to the separate IRAs is a rollover or whether the rollover is the distribution and it's fine that you're then rolling over to separate IRAs? I don't know the answer to this, so that would be worth looking into. The one rollover per year rule started in 2015.

Other than that, what you're doing definitely sounds right.

Hmm, maybe I need to clarify that this is after-tax money inside of my 401k plan, which I am rolling over.  I roll-over the after-tax principle (already taxed) to the Roth IRA, and the after-tax growth (not yet taxed) to the IRA.  No taxes have further been held during this process, I don't think.

This has prompted me to look up the rules on direct and 60 day roll overs (which I may or may not be interpreting correctly).  I don't think this is a 60-day roll over; I am not receiving the funds as a check.  It is going directly into the Roth IRA / IRA (into a money/case account which I then invest).
This is the second I've done in 2020 (or 4th, depending on terminology; e.g. if each rollover to Roth IRA vs IRA is seperate), and Merrill Lynch allowed it, but I don't know if that means anything.  When I check online, I am seeing the rollovers to/from a qualified 401k plan to not count towards the 1 per year limit, so perhaps there is nothing to worry about?

terran

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Re: have I been screwing up my mega back door?
« Reply #11 on: October 19, 2020, 03:18:52 PM »
If it's going directly from your 401(k) to each separate IRA then it's a trustee-to-trustee transfer, not a 60 day rollover, so you're definitely fine. I interpreted "I have to roll it into a Merrill Edge account" as rolling from a 401(k) to a taxable brokerage account and then from there to the IRAs. This would be a 60 day rollover (or possibly 2 60 day rollovers depending on whether the roll out of the 401(k) or the roll in to the IRAs is what counts, which I don't know).

TheGibberingPotato

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Re: have I been screwing up my mega back door?
« Reply #12 on: October 20, 2020, 08:06:58 AM »
If it's going directly from your 401(k) to each separate IRA then it's a trustee-to-trustee transfer, not a 60 day rollover, so you're definitely fine. I interpreted "I have to roll it into a Merrill Edge account" as rolling from a 401(k) to a taxable brokerage account and then from there to the IRAs. This would be a 60 day rollover (or possibly 2 60 day rollovers depending on whether the roll out of the 401(k) or the roll in to the IRAs is what counts, which I don't know).

Ok, Thanks for all of your help and clarifications.

Uff, precision of language and definitions are so important with taxes!