Author Topic: Mega Backdoor Roth sanity check  (Read 1819 times)

new mustache city

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Mega Backdoor Roth sanity check
« on: March 15, 2018, 08:16:43 AM »
I am investigating the Mega Backdoor Roth for the first time. I currently max my 403(b) & Roth IRA & HSA, so I'm trying to get any remaining tax advantages.

My 403(b) does accept Roth contributions. However, they do not offer in-service withdrawals. (But do offer loans - I don't think I care, should I?)

Most likely I will be leaving my current job within 5 years at the very latest. As I understand it, any Roth contributions I make will create growth that will be taxed like any other after-tax investment until I leave, then contributions + growth will become a lump contribution to my existing Roth IRA when I leave this job, then all growth will be tax-free like the rest of the money in the Roth IRA.

Do I have that right? Is there any reason I shouldn't contribute as much as possible this way?

Scortius

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Re: Mega Backdoor Roth sanity check
« Reply #1 on: March 15, 2018, 11:57:48 AM »
That doesn't sound quite right. Mega-backdoor is done using after-tax contributions paired with in service withdrawals. By definition any Roth contributions you make should come from after-tax money and should not be "taxed like any other investment until you leave", rather they should be tax free forever once you put the money in. You should be able to roll them tax free into any other Roth IRA you have once you leave your job without having to do any backdoor anything.

Case

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Re: Mega Backdoor Roth sanity check
« Reply #2 on: March 15, 2018, 12:22:18 PM »
That doesn't sound quite right. Mega-backdoor is done using after-tax contributions paired with in service withdrawals. By definition any Roth contributions you make should come from after-tax money and should not be "taxed like any other investment until you leave", rather they should be tax free forever once you put the money in. You should be able to roll them tax free into any other Roth IRA you have once you leave your job without having to do any backdoor anything.

This answer is correct.

Not many companies offer this, so the OP should be careful that he is correctly doing it.  Otherwise, it could turn out non-optimally or even poorly.

JohnGalt

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Re: Mega Backdoor Roth sanity check
« Reply #3 on: March 15, 2018, 12:32:56 PM »
Here's how it works with mine.

1. Each paycheck, "post tax" contributions are made to my 401k account in addition to the "pre tax" contributions
2. As soon as I remember after the paycheck, I rollover the "post tax" portion in the 401k into a roth IRA
3. Any gains made on the money between steps 1 and 2 are taxable gains, this is why I try to do it as fast as possible
4. Any gains made after step 2 are within the roth so they are not taxable

Lady SA

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Re: Mega Backdoor Roth sanity check
« Reply #4 on: March 15, 2018, 12:56:48 PM »
sorry to hijack the thread, but a question just occurred to me--
is there any specific reason to pull out the after tax contributions immediately into another IRA (ie using the in service withdrawals)? Is the only reason to do it so often, to take advantage of better fees/funds at your institution of choice? Or is that a necessary step to the mega backdoor roth?

I ask because my 401k plan allows after tax contributions, but not in service withdrawals (arg!), so I'm wondering if it is still advantageous to contribute after tax but just leave the contributions in the 401k and not pull them out into an IRA. Then when I leave the company, roll the whole thing (both before tax and after tax) into my respective tIRA and Roth IRA at Vanguard.

It isn't as great as doing the in-service distribution, because my 401k doesn't have vanguard funds, but I've still invested in the 401k plan's index fund and it has suitably low ER%.

new mustache city

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Re: Mega Backdoor Roth sanity check
« Reply #5 on: March 15, 2018, 01:12:28 PM »
By definition any Roth contributions you make should come from after-tax money and should not be "taxed like any other investment until you leave", rather they should be tax free forever once you put the money in. You should be able to roll them tax free into any other Roth IRA you have once you leave your job without having to do any backdoor anything.

I think I conflated "Roth contributions" and "after-tax contributions" because this is apparently the difference between them - according to https://www.madfientist.com/after-tax-contributions/

Quote
After-tax contributions are made with money you’ve already paid tax on (like Roth contributions) and the contributions can grow tax-free but all growth will be taxed upon withdrawal.

My provider specifically said they allow "Roth contributions (source 2)" (as opposed to "after-tax contributions" which is actually what I asked about).

This is exactly what I'm trying to acheive:

I ask because my 401k plan allows after tax contributions, but not in service withdrawals (arg!), so I'm wondering if it is still advantageous to contribute after tax but just leave the contributions in the 401k and not pull them out into an IRA. Then when I leave the company, roll the whole thing (both before tax and after tax) into my respective tIRA and Roth IRA at Vanguard.

Without in-service withdrawals this still seems like a good idea because I can increase my investment into accounts where the gains will be tax-free. If I could withdraw the funds each year I could save taxes for that year, but I still get the benefit when I leave the company and roll into trad & roth IRAs right? What am I missing?
« Last Edit: March 15, 2018, 01:28:25 PM by new mustache city »

the_fixer

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Re: Mega Backdoor Roth sanity check
« Reply #6 on: March 15, 2018, 01:15:58 PM »


sorry to hijack the thread, but a question just occurred to me--
is there any specific reason to pull out the after tax contributions immediately into another IRA (ie using the in service withdrawals)? Is the only reason to do it so often, to take advantage of better fees/funds at your institution of choice? Or is that a necessary step to the mega backdoor roth

You want to lock it into tax free growth as soon as possible. Once that money is in the Roth it can grow tax free.

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Scortius

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Re: Mega Backdoor Roth sanity check
« Reply #7 on: March 15, 2018, 03:02:47 PM »
By definition any Roth contributions you make should come from after-tax money and should not be "taxed like any other investment until you leave", rather they should be tax free forever once you put the money in. You should be able to roll them tax free into any other Roth IRA you have once you leave your job without having to do any backdoor anything.

I think I conflated "Roth contributions" and "after-tax contributions" because this is apparently the difference between them - according to https://www.madfientist.com/after-tax-contributions/

Quote
After-tax contributions are made with money you’ve already paid tax on (like Roth contributions) and the contributions can grow tax-free but all growth will be taxed upon withdrawal.

My provider specifically said they allow "Roth contributions (source 2)" (as opposed to "after-tax contributions" which is actually what I asked about).

This is exactly what I'm trying to acheive:

I ask because my 401k plan allows after tax contributions, but not in service withdrawals (arg!), so I'm wondering if it is still advantageous to contribute after tax but just leave the contributions in the 401k and not pull them out into an IRA. Then when I leave the company, roll the whole thing (both before tax and after tax) into my respective tIRA and Roth IRA at Vanguard.

Without in-service withdrawals this still seems like a good idea because I can increase my investment into accounts where the gains will be tax-free. If I could withdraw the funds each year I could save taxes for that year, but I still get the benefit when I leave the company and roll into trad & roth IRAs right? What am I missing?

The short answer is that Roth contributions are made with after-tax money and are tax free after. Vanilla after-tax contributions are also made with after-tax money, but are also taxed when you take them out. The Mega-backdoor allows you to convert from vanilla after-tax contributions to Roth contributions. If you already have the option of contributing straight to a Roth account, there is no need to worry about any kind of backdoor contribution.

For example, my 401k allows three types of contributions: pre-tax, Roth, and after-tax. I can contribute $18,500 combined into the first two, but no more. Since I am making a full salary, I put all $18,500 into my pre-tax 'bucket'. At this point I can no longer contribute any to the Roth. I can however contribute up to $56,000 into all 401k accounts combined (including my employer match). Thus, I can contribute money in excess of the $18,500 into the after-tax bucket and later convert that into a Roth IRA.

new mustache city

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Re: Mega Backdoor Roth sanity check
« Reply #8 on: March 15, 2018, 09:10:02 PM »
If you already have the option of contributing straight to a Roth account, there is no need to worry about any kind of backdoor contribution.

I thought the point of the mega backdoor is that rolling after-tax 403(b) contributions into a Roth IRA doesn't count towards the $5500 limit. Why would I not take advantage of after-tax contributions to the 403(b) because I have a separate Roth IRA?

Scortius

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Re: Mega Backdoor Roth sanity check
« Reply #9 on: March 16, 2018, 11:28:27 AM »
If you already have the option of contributing straight to a Roth account, there is no need to worry about any kind of backdoor contribution.

I thought the point of the mega backdoor is that rolling after-tax 403(b) contributions into a Roth IRA doesn't count towards the $5500 limit. Why would I not take advantage of after-tax contributions to the 403(b) because I have a separate Roth IRA?

Yes, just like the 401k, if those after-tax 403b contributions are not Roth (e.g. they will be taxed when accessed), then it's a way to convert them to Roth investments and they don't count against your other limits. Your earlier quote stated: "My provider specifically said they allow "Roth contributions (source 2)" (as opposed to "after-tax contributions" which is actually what I asked about).", which suggested that those after-tax 403b contributions were already Roth investments, in which case there would be no need to convert them.

new mustache city

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Re: Mega Backdoor Roth sanity check
« Reply #10 on: March 30, 2018, 09:36:29 AM »
Your earlier quote stated: "My provider specifically said they allow "Roth contributions (source 2)" (as opposed to "after-tax contributions" which is actually what I asked about).", which suggested that those after-tax 403b contributions were already Roth investments, in which case there would be no need to convert them.

I'm not sure what my provider meant here (maybe they conflated after-tax & Roth...?), because I don't understand how it would be possible for these to be Roth contributions - it's not a Roth 403(b). My only Roth account is my IRA which I don't think is relevant (other than being the eventual destination for the backdoor contributions). Wouldn't I need a Roth 403(b) for the contributions to be considered Roth contributions or is there some other way?
« Last Edit: March 30, 2018, 09:38:24 AM by new mustache city »