Author Topic: Questions on 401(a) versus VTSAX  (Read 2635 times)

desert_phoenix

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Questions on 401(a) versus VTSAX
« on: July 30, 2017, 01:59:04 PM »
I try to do my due diligence on reading old threads around here, the Mad Fientist, boglehead, etc.....but I am a bit flummoxed and would really appreciate some help!  I hope this is the right forum and that it is alright if one's first post is asking for help rather than offering.  I feel like I have a ton to learn and I hope I can be on the other side helping others eventually!

I am a U.S. government federal employee.  I max out my TSP and recently changed from doing the Roth contributions to the traditional TSP since I think having the tax savings up front now when I am in the 28% tax bracket makes the most sense.

My question pertains to what to do with extra income beyond that.  I have been convinced of the wisdom of savings rate as essential and have made the lifestyle changes to greatly increase my savings rate (well over 50%).  I also have drank the kool-aid of VTSAX due to jlcollins' stock series.

Now I am trying to figure out if it makes more sense to direct the extra cash I have each month into my 401(a) or straight into my non-tax advantaged VTSAX account that I already have with Vanguard.

The 401(a) money would be post-tax, and I read that I can roll over the 401(a) penalty- and tax-free if I do it to an "IRA or eligible pension plan."

A)  Does this mean either a traditional IRA or a Roth IRA? 

Part of the literature says, "All increases in the value of a member's account resulting from appreciations and the Plan's reinvestment of interest dividends and capital gains distributions are exempt from taxation until a partial or full withdrawal is made."

Outside of TSP, I only have a Roth IRA with Vanguard.  I am wondering if I am able to just roll over 401(a) money direct to that Roth IRA?  If so, that seems ideal since I have already paid taxes before investing and then never again. Or does it have to get rolled to a traditional IRA?

My 401(a) options are somewhat limited, but one option is invested in the Vanguard Institutional Index Fund Institutional Shares (which I believe is VINIX).  It tracks the S&P 500 and has the same expense ratio as VTSAX.

Since I can put in up to 10% of my bi-weekly pay, I can easily put less in VTSAX and roll it into this 401(a).

I guess I just want a sanity check.  Does it make sense, and is it legal/okay to:
1)  max this 401(a) option into the Vanguard S&P 500 Institutional Index Fund
2)  once a year (you get one-withdrawal per year minus $5 per pay period so you are maintaining a minimal account balance) roll all that money into the Roth IRA I have with Vanguard and have it be tax- and penalty-free
3)  then put the rest of the cash beyond that into my non-tax advantaged VTSAX account

**years later (but hopefully not too many) live the dream on this Roth money immediately after early retirement if needed since it is tax-free and doesn't have to be delayed on a Roth ladder/conversion?**

Thanks so much for helping me check my work on this and pointing out anything I may be missing here (like if I can't roll 401(a) into the Roth I have personally, it may change things a lot, etc....)

MDM

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Re: Questions on 401(a) versus VTSAX
« Reply #1 on: July 30, 2017, 02:31:01 PM »
Might be worth reading Contribute After-Tax, Rollover to Roth and Notice 2014-54 Allows After-Tax 401k Roth Conversions, and perhaps other discussions about the "mega backdoor Roth" as it appears your 401a may allow that.

See Investment Order for thoughts on where that might fit in your situation.

desert_phoenix

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Re: Questions on 401(a) versus VTSAX
« Reply #2 on: July 30, 2017, 02:59:53 PM »
Might be worth reading Contribute After-Tax, Rollover to Roth and Notice 2014-54 Allows After-Tax 401k Roth Conversions, and perhaps other discussions about the "mega backdoor Roth" as it appears your 401a may allow that.

See Investment Order for thoughts on where that might fit in your situation.
Thanks for the links! The answer is always out there somewhere if you dig, it seems.  I guess it would have made sense to check the IRS site for guidance too before bothering the forum here, haha.

https://www.irs.gov/irb/2009-39_IRB/ar15.html

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"Q-1: What amount is included in gross income as a consequence of a rollover to a Roth IRA from an eligible employer plan ( i.e., a qualified plan described in § 401(a), an annuity plan described in § 403(a), a plan described in §403(b), or a governmental § 457(b) plan)?

A-1: (a) Rollovers to a Roth IRA of distributions that are not made from a designated Roth account. If an eligible rollover distribution from an eligible employer plan is rolled over to a Roth IRA and the distribution is not made from a designated Roth account, then the amount that would be includible in gross income were it not part of a qualified rollover contribution is included in the distributee’s gross income for the year of the distribution. For this purpose, the amount included in gross income is equal to the amount rolled over, reduced by the amount of any after-tax contributions that are included in the amount rolled over, in the same manner as if the distribution had been rolled over to a non-Roth IRA that was the participant’s only non-Roth IRA and that non-Roth IRA had then been immediately converted to a Roth IRA. Thus, the special rules relating to net unrealized appreciation at § 402(e)(4) and certain optional methods for calculating tax available to participants born on or before January 1, 1936 are not applicable."

My emphasis added.  So it seems that if I am adding after tax dollars to this 401(a) and then having the gains taxed when I roll to the Roth, that that makes it a bit pointless......

Am I right in thinking then that the play would be to invest in this 401(a),  roll it all into a traditional IRA at some point (whether annually or when I quit my job since there would be NO taxes on the growth if going to a traditional), and then just include it in future money destined to be "Roth ladder'd" to avoid taxes on the back end?  At least then the growth is tax-free, right?

The alternative is putting the cash in VTSAX, getting taxed on the dividends yearly, and saving capital gains for later on.

The tax free growth on capital gains and dividend reinvestment seems to me that it would still make the 401(a) worthwhile, even with the pain in the butt of rolling the money out later.  Thoughts?  Also, since I only have a Roth IRA in Vanguard, will it be possible to roll 401(a) money into a "new" traditional IRA in the future even though I make too much to start one?  And does money in my TSP count when figuring out any of that pro-rata stuff?

MDM

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Re: Questions on 401(a) versus VTSAX
« Reply #3 on: July 30, 2017, 03:41:31 PM »
So it seems that if I am adding after tax dollars to this 401(a) and then having the gains taxed when I roll to the Roth, that that makes it a bit pointless......
What if, after maxing your TSP, you put $36,000 into the after-tax 401a, then distribute the $36K into a Roth IRA and whatever gains into a tIRA, and repeat this each year?

desert_phoenix

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Re: Questions on 401(a) versus VTSAX
« Reply #4 on: July 31, 2017, 10:34:24 AM »
So it seems that if I am adding after tax dollars to this 401(a) and then having the gains taxed when I roll to the Roth, that that makes it a bit pointless......
What if, after maxing your TSP, you put $36,000 into the after-tax 401a, then distribute the $36K into a Roth IRA and whatever gains into a tIRA, and repeat this each year?
Great idea :)  Fantastic news; I was able to confirm today that I can do the split withdrawal once a  year with putting the contributions into a Roth IRA and profit into a traditional IRA.

This leads to a few other questions, though.  My only retirement accounts right now are a TSP and a standalone Roth IRA with Vanguard.  Obviously, I'd transfer the 401(a) contributions to that Roth IRA.

1.  Vanguard seems to have a $1,000 minimum for opening up a traditional IRA.  I am capped on the amount I can contribute after-tax on this 401(a) at 10% of my base pay, which is only $8216 a year at the moment.  So the interest/gains on that from a year to year basis are going to be low. So what is the answer here?
A)  Do I have to wait (potentially years) until I have gained $1,000 in growth to roll it out? lol. 
B)  Be sad I can't keep all my retirement stuff just in Vanguard and find a place with no minimum to open a traditional IRA?
C)  Some other option I am unaware of. Perhaps open an after-tax traditional IRA (see #2 below).
D)  Is it possible to roll that money into my TSP directly from the 401(a) using TSP-60? https://www.tsp.gov/PDF/formspubs/tsp-60.pdf

2.  A maxed TSP + 5% matching + ~$8216 a year in 401(a) still falls short of the Annual Defined Contribution Limit for a Single filer of $54,000 in 2017.  Is this what you were referring to with your $36,000 reference?  Or am I conflating different things?  If this is what you meant, could I open a Traditional IRA with Vanguard right now with $3,000 in after tax money and leave it alone to roll profit from the 401(a) into each year?

I think a yearly roll-over makes sense for the 401(a) just in case the split withdrawal loophole ever gets closed.

3.  Final two-part question:  If my question is correct in #3 that I can open up a traditional IRA with after-tax money, will converting that to a Roth IRA be tax-free since I did not take a deduction? ie, no tax and not added to my gross income for the year I roll it to the Roth.  Second part:  Does money in a TSP play a role in the pro-rata rule when it come to doing a conversion of this traditional IRA later on?  I only see references to "Traditional, SEP, and/or SIMPLE IRA" when reading about the rule, and I just am not sure how the TSP would count. 

MDM

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Re: Questions on 401(a) versus VTSAX
« Reply #5 on: July 31, 2017, 01:00:01 PM »
1.  Vanguard seems to have a $1,000 minimum for opening up a traditional IRA.  I am capped on the amount I can contribute after-tax on this 401(a) at 10% of my base pay, which is only $8216 a year at the moment.  So the interest/gains on that from a year to year basis are going to be low. So what is the answer here?
Not an expert on Vanguard account details, but it seems that
for ETFs (exchange-traded funds), the minimum initial investment is the price of 1 share.  Might be worth confirming with Vanguard.

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2.  A maxed TSP + 5% matching + ~$8216 a year in 401(a) still falls short of the Annual Defined Contribution Limit for a Single filer of $54,000 in 2017.  Is this what you were referring to with your $36,000 reference?
Yes. 

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If this is what you meant, could I open a Traditional IRA with Vanguard right now with $3,000 in after tax money and leave it alone to roll profit from the 401(a) into each year?
3.  Final two-part question:  If my question is correct in #3 that I can open up a traditional IRA with after-tax money, will converting that to a Roth IRA be tax-free since I did not take a deduction? ie, no tax and not added to my gross income for the year I roll it to the Roth.
Yes to both (other than possibly a minimal amount if there are any gains between the contribution and conversion).  See Backdoor Roth IRA - Bogleheads (which you may have done already, based on the question below).

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Second part:  Does money in a TSP play a role in the pro-rata rule when it come to doing a conversion of this traditional IRA later on?
No.

desert_phoenix

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Re: Questions on 401(a) versus VTSAX
« Reply #6 on: July 31, 2017, 03:09:29 PM »
1.  Vanguard seems to have a $1,000 minimum for opening up a traditional IRA.  I am capped on the amount I can contribute after-tax on this 401(a) at 10% of my base pay, which is only $8216 a year at the moment.  So the interest/gains on that from a year to year basis are going to be low. So what is the answer here?
Not an expert on Vanguard account details, but it seems that
for ETFs (exchange-traded funds), the minimum initial investment is the price of 1 share.  Might be worth confirming with Vanguard.

Quote
2.  A maxed TSP + 5% matching + ~$8216 a year in 401(a) still falls short of the Annual Defined Contribution Limit for a Single filer of $54,000 in 2017.  Is this what you were referring to with your $36,000 reference?
Yes. 

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If this is what you meant, could I open a Traditional IRA with Vanguard right now with $3,000 in after tax money and leave it alone to roll profit from the 401(a) into each year?
3.  Final two-part question:  If my question is correct in #3 that I can open up a traditional IRA with after-tax money, will converting that to a Roth IRA be tax-free since I did not take a deduction? ie, no tax and not added to my gross income for the year I roll it to the Roth.
Yes to both (other than possibly a minimal amount if there are any gains between the contribution and conversion).  See Backdoor Roth IRA - Bogleheads (which you may have done already, based on the question below).

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Second part:  Does money in a TSP play a role in the pro-rata rule when it come to doing a conversion of this traditional IRA later on?
No.

Wait, I think I may be missing something.  Annual Defined Contribution Limit is $54,000.

I put $5500 into a Roth IRA this year (and also rolled over an old Roth from a higher-fee account outside of Vanguard). I do not have a TIRA.

I will have contributed $18,000 to my TSP this year.  I will double check the math, but I believe a full match from the government is $4,000.

This leaves $26,500 if those numbers are correct.  Why wouldn't I just open up an "after-tax" TIRA with Vanguard today with 26.5k and instantly convert it to a Roth IRA once it posts since there would hardly be time for any taxable gains to occur?

What does jumping through hoops for the 401(a) do for me?  I feel like I must be missing something.  There has to be some reason the 401(a) after tax thing exists, but now I can't figure out why.

MDM

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Re: Questions on 401(a) versus VTSAX
« Reply #7 on: July 31, 2017, 07:04:42 PM »
Wait, I think I may be missing something.  Annual Defined Contribution Limit is $54,000.

I put $5500 into a Roth IRA this year (and also rolled over an old Roth from a higher-fee account outside of Vanguard). I do not have a TIRA.

I will have contributed $18,000 to my TSP this year.  I will double check the math, but I believe a full match from the government is $4,000.

This leaves $26,500 if those numbers are correct.  Why wouldn't I just open up an "after-tax" TIRA with Vanguard today with 26.5k and instantly convert it to a Roth IRA once it posts since there would hardly be time for any taxable gains to occur?

What does jumping through hoops for the 401(a) do for me?  I feel like I must be missing something.  There has to be some reason the 401(a) after tax thing exists, but now I can't figure out why.
See Retirement Topics - IRA Contribution Limits and
401(k) Plans - Deferrals and matching when compensation exceeds the annual limit.

Does that help?

desert_phoenix

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Re: Questions on 401(a) versus VTSAX
« Reply #8 on: August 01, 2017, 03:21:25 PM »
Wait, I think I may be missing something.  Annual Defined Contribution Limit is $54,000.

I put $5500 into a Roth IRA this year (and also rolled over an old Roth from a higher-fee account outside of Vanguard). I do not have a TIRA.

I will have contributed $18,000 to my TSP this year.  I will double check the math, but I believe a full match from the government is $4,000.

This leaves $26,500 if those numbers are correct.  Why wouldn't I just open up an "after-tax" TIRA with Vanguard today with 26.5k and instantly convert it to a Roth IRA once it posts since there would hardly be time for any taxable gains to occur?

What does jumping through hoops for the 401(a) do for me?  I feel like I must be missing something.  There has to be some reason the 401(a) after tax thing exists, but now I can't figure out why.
See Retirement Topics - IRA Contribution Limits and
401(k) Plans - Deferrals and matching when compensation exceeds the annual limit.

Does that help?

Yes, I think I get it now.  I am a federal employee and the TSP doesn't allow after tax contributions, so since I'll make over the Roth IRA contribution limit starting in 2018, all I can do then is the $5500 after tax TIRA and roll it into my Roth (backdoor Roth).

For work, it seems I am just out of luck on maxing out the Defined Contribution Limit, but my best bet is to max TSP deductions, get the match from work, max my 401(a) contributions, and then just roll any excess cash I have each paycheck into my VTSAX.  I think that about sums it up.